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Banking on
Non-Banking
Finance Companies
www.pwc.in
1
Foreword
For a large and diverse country like India, ensuring financial access to fuel growth and entrepreneurship is a
critical priority. Banking penetration continues to be low, and even as the coverage is sought to be aggressively
increased through programs like the Pradhan Mantri Jan Dhan Yojana, the quality of coverage and ability to
access comprehensive financial services for households as well as small businesses is still far from satisfactory.
In this scenario, the Non-Banking Finance Companies (NBFC) sector has scripted a story that is remarkable.
It speaks to the truly diverse and entrepreneurial spirit of India. From large infrastructure financing to small
microfinance, the sector has innovated over time and found ways to address the debt requirements of every
segment of the economy. To it’s credit, the industry has also responded positively to regulatory efforts to better
understand risks and to address such risks through regulations. Over time, the sector has evolved from being
fragmented and informally governed to being well regulated and in many instances, adopted best practices in
technology, innovation and risk management as well as governance.
There has been greater recognition of the role of NBFCs in financing India’s growth in the recent past, even as
global debates on systemic risks arising from non-banks have travelled to Indian shores and led to somewhat
fundamental shifts in the policy environment governing NBFCs. Much public discussion and regulatory action
later, clarity regarding goals and signposts of public policy have emerged. Scepticism about ‘shadow banks’
has settled to a more healthy understanding of the risks and rewards of a diverse financial system. For the
industry, there are some costs associated with greater regulations, but the opportunity of being a well regulated
participant in the financial system is likely to outweigh the costs in the long run. We believe that some shadow
zones persist in the regulatory landscape, but there is enough clarity for NBFCs to define their way forward.
We congratulate The Associated Chambers of Commerce & Industry of India (ASSOCHAM) for taking this
dialogue forward when the country is looking forward to capitalizing on its potential aggressively. Thanks are
due to Amit, Varun, Dhawal, Bhumika and Aarti in the PricewaterhouseCoopers (PwC) team for compiling
the report. We hope you will find it useful.
2
Message from ASSOCHAM
– Secretary General
ASSOCHAM along with PwC have come out with this knowledge
paper with the objective to contemplate the issues and challenges
being faced by NBFCs (specifically considering the revised regulatory
framework) and suggest measures that can be taken to optimize their
contribution thereto.
D.S. Rawat
Secretary General
ASSOCHAM
3
Message from ASSOCHAM
– Co-Chairman, National Council for NBFCs
Raman Aggarwal
Co-Chairman
ASSOCHAM National Council for NBFCs
4
Analysing the Revised Regulatory
Framework for NBFCs
Background
The roller coaster liquidity ride post Households under the Chairmanship of
the global financial crisis witnessed Dr. Nachiket Mor (hereinafter referred
Indian NBFCs facing a predicament. to as the ‘Mor Committee’) were
Many of them had a favorable business landmarks in aggregating concerns
opportunity to convert the available and issues and throwing up ideas and
liquidity into short-term, profitable recommendations for discussions.
assets as the banking system and
infrastructure-focused NBFCs dealt In this context of high anxiety levels,
with asset quality issues. On the other the final guidelines released in
hand, global regulatory attention on November 2014 by Reserve Bank of
shadow banks brought the spotlight on India (RBI) came as a polite regulatory
their operations, governance, liquidity action. Few hoped for retaining the
management and most of all, linkages status quo on classification of non-
with the banking system. performing assets (NPA). Even to them,
the extended implementation timelines
Although the impact of the global and one-time restructuring exemption
financial crisis on India was limited, it will lessen the pain.
left its marks on the regulatory psyche.
Prior to this, the NBFC regulation had Apart from being a milestone in the
evolved in phases. Some phases were NBFC regulations, these guidelines
marked with great benevolence, such also mark an interesting shift in
as the registration of all entities with the regulatory approach-that of
minimum capital and priority sector activity-based regulation. The NBFC
benefits to portfolio origination for sector has created for itself the
banks. In contrast, some were marked type of differentiation that was not
with adverse business impact, such as possible within the universal banking
restricting the flow of funds from banks construct. The sector is thus, marked
to NBFCs and expression of displeasure by remarkable diversity of players and
with ‘high growth’ and concerns of businesses that act as an effective layer
systemic risks. The Working Group of financial intermediation between
under the Chairmanship of Smt. Usha the informal sector of the economy
Thorat (hereinafter referred to as the and the formal sector of finance.
‘Thorat Committee) and the Committee NBFCs can claim credit for converting
on Comprehensive Financial Services many Indians to first time users of
for Small Businesses and Low Income formal, regulated financial system.
