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Understand the workings, regulations and other concepts related to NBFCs and banking in India. Be abreast with the changing trends in the banking sector and analyse the various economic impacts of the same.

To understand various pros and cons of induction of NBFCs to the banking sector

The project deals with the banking sector at large with working and regulations and further understand NBFCs with respect to: Classification Regulatory Norms Present Conditions Future Discussion and probable developments

Economy Industry Analysis

Banks are the nodal points of the financial sector and the backbone of any economy.

The Indian financial sector reported a compounded annual growth rate of over 19% for the last few years now where Banks accounted for the major chunk of the credit flow.


The importance of Banking Sector for the growth of economy

Affects of RBI Monetary Policies ( CRR, Repo Rate etc) Financial Inclusion Importance and Requirements Exposure Norms


The exposure ceiling is linked to the capital funds of the lending bank. Capital funds is the sum total of the tier 1 and tier 2 capital recognised for the computation of the capital adequacy.
The exposure ceiling is 15% of capital funds in case of a single borrower and 40% in case of a borrower group. Credit exposure comprises of all types of funded and nonfunded credit limits and also the credit facilities Priority Sector Advances


Priority sector constituted of only those sectors that impact large sections of the population, the weaker sections and the sectors which are employment intensive such as agriculture and tiny and small enterprises. Loans to agriculture and allied activities, small scale industries, poultry and core economic activities in rural areas including loans to micro-finance companies come under the priority sector loans 40% of loan advances for local banks and 32% of net credit facility of foreign banks. 32% inclusive of 10% of Adjusted Net Bank Credit towards small enterprises.


total agricultural advances should be 18% of ANBC. This includes indirect lending up to 4.5%. No specific target has been earmarked for the foreign banks in this account. 40% of the total advances to small enterprises sector should go to micro (manufacturing) enterprises having investment in plant and machinery above Rs. 5Lac and up to Rs. 25lac and micro service enterprises with investment in equipment above Rs 2lac and up to Rs 10lac.To sum it up 60% of small sector advances should go to micro enterprises. Export credit is a part of the priority sector only in respect of foreign banks. have to maintain a target towards achieving export credit as specified by RBI from time to time. The level is at 12% of ANBC. If the banks are not able to meet the above requirement then the deficit amount has to be forwarded as a loan to the Rural Infrastructure Development Fund and other similar funds setup by the National Bank of Agriculture and Rural Development(NABARD) at substantially lower rates



ICICI remains the largest private sector lender private sector banks have a low stable NPA level at 2.26% which has been rising marginally owing to the higher interest rates and tight monetary policy Capitalisation levels of public sector banks remained under control owing to the strong capital infusion by the Government of India of over Rs 150 billion The levels remained much above the required levels of 6% and 9% for tier 1 capital and CRAR. private banks maintain a better capitalization levels of around 16% whereas the public sector banks maintained it around 13%. However due to continuous government support via capital infusion enables the public sector banks to maintain a minuimum tier 1 capital of 8%



A steady decline in the non interest incomes of the banks have been witnessed due to lower trading profits on the portfolio maintained by the bank. The declining yields from the government securities has an adverse effect on the incomes of the banks from non interest areas. Private sector banks have showed a positive improvement in the CASA share at 40.92% public sector banks on the other hand faced a decline in the same at a 33.01%. Out of which SBI has managed to show better performance than the peer public sector banks with CASA at 42.09% Savings account have made up 22-23% of total bank deposits and thus such an increase in the interest rate could put a pressure on the net interest margin by 8- 15 basis points. The gross NPAs of all the banks first increase from 2.16% in march 09 to 2.31 in march 10 and marginally decreased in march 11 to 2.26%. Private sector banks have showed a strong improvement in NPAs from 2.83% to 2.34%. For all the banks the solvency ratio maintains a comfortable situation of 10% as on march 11 marginally better than the previous 10.77% . PSU were at a better position due to the equity infusion from the government in many PSU banks. The ratio declined for SBI to 17.65% from 15.47% due to a substantial increase in the NPA levels. Presently out of the 42 banks 4 banks have capital adequacy less than 12% and 7 have their capital adequacy ratios above 15%. The average Tier 1 capital adequacy ratio improved to 9.24% from 9.11%, whereas the same declined for private sector banks marginally from 11.40% to 11.30%.