5
In the process, they have played a and asset finance companies (AFCs) The Foreign Direct Investment (FDI)
meaningful role in shaping borrower get broadly aligned on deposit cap definition of an NBFC is still not
behavior, collecting credit related and rating requirements. Further, aligned with the RBI definition, causing
data and deepening the footprints of credit concentration norms for AFCs pain to foreign investors in the sector
finance where data and information are aligned with those applicable specifically in terms of investment
can be accessed by regulators and to systemically important NBFCs activity.
policymakers as well as other market (NBFCs-ND-SI) and of course, the
participants. NPA classification and provisioning This paper presents an analysis of the
guidelines are harmonised. historical and current framework of
NBFC regulation, on the other hand, NBFC regulations and examines some
deriving broadly from the banking Another good move is resisting of the issues in detail. It also discusses
framework, has been tweaked the formalisation of NBFC classes. the current business scenario and
over time to ensure as good a fit as The unique advantage of the NBFC looks at some of the outstanding issues
possible. The other pressure on the business is the ability to adapt to facing the sector. The discussion closes
regulatory approach has been the market demand conditions. Formal with a broad look at the way forward
desire to conform to global standards, categories, in the absence of any for NBFCs.
even when the Indian economy and regulatory benefit attached to them,
the demands of the services led, create barriers. Diluting the NBFC-
diverse, informal economy have Factor asset-income requirement to Evolution of the regulatory
been very different from the global 50% and not placing restrictions on framework for NBFCs
counterparts. This tension, between Captive NBFCs are all welcome. The In 1964, Chapter III B of the Reserve
a highly differentiated sector and the other advantage of the approach is Bank of India Act, 1934 was introduced
natural tendency of regulation to drive the continued ability of regulators to to regulate NBFCs-D. Various expert
to standards goes to the core of the address any temporary issues through committees – the most noteworthy
challenge of NBFC regulation in India. activity-based regulation or guidance. being the Narasimham Committee
In what can be described as an optimal and the Working Group on Financial
outcome, the final guidelines have A few niggling issues remain. The Companies chaired by Dr. A. C. Shah –
addressed many fault lines without debate on whether a Core Investment were formed to evaluate and provide
running into legal wrangles or creating Company (CIC) is or is not an NBFC their inputs on the role of NBFCs
widespread pain to participants. rages on. Interestingly, with no more in the financial sector, their growth
credit concentration norms for non- potential, and the regulatory changes
The segmentation of the market deposit accepting NBFCs that are not that could be introduced to bridge
on deposit acceptance, customer systemically important (NBFCs-ND), the inefficiencies / gaps in the sector.
interface, and liability structure group holding companies may have Many of the recommendations of these
and consumer protection not only an incentive to continue as NBFCs and committees were gradually interwoven
aligns regulation to current realities, not get classified as CIC, given that the into the fabric of the regulations for the
but also sets the direction of future leverage cap is higher for such NBFCs NBFC sector.
growth, likely to be synchronized compared to CICs (although defined
with regulatory perception of risk. For differently under the two regulations).
example, capping leverage of non-
systemically important NBFCs, while
also exempting them from the Capital Figure 1: Number of NBFCs registered with RBI
Risk Adequacy Ratio (CRAR), credit
12968
concentration norms and revised
12809
NPA norms, will gradually lead to 12740
business models that can balance 12630
that opportunity and constraint.
12409 12385
Hopefully, the implementation of
this risk-based framework will also 12225
close the discussion on `regulatory 12029
arbitrage’ since major arbitrage
opportunities are getting addressed
through harmonising minimum capital
benchmark, setting one threshold for
systemic importance and making it
applicable on a group basis. Similarly, 2007 2008 2009 2010 2011 2012 2013 2014
deposit accepting NBFCs (NBFCs-D) Source: RBI reports
6
With NBFCs emerging as an important Figure 3: Composition of NBFC advances
segment closely connected with
Infrastructure 47%
other entities in the financial sector
coupled with the failures of several Commercial Vehicles 12%
NBFCs asset growth and NBFCs-ND-SI were also witnessing a stress in the asset quality over the last 3-5
composition of advances years due to economic slowdown and weak operating environment. The increased
NBFCs have grown rapidly in India and positivity in the business environment can be evidenced by the significant drop
that is reflected from their asset growth in the NPA levels in 2014. However, given the fact that asset classification norms
pattern over the years. NBFCs, over a have been strengthened in the revised regulatory framework, one could expect to
period, have created product niches see higher NPA levels in the upcoming years.
in sectors like infrastructure finance, Figure 5: Non-performing asset growth of NBFCs-ND-SI
automobile finance, gold loans,
4.90%
personal finance and capital markets.
Figure 2: Asset Growth of NBFCs-ND-SI
In INR Billion 12701
3.10%
11177 2.90%
2.80%
9353
2.10%
2.20%
7613 2%
1.90% 1.70%
5888 1.30%
4829 1.20% 1.10%
4087
1%
3179 0.70% 1.09% 0.75%
7
Banks and NBFCs – Inter-connectedness and inter-linkages
Size and Market Share The share of NBFCs has steadily grown (GDP) at current market prices has
from 10.7% of banking assets in 2009 increased steadily from 8.4% in 2006 to
NBFCs have steadily grown in number
to 14.3% of banking assets in 2014, 12.5% in 2013.
and market share, indicating the
thus gaining systemic importance. On
success of their business models and
the assets side, the share of NBFCs’ The exhibit below capture the growth
the opportunities/potential in their
assets as a proportion of trend of NBFCs vis-à-vis banks.
target markets.
Gross Domestic Product
13.30% 14.30%
11.60% 12.70%
10.70% 11.30%
Source: CARE Ratings
Report on NBFC sector
dated December 05, 2014
Profitability
Return on Assets of NBFCs-ND-SI has
shown stability with figures ranging
account of lower operating costs and no
statutory requirements like Statutory “ The growing
around 2% since 2008.
Liquidity Ratio and Cash Reserve Ratio. reliance of NBFCs
The graph below shows the profitability
The Return on Assets for NBFCs is
of NBFCs vis-à-vis banks. on bank funding
typically higher than that for banks on
Figure 7: Trends in Returns on Assets — NBFCs vis-a-vis Banks
could place a
3.00 Source: Speech
delivered by Shri
strain on the
2.50 P Vijaya Bhaskar,
2.00
Executive
Director, Reserve
banks if NBFCs
Per Cent
Bank of India,
1.50
1.00
at the National
Summit on Non- were to deleverage
Banking Finance
0.50 Companies –
Game Changers’ under conditions
0.00 on January 23,
March
2008
March
2009
March
2010
March
2011
March
2012
March
2013
2014 at New Delhi
of stress.
NBFC Sector Banking Sector
NBFCs themselves
Growing bank advances to NBFCs
Banks have been a major funding NBFCs over the last seven years. The could also face
source of NBFCs and the rapid growth increasing inter-linkage between
in bank advances reflects an increasing banks and NBFCs has spurred the RBI
difficulties if banks
dependency of NBFCs on leverage from to introduce additional safeguards to were to become
banks. The graph below depicts the contain systemic risks.
growth in bank advances obtained by reluctant to lend
Figure 8: Growth of bank advances to NBFCs-ND-SI (INR billion) to them in case of a
”
2164
Source: 2013 RBI reports
1943
liquidity crunch.
1467
720
786.93
894.25
– Financial Stability
527
Board (FSB)
2007 2008 2009 2010 2011 2012 2013
8
Journey So Far
The aftermath of the financial system. There was a need to harmonise In light of this, the RBI in March 2011,
crisis highlighted the importance the entire framework so that the constituted the Thorat Committee to
of increasing the scope of NBFC objectives of the RBI could be met in examine the risks in the NBFC sector
regulations to account for the risks that an efficient way, while ensuring that and recommend appropriate measures
arise from regulatory gaps, arbitrage the impact on business and at the same to address these risks with the aim of
opportunities and from the linkages time, the impact on business operations creating a robust financial sector.
and inter-dependence of the NBFC remained minimal or was phased over
sector with the rest of the financial time.
Transition mechanism
All NBFCs Achieve the Principal Business criteria (PBC) within 2 years with prescribed milestones (March 2014 - 65% and March 2015 - 75%)
NBFC-ND If applicable, approach RBI with plan to achieve INR 25 crore in assets within 2 years
NBFC-D Achieve 75% PBC threshold by March 2015 else banned from raising deposits / repayment of deposits
Recovery norms & • Maintenance of high liquid assets; no liquidity gap in 1-30 day bucket
liquidity
requirements • Extension of SARFAESI framework
Tier 1 capital • NBFCs having exposure to sensitive sectors namely, capital market, commodities and real estate to maintain Tier 1
adequacy & Risk capital at 10%
Weights • Captive NBFCs – minimum 12% of Tier I Capital
• Higher risk weights of 150% for capital market exposures and 125 % for commercial real estate exposures
9
The RBI had in September 2013 set up financial deepening in India, including comprehensive monitoring framework
the Mor Committee which was tasked a set of design principles, reviewing to track the progress of the financial
with laying out clear and detailed existing strategies and developing inclusion and deepening efforts
vision for financial inclusion and new ones as well as developing a nationwide.
A diagrammatical representation of Figure 11: Timeline for overhaul of the NBFC regulatory framework
the sequence of events that led to
the overhaul of the NBFC regulatory Draft guidelines for Fresh NBFC Revised NBFC
framework is shown alongside. NBFCs applications kept in framework
abeyance
10
Revised regulatory framework
1
Circular No. DNBR (PD) CC.No.002/3/0/001/2014-15 dated November 10, 2014
11
Threshold and Activity Figure 12: Broad NBFC categories
Based Categorisation
The phenomenal growth in the Total registered NBFCs
NBFC sector along with its increasing 12,029
inter-linkage and inter-dependence
with other financial institutions has
prompted the introduction of stringent
regulations in order to contain the Non-deposit accepting Deposit accepting
risks. This has included regulation 11,788 241
by the RBI even of NBFCs which do
not pose a high systemic risk to the
financial sector. On the other hand,
introducing light touch regulation NBFCs-ND-SI NBFCs-ND
could lead to disrupting factors 190 11,598
remaining unnoticed, resulting in Source: Speech delivered by Shri R. Gandhi, Deputy Governor, RBI on November 23, 2014
unintended consequences for the
financial system. Under the existing Based on the modified threshold of Rs.500 crore, around 11,598 out of the total
regulations, NBFCs were categorised 12,029 registered NBFCs would be considered as non-systemically important
into the following three groups, NBFCs. Therefore, majority of the NBFC sector will be covered by the simplified
primarily for administrative purposes: framework. Around 275 entities which were hitherto NBFCs-ND-SI, will now be
• Depositing accepting NBFCs classified as NBFCs-ND and therefore be subject to less stringent regulations. This
will also help create some bandwidth within the RBI to direct greater regulatory
• Non-deposit accepting NBFCs with
focus onto NBFCs with larger asset size.