IDBI Bank is one of the largest public sector bank in India As on 31st March 2012, IDBI had a network of 973 branches and 1542 ATMs. The banks total business during financial year 2011-12 reached Rs. 3,91,651 crore, the balance sheet reached Rs. 2,90,837 crore and it was able to earn a net profit of Rs. 2032 crore which was up by 23.15%. During the financial year 2010-11, the government of India infused fresh equity capital to the extent of Rs.3119.4 crore thus increasing the equity holding to 65.13% Against the stipulated RBI norm of 9% CRAR and 6% for core CRAR the bank maintained its levels way above at 13.64% of CRAR and 8.03% of Tier 1 CRAR. There was an addition of 107 branches during the financial year 2011 thus adding to the already huge network and taking the number to 815. Out of these 238 are at metropolitan centres, 307 at urban centres, 184 in semi urban and 86 in rural.



In the business of trade finance the non fund based business of LC and BG grew by 18% crossing Rs.60,000 crore . Fee income from Trade finance activities rose by 30%. The provision coverage ratio is the ratio of provisions held to gross nonperforming assets of the bank works out to be 74.66% as on march 2011 healthy against the regulatory guidelines of 70%. The government of India holds 65.13% of shares in the bank but after the preferential allotment that could go upto 71%. According to the latest details the bank has maintained a net interest margin of 2% and is expecting to have it constant in the days to come. IDBI has a gross NPA less than 3% and net NPAs less than 2%. The banks growth has been fuelled by a steady CASA and has now become the fastest growing state owned bank today. Presently the bank has its operations of 2/3rd in corporate and 1/3rd in retail. The banks exposure to stressed sectors such as power (15% of all exposure), Iron and steel(9.3%), Telecom (7.2%) and textile (4.3%) have led to high NPAs for the bank lately. The banks restructured book stands at 6% which is higher than the peers where PSU banks have a level of approximately 4.5%.



In FY 2012 net profit was up by 23.15% to Rs. 2,032 crore ( previous year Rs. 1,650 crore) Net Interest Income grew by 6.46% to Rs. 4,545 crore ( previous year Rs. 4,269 crore) Deposits increased by 16.63% to Rs. 2,10,493 crore ( previous year Rs. 1,80,486 crore) Total assets grew by 14.78% to Rs. 2,90,837 crore( previous year Rs. 2,53,377 crore) Advances were up by 15.32% to Rs. 1,81,158 crore( previous year Rs. 1,57,098 crore)



vertical under corporate banking which focuses attention towards the companies having turnover between Rs.100 crore and Rs.500 crore intends to cater to all kinds of financial requirements of such corporate clients.



The various asset products at offering at the MCG branch in Kolkata are as follows:FUND BASED

Term Loans Working Capital Loan( WCDL, CashCredit, Export Credit) Bill Discounting Buyout Receivables Bills Discounting


Letter of Credit Bank Guarantee


What are NBFCs?

Broadly speaking all such entities that offer financial services other than banking can be said to be Non Banking Financial Companies (NBFC). such entities are not banks but yet carry lending activities at par with banks. They may also accept public deposits however these deposits are term deposits for a specific duration and cant be withdrawn on demand of the public. NBFCs have been a topic of intense discussion and speculation since their inception in the Indian system The role of NBFCs as effective financial intermediaries has been well recognised as they have inherent ability to take quicker decisions, assume greater risks, and customise their services and charges more according to the needs of the clients The distinction between banks and NBFC has been gradually getting blurred since both the segments of the financial system engage themselves in many similar types of activities.