assets of less than Rs.100 crore
• Non-deposit accepting NBFCs with
Hitherto, regulations were prescribed for NBFCs depending on whether they
assets of Rs.100 crore and above
were systemically important or otherwise. Depending on their classification,
each NBFC had to comply with the full gamut of regulations such as detailed
Aiming to strike a balance between prudential norms, the Fair Practices Code, Know Your Customer (KYC) norms,
under-regulation and over-regulation return filings, etc., leading to an enhanced compliance burden on NBFCs with
in the sector, the RBI has increased specific business activities. For example, under the earlier regulations, an NBFC
the threshold asset size for an NBFC to engaged exclusively in the business of investing in shares was also required to
be considered systemically important adopt the Fair Practices Code and put KYC policies in place. The revised regulatory
(NBFC-ND-SI) from Rs.100 crore and framework has addressed this aspect by categorising NBFC-NDs based on their
above to Rs.500 crore and above 2. access to public funds and customer interface.
Furthermore, a simplified framework
for light touch regulation has been put
Broadly, under the revised regulatory framework, NBFCs will get categorised and
into place for NBFCs which are not
further sub-categorised in the following manner:
systemically important (NBFCs-ND)
i.e. NBFCs having total assets less than
Rs.500 crore.
Figure 13: Revised Regulatory Framework
2
Proposed to be Rs.1,000 crore in the Thorat Committee report and the draft NBFC guidelines
12
Aggregation of assets of The RBI framework excludes NBFCs
Practical difficulties
multiple NBFCs in a group registered as primary dealers from the
could arise in
provisions of the revised framework
The Thorat Committee had proposed implementing the
since the business activity of a primary
that multiple NBFCs that are part statutory auditor
dealer is entirely different from a
of a single corporate group 3 or are certification requirement.
lending/investment NBFC. However,
floated by common set of promoters A possible alternative
no specific exclusion is provided for
should not, for regulatory and could be to accept a
aggregation of NBFCs registered as
supervisory purposes, be viewed on certificate from any
primary dealers within the group.
a stand-alone basis, but should be independent Chartered
Similarly, in the case of CICs investing
viewed in aggregate. In line with Accountant for certifying
in NBFC subsidiaries, aggregation of
the recommendation, the revised the asset size of all NBFCs
funds within the group could result in
regulatory framework provides for the in a group.
the same funds being aggregated twice.
aggregation of the total assets of all
NBFCs in a group (including NBFCs-D)
to determine the categorisation and
Will assets of CICs and NBFCs For the purpose of aggregating
supervision of an NBFC as an
registered as primary dealers the assets of all NBFCs in a group,
NBFC-ND or NBFC-ND-SI. If the
in the group also need to be Statutory Auditors need to certify the
combined asset size of all NBFCs
aggregated? It would be useful asset size of all the NBFCs in a group.
within the group is Rs.500 crore or
if RBI clarifies this aspect. In a scenario where there are different
more, each NBFC in the group would
auditors for different NBFCs in the
have to comply with the regulations Further, no specific time
same group, the respective auditor of
applicable to an NBFC-ND-SI. period has been provided for
any particular NBFC may not be in a
compliance by NBFCs-ND
position to certify the asset size of other
Under the revised framework, the total (within a group) impacted
NBFCs in the group, thereby creating
assets of NBFCs in a group including by these provisions. Timeline
practical difficulties.
deposit-accepting NBFCs, if any, are to be prescribed for smooth
to be aggregated to determine if such transition and effective
consolidation results in each NBFC of compliance.
the group being categorised as NBFC-
ND or NBFC-ND-SI.
3
“Companies in the group” is defined to mean an arrangement involving two or more entities related to each other through any of the following relationships:
• Subsidiary – parent [defined in terms of Accounting Standard (AS) 21]
• Joint venture (defined in terms of AS 27)
• Associate (defined in terms of AS 23)
• Promoter – promote as provided in the SEBI (Acquisition of Shares and Takeover) Regulations, 1997 for listed companies,
• Related party (defined in terms of AS 18)
• Common brand name, and
• Investment in equity shares of 20% and above
13
Revised Regulations for NBFCs-ND
Access to public funds and customer interface
As a principle, under the revised regulatory framework, NBFCs-ND need to Considering that access to
comply with limited prudential norms only if they have access to public funds. public funds would now be
Further, they need to comply with conduct of business regulations only if they relevant to determine the
have a customer interface. Limited prudential norms would essentially include applicability of prudential
all extant prudential norms other than capital adequacy norms and credit norms, it becomes imperative
concentration norms. that the meaning of the
term ‘indirect access’ be
Customer No Customer appropriately clarified through
NBFCs-ND
Interface Interface illustration to provide clarity.