Growth of NBFCs

Simplified sanction procedures, flexibility and timeliness ability to meet the credit needs and low cost operational functions resulted in NBFCs getting an edge over the banks in providing finance. build up a clientele base among the depositors mop up public savings command large resources as reflected in the growth of their deposits from public, shareholders, directors and other companies, and borrowings by issue of nonconvertible debentures etc Fitch report in 2010 the compounded annual growth rate of NBFCs was 40% compared to a meagre 22% of banks Credit to retail underserved areas and to unbanked customers of immense importance in the growth of the economy at large.


Definition of NBFC as per RBI

a company defined in the Companies Act of 1956 and also registered under the provisions of Section 45-IA of the Reserve Bank of India Act 1934,which provides banking services without meeting the legal definition of a bank such as holding bank license. basically engaged in the business of loans and advances,acquisition,ofshares/stocks/bonds/debentures/securities issued by government or local authority or other securities of like marketable nature, leasing, hire purchase, insurance business does not include any institution whose principal business is that of agricultural activity or any industrial activity or sale, purchase or construction of immovable property. In terms of the RB1 Act, 1934, registration of NBFCs with the RBI is mandatory, irrespective of whether they hold public deposits or not. The amended Act (1997) provides an entry point norm of Rs. 25 lakh as the minimum net owned fund (NOF), which has been revised upwards to Rs.2 crore for new NBFCs seeking grant of CoR.


Requirements to be classified as NBFC

financial assets of a company are more than 50 per cent of its total assets and income from financial assets is more than 50 per cent of the gross income new credential was added in form of a requirement of an annual certificate to be given by the auditor of the NBFC in support of commencement/continuance of business of NBFI and fulfilling the criteria of principal business. addition that such certificate shall also indicate the asset/income pattern of the NBFC for making it eligible for classification as Asset Finance Company, Investment Company or Loan Company. RBI granted Certificate of Registration (CoR) to new companies on the basis of their intention to engage in the business of NBFI ( to minimize the ambiguity of the COR auditors certificate is required to be filled at every financial year ending) The asset-income criteria have become a tool in the hands of the RBI to deprive the companies of their NBFC status on extraneous grounds.


Classifications of NBFCs
On the basis of nature of business Asset Finance Company Core Investment Company Loan Company Infrastructure Finance Company Infrastructure Debt Fund Micro Finance Institution


Classification of NBFCs
On the basis of deposits NBFC-D NBFC-ND On the basis of asset size NBFC-ND Systematically Important NBFC- ND Non-Systematic


Sources of funds
Debentures Borrowings from banks Commercial Papers Inter Corporate Loans

(in the descending order of share)


Regulations of acceptance of deposits

The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months NBFCs cannot offer interest rates higher than the ceiling rate prescribed by RBI from time to time. The present ceiling is 11 per cent per annum. The deposits with NBFCs are not insured The repayment of deposits by NBFCs is not guaranteed by RBI. NBFCs (except certain AFCs) should have minimum investment grade credit rating.


NBFCs accepting public deposits having mandatory disclosures

Audited balance sheet of each financial year and an audited profit and loss account in respect of that year as passed in the general meeting together with a copy of the report of the Board of Directors and a copy of the report and the notes on accounts furnished by its Auditors

Statutory Annual Return on deposits

Certificate from the Auditors that the company is in a position to repay the deposits as and when the claims arise Quarterly Return on liquid assets

Half-yearly ALM Returns by companies having public deposits of Rs 20 crore and above or with assets of Rs 100 crore and above irrespective of the size of deposits
Monthly return on exposure to capital market by companies having public deposits of Rs 50 crore and above A copy of the Credit Rating obtained once a year along with one of the Half-yearly Returns on prudential norms as above. non-deposit taking NBFCs with assets size of Rs 100 crore and above have been advised to maintain minimum CRAR of 10% and shall also be subject to single/group exposure norms. An unrated NBFC, except certain Asset Finance companies (AFC), cannot accept public deposits. An exception is made in case of unrated AFC companies with CRAR of 15% which can accept public deposit up to 1.5 times of the NOF or Rs 10 crore whichever is lower without having a credit rating.


Fundings and growth by NBFCs

NBFC account for 11.2% of assets of the total financial system according to the economic surveys in 2010-11. 11.2 % asset finance companies held the largest share of assets of nearly 74.5% and also the largest share of deposits amongst the NBFC-D segment by the end of march 2010.

Typical fundings into :

Construction Equipment Commercial Vehicles Gold Loans Microfinance Consumer Durables Loan against shares etc.


Instruments implemented
Loans Hire Purchase Financial Lease Operational Lease



All NBFCs ND with an asset size of Rs. 100 crore and more as per the last audited balance sheet will be considered as a systemically important NBFC-ND-SI. once an NBFC reaches an asset size of Rs. 100 crore or above, it shall come under the regulatory requirement for NBFCs-ND-SI despite not having such assets as on the date of last balance sheet. shall maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) of 10% which was changed to 12% as on March 31, 2010 and 15% as on March 31, 2011. advised to have a policy in respect of exposures to a single entity / group. NBFCs-ND-SI not accessing public funds both directly and indirectly can apply to the Reserve Bank for an appropriate dispensation consistent with the spirit of the exposure limits. may augment their capital funds by issue of Perpetual Debt Instruments (PDI) which shall be eligible for inclusion as Tier I Capital to the extent of 15% of total Tier I capital as on March 31 of the previous accounting year.

ALM System for NBFCs

decided to introduce an ALM System for the Non-Banking Financial Companies (NBFCs), as part of their overall system for effective risk management in their various portfolios would be applicable to all the NBFCs irrespective of whether they are accepting / holding public deposits or not. to begin with NBFCs meeting the criteria of asset base of Rs.100 crore (whether accepting / holding public deposits or not) or holding public deposits of Rs. 20 crore or more (irrespective of their asset size) as per their audited balance sheet as of 31 March 2001 would be required to put in place the ALM System. A system of half yearly reporting was put in place in this regard and the first Asset Liability Management to be submitted to RBI by only those NBFCs which are holding public deposits within a month of close of the relevant half year.


Cover for Public Deposits

In order to ensure protection of depositors interest, NBFCs should ensure that at all times there is full cover available for public deposits accepted by them. While calculating this cover the value of all debentures (secured and unsecured) and outside liabilities other than the aggregate liabilities to depositors may be deducted from the total assets. the assets should be evaluated at their book value or realizable/market value whichever is lower for this purpose. incumbent upon the NBFC concerned to inform the Regional Office of the Reserve Bank in case the asset cover calculated as above falls short of the liability on account of public deposits.


Required NOF

To ensure a measured movement towards strengthening the financials of all deposit taking NBFCs by increasing their NOF to a minimum of Rs.200 lakh in a gradual, non-disruptive and non-discriminatory manner NBFCs having minimum NOF of less than Rs. 200 lakh may freeze their deposits at the level currently held by them. Asset Finance Companies (AFC) having minimum investment grade credit rating and CRAR of 12% may bring down public deposits to a level that is 1.5 times their NOF while all other companies may bring down their public deposits to a level equal to their NOF Companies on attaining the NOF of Rs.200 lakh may submit statutory auditor's certificate certifying its NOF. The NBFCs failing to achieve the prescribed ceiling within the stipulated time period, may apply to the Reserve Bank for appropriate dispensation in this regard which may be considered on case to case basis.