Compliance with limited Compliance only with limited
Public Funds
4 prudential norms and conduct prudential norms For the purpose of leverage ratio,
of business regulations 5
the term ‘Outside Liabilities’ is not
No Public Funds
Compliance only with conduct Not subject to prudential norms defined in the RBI circular in which it
of business regulations or conduct of business regulations
has been introduced. There is no such
definition even under the current NBFC
(Non-Deposit Accepting) Companies
The regulations covered under ‘Conduct of business Directions, 1997. The Core Investment
regulations’ have not been separately defined and Companies (Reserve Bank) Directions,
the notification should clarify this aspect. 2011 (CIC regulations) do define
Outside Liabilities to mean “total
liabilities as appearing on the liabilities
Under the earlier NBFC prudential norms, the term “public funds” was defined side of the balance sheet, excluding
to include funds raised either directly or indirectly through public deposits, ‘paid up capital’ and ‘reserves and
commercial papers, debentures, inter-corporate deposits and bank finance. As a surplus’, instruments compulsorily
measure of further liberalisation, the definition of public funds has been amended convertible into equity shares within
to exclude funds raised by issue of instruments compulsorily convertible into a period not exceeding 10 years from
equity shares within a period not exceeding 5 years from the date of issue”. the date of issue but including all
forms of debt and obligations having
The revised regulations define public funds to include funds raised either directly the characteristics of debt, whether
or indirectly ……”. created by issue of hybrid instruments
or otherwise, and value of guarantees
The meaning of the term “indirectly” still remains unclear and could be subject to
issued, whether appearing on the
varied interpretations. For example, if the Parent Co. (which is not an NBFC/CIC)
balance sheet or not”.
accesses public funds and infuses them into its NBFC Subsidiary Co. as debt (or
any other instrument qualifying as public funds), this should qualify as indirect
access to public funds. However, it needs to be clarified, for example, whether the Simplified reporting
following two scenarios would or would not be construed to be indirect access to It is provided that NBFCs-ND, including
public funds: investment companies, will be required
• A Parent Co. (not an NBFC/CIC) accesses public funds but infuses them as to submit only a simplified annual
equity into the NBFC subsidiary return, the details of which are yet
• Parent Co. (not an NBFC/CIC) infuses its own funds in its subsidiary NBFC by to be notified. This is a welcome
way of debt or debt instrument move as it will substantially reduce
the compliance burden on these
NBFCs, and at the same time keep the
Leverage Ratio
regulator aware of the activities of such
The revised regulatory framework has introduced a new concept of the Leverage companies.
Ratio as part of the limited prudential norms, which will be applicable to all
NBFCs-ND that are subject to limited prudential norms. Such NBFCs-ND need to
ensure a leverage ratio of 7 (i.e. total outside liabilities do not exceed 7 times their
The term ‘outside liabilities’
owned funds). This additional requirement would link the asset growth of such
needs to be defined for the
NBFCs to the capital they hold.
purpose of calculating the
4
“Public Funds” includes funds raised directly or indirectly through public deposits, commercial papers, leverage ratio. The definition
debentures, inter-corporate deposits and bank finance, provided under the CIC
but excludes funds raised by issue of instruments compulsorily convertible into equity shares within a regulations could be considered
period not exceeding 5 years from the date of issue
in order to harmonise both the
5
The term “Conduct of business regulations” is stated to include Fair Practices Code, KYC, etc. but has regulations.
not been defined
14
Revised Regulations for NBFCs-ND-SI
Credit Concentration
norms
Credit concentration norms for NBFCs-
ND-SI remain unchanged, except in the
case of AFCs where the same are now
brought in line with other NBFCs.
6
“owned fund” means paid up equity capital, preference shares which are compulsorily convertible into equity, free reserves, balance in share premium account, and capital reserves
representing surplus arising out of sale proceeds of asset, excluding reserves created by revaluation of asset, as reduced by accumulated loss balance, book value of intangible assets
and deferred revenue expenditure, if any.
7
“Tier I capital” is defined to mean owned funds as reduced by investment in shares of other NBFCs and in shares, debentures, outstanding loans and advances including hire
purchase and lease finance made to and deposits with subsidiaries and companies in the same group exceeding, in aggregate ten percent of the owned fund.
15
Strengthening the Figure 14
Corporate Governance Governance Fit and proper
and Disclosure Norms criteria for
Directors
In line with the recommendations of Constitution of Audit Committee, Appropriate policy in accordance with
Nomination Committee and Risk prescribed guidelines
the Thorat Committee set up to study Management Committee
Under the revised guidelines the RBI Information viz., area, country of
operation and joint venture partners with
regard to Joint Ventures and Overseas
has tightened the corporate governance Registration/ licence/ authorisation
obtained from other financial sector Subsidiaries
regulators
and disclosure norms for NBFC-D and
NBFC-ND-SI. Certain requirements, Ratings assigned by credit rating Asset liability profile, extent of financing
agencies and migration of ratings during of parent company products, NPAs and
such as the rotation of audit partners, the year movement of NPAs, details of all
off-balance sheet exposures
the constitution of Nomination and
Risk Management Committee which Penalties, if any, levied by any regulators Structured products issued,
securitisation/ assignment transactions
under the erstwhile regulations were etc.
16
Revised Regulations for NBFCs-D
Regulations for NBFCs-D will be similar other deposit-accepting NBFCs. Even with sub-investment ratings can only
to those applicable to NBFCs-ND-SI, unrated AFCs were allowed to accept renew existing deposits on maturity
as protection of depositors is a key public deposits. Furthermore, deposit and cannot accept fresh deposits until
concern of the RBI. The extant norms accepting AFCs also enjoyed higher they obtain an investment grade rating.
as applicable to the NBFCs-D will limits for deposit acceptance and
continue to apply. credit concentration. However, the
regulations for AFCs have now been The limit for acceptance of deposits
brought in line with those for other by deposit accepting AFCs has been
Mandatory rating deposit-accepting NBFCs. Existing reduced from 4 times to 1.5 times the
and limits on deposit- unrated AFCs would now have to net owned funds.
acceptance obtain an investment grade rating by
Hitherto, the regulatory regime March 31, 2016 to be allowed to accept
for deposit-accepting AFCs was deposits. In the intervening period to
comparatively less stringent than for March 31, 2016, unrated AFCs or those
Yes
• Prudential norms applicable NBFC-D
• No leverage ratio
• Conduct of business regulations No
• Additional governance
• Additional disclosure Yes NBFC-ND
assets => 500 crore
No
17
18
Change in management
or control of NBFCs
The Thorat Committee recommended of depositors. Thus to enable the RBI to ensure continuous maintenance of the ‘fit
that the requirement to obtain prior and proper’ character of the management of NBFCs, both prior to and post change
approval from the RBI for a change in in control, the RBI released the Change in Control Directions.
management or control be extended to
NBFC-ND which was considered and Figure 16: Revised framework
incorporated into the draft guidelines
issued by the RBI. All of this culminated
in the issuance of the Non-Banking Takeover or acquisition of control of an NBFC, whether
by acquisition of shares or otherwise
Financial Companies (Approval of
Acquisition or Transfer of Control) Merger/amalgamation of an NBFC with another
Prior written
Directions, 2014 8 [herein after referred entity or vice versa that would give the permission
to as ‘Change in Control Directions’] of the RBI
– a step towards ensuring that all Merger/amalgamation of an NBFC with another +
entity or vice versa which would result in
NBFCs are managed by ‘fit and proper’ acquisition/ transfer of shareholding in excess of 30 days
10% of paid up capital of the NBFC
management. The Change in Control prior public
Directions were issued by RBI in May Before approaching Court/Tribunal seeking an
notice
order for mergers/amalgamations with other
2014 prior to issuance of the revised companies or NBFCs
8
DNBS (PD). C. No.376/03.10.001/2013-14 dated May 26, 2014
19
Applicability where the ultimate control remains unchanged
It is unclear whether the Change in Control Directions will apply to cases where there is no
change in control at an overall group level or there is a change but control remains amongst the
existing shareholders of the NBFC. Prior approval in this scenario would impact timelines on
transactions such as:
• Internal group restructurings where the ultimate control stays within the group; or
• Transfer of shareholding inter-se by existing shareholders of the NBFC (already having
control prior to the change)
In cases where control stays within the same group, the RBI would have already undertaken a
detailed due diligence and the group would ideally be in compliance with the ‘fit and proper’
criteria; and there is no effective change in control or management of the NBFC.
20
Conclusion
Prior approval for all mergers and amalgamations involving NBFCs
The extension of the corporate
Regulation (ii)(d) of the Change in Control Directions states that that an RBI approval will
be required before approaching the Court or Tribunal for mergers/amalgamations involving governance compliance procedures
NBFCs. This is in addition to the two identifiable points (Regulation (ii)(b) and (ii)(c) with to NBFC-ND is certainly a step in the
respect to mergers/ amalgamations – first where there is an acquisition of control through right direction as this will help ensure
merger / amalgamation and second where there is a transfer of shareholding in excess of 10%
that the management of NBFCs is of
in an NBFC under merger / amalgamation.
“fit and proper” character and help
It is unclear whether the intent is to cover all Court-approved mergers/ amalgamations
build investor/ customer confidence.
involving an NBFC or only the two specific types of transactions. All mergers/ amalgamations
being required to comply with the requirement of obtaining prior RBI approval, could result However, the RBI will still need to
in a delay in timelines and other practical challenges for transactions that do not involve any provide clarity on a number of aspects
acquisition or transfer of control or management. for the effective implementation and
compliance with the regulations.
The RBI could consider issuing a clarification on this matter so that Furthermore, adequate guidance
there is no ambiguity surrounding the need for compliance by NBFCs is still awaited on the details of the
in cases where the mergers/amalgamationsdo not fall in Regulation application process, application format,
(ii)(a), (b) and (c) of the Change in Control Directions. supporting documentation required,
etc. that have been specifically
prescribed with respect to fresh NBFC
applications, to ensure simplicity
and transparency in the process,
resulting in awareness both amongst
the applicants and the RBI officials
reviewing the application, thereby
ensuring the efficient disposal of
applications.
21
22
Areas requiring
consideration
There are certain other areas in which Securitisation and NBFCs play an important role in the
recommendations have been made in Reconstruction of banking system by complementing
the Committee reports or have been Financial Assets and banks, broadening access to financial
represented by the NBFC industry Enforcement of Security services, and diversifying the sector.