An NBFC-MFI is defined as a non-deposit taking NBFC that fulfils the following conditions

Minimum Net Owned Funds of Rs.5 crore. (For NBFC-MFIs registered in the North Eastern Region of the country, the minimum NOF requirement shall stand at Rs. 2 crore). Not less than 85% of its net assets are in the nature of qualifying assets. An NBFC which does not qualify as an NBFC-MFI shall not extend loans to micro finance sector, which in aggregate exceed 10% of its total assets.



loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding Rs. 60,000 or urban and semi-urban household income not exceeding Rs. 1,20,000 loan amount does not exceed Rs. 35,000 in the first cycle and Rs. 50,000 in subsequent cycles total indebtedness of the borrower does not exceed Rs. 50,000 tenure of the loan not to be less than 24 months for loan amount in excess of Rs. 15,000 with prepayment without penalty loan to be extended without collateral aggregate amount of loans, given for income generation, is not less than 75 per cent of the total loans given by the MFIs loan is repayable on weekly, fortnightly or monthly instalments at the choice of the borrower


Regulatory Framework
(After Andhra Pradesh incident)

As stated above, all new NBFC-MFIs except those in the North Eastern Region of the country should have a minimum Net Owned Funds(NoF) of Rs 5 crore; those located in the North eastern region should have a minimum NoF of Rs. 2 crore for purposes of registration. maintain a capital adequacy ratio consisting of Tier I and Tier II Capital which shall not be less than 15 percent of its aggregate risk weighted assets. The total of Tier II Capital at any point of time, shall not exceed 100 percent of Tier I Capital.


Provisioning Norms

The aggregate loan provision to be maintained by NBFC-MFIs at any point of time shall not be less than the higher of :1% of the outstanding loan portfolio or 50% of the aggregate loan instalments which are overdue for more than 90 days and less than 180 days and 100% of the aggregate loan instalments which are overdue for 180 days or more.

All other provisions of the Non-Banking Financial (NonDeposit accepting or holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 will be applicable to NBFC-MFIs


Pricing Norms

All NBFC-MFIs shall maintain an aggregate margin cap of not more than 12%. The interest cost will be calculated on average fortnightly balances of outstanding borrowings and interest income is to be calculated on average fortnightly balances of outstanding loan portfolio of qualifying assets Interest on individual loans will not exceed 26% per annum and calculated on a reducing balance basis. Processing charges shall not be more than 1 % of gross loan amount



only three components in the pricing of the loan viz., the interest charge, the processing charge and the insurance premium. no penalty charged on delayed payment.
shall not collect any Security Deposit/ Margin from the borrower Non Coercive Methods of recovery



NBFC carrying on the business of acquisition of shares and securities which satisfied the following conditions:at least 90% of its Total Assets are in the form of investment in equity shares, preference shares, debt or loans in group companies CICs is that 90% of its assets must have been invested in group companies. Out of 90%, at least 60% must be in form of equities. That leaves a scope for only 30% for non-equity investments. the remaining 10% investments also cannot be directed towards any activity other than deposits in banks, investments In government securities, etc its investments in the equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies constitutes not less than 60% of its Total Assets

it does not trade in its investments in shares, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment
it does not carry on any other financial activity except investment in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of group companies or guarantees issued on behalf of group companies.

Revised Regulatory Framework

CICs, having an asset size of less than Rs 100 crores will be declared as exempted from all the requirements of NBFCs including registration. for this purpose all CICs belonging to a group will be aggregated. CICs which have assets of Rs 100 crores or above will be considered as systematically important. Registration requirements will continue to apply to such companies. In addition, there are new requirements, including maintenance of 30% capital adequacy ratio and leverage restraints.

The rest of the prudential requirements currently applicable to NBFCs will be exempted in case of systematically important CICs adhering to the above requirements CIC cannot sell its holdings except by way of block deals. asset size of Rs 100 crores or more will be considered as Systemically Important Core Investment Companies (CICs-NDSI). These companies will continue to require Certificate of Registration