NBFCs should thus also be brought
players which require deliberation and Interest Act, 2002 under the ambit of the SARFAESI Act
consideration for the benefit of the (SARFAESI Act) coverage to enhance investor confidence and
NBFC sector as a whole.
Currently, NBFCs have been kept ensure robust growth of the financial
outside the purview of the SARFAESI service sector.
Act. The NBFC sector has been
Figure 17
requesting the extension of the
Differential risk weights
benefits of the SARFAESI Act, which
for capital adequacy ratio
Regulatory is long overdue. Though banks and
public financial institutions enjoy the The risk weights to be applied by
SARFAESI Act’s benefits, the NBFCs banks for capital adequacy purposes
are still outside the purview of this also take into account the credit rating
Foreign
Investment framework. Both the Thorat Committee of the borrower. This provision is
and the Mor Committee recognised not available for NBFCs even though
Tax this and recommended that NBFCs banks and NBFCs operate in the
be given access to benefits under the same macroeconomic environment.
SARFAESI Act. Even in respect of secured lending
/ investments where the quality of
security is similar to that of banks,
Regulatory Several trade associations, along no differentiation in risk weights is
• Extension of SARFAESI
coverage
with industry players, have made allowed for NBFCs. To add to their
• Differential risk weights for representations seeking extension difficulties, the draft NBFC guidelines
capital adequacy ratio of the provisions of the SARFAESI proposed higher risk weights for
• Access to refinancing
schemes
Act to registered NBFCs. A reform in exposure to capital markets and the
• Simplification and clarity in this area is critical as the SARFAESI commercial real estate sector.
CIC regulations Act empowers banks and financial
institutions to recover their NPAs
Foreign Investment without court intervention. Given that The NBFC industry has long been
• Challenges in undertaking
the RBI’s intent is to harmonise the requesting revision in the allocation of
investment by way of
treasury functions by foreign regulatory framework for banks and risk weights and introduction of norms
owned NBFCs
NBFCs, coverage of NBFCs under the similar to those prescribed for banks.
SARFAESI Act would go a long way While differential risk weights have not
Tax
towards creating a level playing field been introduced, the revised regulatory
• Extension of tax benefits
available to banks to NBFCs for NBFCs. framework has enhanced the Tier I
23
capital requirement to 10% for the Challenges in undertaking deployment of surplus funds should be
purpose of computing the CRAR that investment by way of construed as a financing and treasury
would result in an increase in the cost treasury functions by management activity permissible under
of operations for the NBFCs. foreign owned NBFCs automatic route. Alternatively, similar
to the heading ‘stock broking’ which
As per the extant FDI policy, foreign
is relevant for stock broking business,
Access to refinancing investment is permitted under
the term ‘Non-banking Financing’ be
schemes automatic route in the prescribed
replaced instead of ‘leasing and finance’
18 non-banking financial service
Currently, NBFCs are not eligible for as that would permit foreign owned
activities. Undertaking any other
access to refinancing schemes from NBFCs to undertake all activities as
financial activity would require prior
the National Bank for Agriculture permitted under the RBI directions
government approval (through the
and Rural Development (NABARD), and at the same time be subject to the
Foreign Investment Promotion Board).
National Housing Bank (NHB), other norms under the FDI policy such
Small Industries Development Bank as sectoral caps, capitalisation, pricing
of India (SIDBI) etc. This is because As per the RBI norms, lending and guidelines, etc.
the refinancing schemes of these investing are the primary activities
bodies are available to only certain permitted to be undertaken by
types of institution. For example, a Core Investment
a registered NBFC. As part of
Housing Finance Company would be Companies – Simplification
liquidity measures and asset liability
eligible for refinancing by the NHB; and clarity in definition
management, NBFCs do need to
however an NBFC providing housing needed
undertake treasury investments. Under
loans to retail consumers does not the extant FDI norms, the only broad The CIC regulations were issued by RBI
have access to such schemes. This head under which the NBFC activities as a welcome move, with the intention
violates the neutrality principle as can get covered under automatic route to simplify the NBFC framework
far as NBFCs are concerned. The Mor is ‘Leasing and finance’. However, the and regulations that apply to group
Committee recommended that the term ‘finance’ has not been defined. holding companies. However, since its
criteria for making use of refinancing Based on its general meaning, while inception, the industry is struggling
from NABARD, NHB, SIDBI and credit ‘lending’ activity would get covered, to get a complete clarity on this
guarantee facilities should be based on ‘investment’ activity (both strategic as framework and thereby the framework
nature / area of activity rather than the well as treasury) would not get covered has not completely taken off well.
institution type. specifically.
Another concern which arises is with
This aspect may not be directly Since both foreign owned and domestic respect to the definition of a CIC. The
under the purview of the RBI as it owned NBFCs are licensed under the current conditions for an entity to
would require amendments to other same Act, as far as RBI regulation are qualify as a CIC are such that it may be
statutory Acts under which the concerned, they are assumed to have difficult for that entity to undertake any
financing institutions were constituted. the same ability to do business. In other business activity from the said
However, given the increasing funding view of the ambiguity surrounding entity. As a fact pattern; there could
constraints of NBFCs, it is important the phrase ‘leasing and finance’, it has be several group holding companies
that the RBI and the Government been a challenge to map the activities which not only hold shares of group
actively consider this matter. permissible under the RBI NBFC companies but also undertake other
regulations to the broad heading of business activities in the same entity.
‘Leasing and Finance’. Interestingly, In order to continue to carry on their
while there is no bar on Indian business operations in a smooth
companies with FDI (non-NBFCs) manner, the CIC framework should
from investing in such instruments, be simplified such that these entities
the NBFCs with FDI struggle with this not only come forward to register
issue due to the lack of harmonisation themselves with the RBI but are also in
in definitions provided under the a position to satisfy the CIC definition
FDI policy with the framework under along with carrying on their business
RBI NBFC regulations. It is therefore operations in a simple and efficient
essential that it is at least clarified that manner.
24
Extension of tax benefits prescribed limits. Alternatively,
to NBFCs similar to that such banks have been given an
currently available to option to claim a deduction in
banks respect of any provision made for
assets classified as doubtful assets
The RBI has been striving to align
or loss assets up to an extent.
the regulatory framework for NBFCs
NBFCs are similar to banks in
with that applicable for banks.
almost respect of financing and are
The Thorat Committee had made
subject to same directions of RBI
recommendations to plug the so
as regards income recognition and
called regulatory arbitrage between
provisioning norms. Accordingly,
banks and NBFCs. Based on these
as per its directions, NBFCs need
recommendations, under the
to necessarily make provisions
revised regulatory framework, the
for NPAs. It is appropriate, in all
asset classification norms and the
fairness, that the provision for
provisioning requirements have already
NPAs made by NBFCs registered
been modified for NBFCs to bring
with RBI also be allowed as a tax
them on par with banks. The Thorat
deduction.
Committee had also recommended
that there should be tax-parity between • As per section 194A of the I.T.
banks and NBFCs. Act, TDS @10% is required to be
deducted on the interest portion
of the instalment paid to NBFCs
Amongst others, the following key whereas banking companies and
provisions under the Income-tax public financial institution are
Act, 1961 (I.T. Act) provide tax relief exempted from the purview of this
to banks and some other financial tax withholding requirement. This
institutions but NBFCs are currently creates severe cash flow constraints
not covered by these provisions. since NBFCs operate on a thin
• Section 43D of the I.T. Act spread/ margin on interest which
recognises the principle of taxing at times is even lesser than the TDS
income on NPA on receipt basis. on the gross interest.
In accordance with the directions • As per section 72A of the I.T.
issued by the RBI, similar to the Act, at the time of amalgamation
other financial institutions, NBFCs of banking companies, the
also follow prudential norms and accumulated losses are allowed to
are required to defer income in be carried forward and claimed by
respect of their non-performing the amalgamated entity. However,
accounts. In the absence of specific similar benefit is not specifically
coverage of this section for NBFCs, available to NBFCs resulting in
the current tax framework requires lapse of accumulated losses upon
NBFCs to recognise income on amalgamation.
such NPAs on an accrual basis,
resulting in levy of tax on income
which may not be realised at all. Distinction in the applicability of
This severely impacts the liquidity various tax provisions puts NBFCs in
of NBFCs in terms of cash flow pay- a disadvantageous position vis-à-vis
other financial institutions including
outs, impacts their profitability and
banks. It is therefore only fair that the
also has a consequent impact on tax benefits available to banks should
their cost of operations. also be made available to NBFCs.
• As per section 36(1)(viia) of the Extension of tax benefits will provide
I.T. Act, provisions for bad and much needed relief to the NBFC sector
doubtful debts made by banks are which is already severely constrained
due to tight profit margins and high
tax deductible subject to certain
cost funding.
25
Looking
Ahead
The recognition of NBFCs as integral As differentiated licensing of different Even after differential licensing
to the financial services ecosystem types of banks creates greater vitality becomes a more accepted reality,
is reflected in the recent policy in the small finance segment that will NBFCs will continue to present
measures. In addition, activity based benefit consumers through increased an attractive business model to
regulation is likely to rationalize the penetration and wider suite of asset focussed organizations, or
cost of compliance and create better products and services, the opportunity organizations that can tap into
fit between the regulations and the for NBFCs will continue to grow. viable funding sources, domestic or
regulated entities. Considering the funding constraints, foreign. Therefore, in the context
conversion to universal or small banks of a growing economy, a stable
will provide viable option for NBFCs regulatory environment will provide
Restrictions on debentures funding, looking to scale up their operations and opportunities to NBFCs to continue to
securitisation and loss of Priority expand their reach in terms of market grow in the financial ecosystem and
Sector status to on-lending through access and customer base. However, create meaningful financial inclusion
NBFCs will continue to constrain the this looks difficult for most of the larger and employment opportunities in the
funding ability of the NBFCs. While players as the migration of a large book remote corners of the country.
the tepid growth environment of the without regulatory forbearance seems
last few years and regulatory push has extremely difficult.
forced banks’ attention towards direct
and indirect lending to priority sector
borrowers, this is very likely to reverse
once the need for project finance and
large scale funding for growth kicks in.
Banks have a different cost structure
and are geared to service a certain
nature of clientele. NBFCs, by virtue of
their business focus are well positioned
to build profitable businesses in the
priority sector borrower segment.
26
Glossary
27
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