India is one of the few countries which are regulating investment companies and financial companies under the same regulatory regime, whereas the nature and business of investment companies may be totally different. de-registration of all non-depository companies with asset size of Rs 50 crores or below. regulate NBFCs with asset size of less than Rs 1000 crores only if they have public funds, including funds from banking channels. Change definition of principle business increase the threshold of 50% of income and assets to 75%. WG brings in a new concept of liquidity ratio which is a part of Basel III recommendations. Basel III, ratio based on 30 days cashflows and helps to maintain better asset liability management. tax deduction for provisions made by NBFCs The WG suggests parity between banks and NBFCs in terms of tax deductibility



non-deposit taking NBFC that has Net Owned Fund of Rs 300 crores or more and which invests only in Public Private Partnerships (PPP) and post commencement operations date (COD) infrastructure projects which have completed at least one year of satisfactory commercial operation and becomes a party to a Tripartite Agreement. IDF- NBFC would raise resources through issue of either Rupee or Dollar denominated bonds of minimum 5 year maturity. The investors would be primarily domestic and off-shore institutional investors, especially insurance and pension funds which would have long term resources. shall have at the minimum, a credit rating grade of 'A' of CRISIL or equivalent rating issued by other accredited rating agencies such as FITCH, CARE and ICRA shall have at the minimum CRAR of 15 percent and Tier II Capital of IDFNBFC shall not exceed Tier I. IDF-NBFCs shall invest only in PPP and post COD infrastructure projects which have completed at least one year of satisfactory commercial operation and are a party to a Tripartite Agreement with the Concessionaire and the Project Authority for ensuring a compulsory buyout with termination payment.



The maximum exposure that an IDF-NBFC can take on individual projects will be at 50 percent of its total Capital Funds (Tier I plus Tier II for the Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007).

An additional exposure up to 10 percent could be taken at the discretion of the Board of the IDF-NBFC.
RBI may, upon receipt of an application from an IDFNBFC and on being satisfied that the financial position of the IDF-NBFC is satisfactory, permit additional exposure up to 15 percent (over 60 percent) subject to such conditions as it may deem fit to impose regarding additional prudential safeguards.


to ensure that the banking system grows in size and sophistication to meet the needs of a modern economy. there is a need to extend the geographic coverage of banks and improve access to banking services. greater financial system depth, stability and soundness contribute to economic growth. vast segments of the population, especially the underprivileged sections of the society, have still no access to formal banking services. larger number of banks would foster greater competition, and thereby reduce costs, and improve the quality of service.



Large industrial houses were not permitted to promote new banks,however, individual companies, directly or indirectly connected with large industrial houses were permitted to own 10 percent of the equity of a bank, but without any controlling interest. NBFC with good track records was considered eligible to convert into a bank, provided it was not promoted by a large industrial house and satisfied the prescribed minimum capital requirements, a triple A (AAA) or its equivalent, credit rating in the previous year, capital adequacy of not less than 12 percent and net Non Performing Assets (NPA) ratio of not more than 5 percent. The initial minimum paid up capital was prescribed at Rs. 200 crore to be raised to Rs.300 crore within three years of commencement of business. Promoters were required to contribute a minimum of 40 percent of the paid up capital of the bank at any point of time, with a lock-in period of five years.



if the promoter's contribution to the initial capital was more than the minimum 40 percent, they were required to dilute their excess stake after one year of the bank's operations. Banks were required to maintain an arms length relationship with business entities in the promoter group and individual company/ies investing upto 10 percent of the equity. could not extend any credit facilities to the promoters and company / ies investing up to 10 percent of the equity. Capital adequacy ratio of the bank had to be 10 percent on a continuous basis from the commencement of operations. Banks were obliged to maintain upto 40 percent of their net bank credit as loans to the priority sector. Banks were obliged to open at least 25 percent of their total number of branches in rural and semi urban centres.


been that banks promoted by individuals, though banking professionals, either failed or merged with other banks or had muted growth. Only those banks that had adequate experience in broad financial sector, financial resources, trustworthy people, strong and competent managerial support could withstand the rigorous demands of promoting and managing a bank. Local Area Bank model has inherent weakness such as unviable and uncompetitive cost structures which are a result of its small size and concentration risk. the size of operations and also the locational disadvantage of these banks act as a constraint to attracting and retaining professional staff as well as competent management.


recommended permitting ownership in Indian banks of up to 15 percent by Indian corporates, and also to increase limits of holdings by any one foreign bank up to 15 percent in private banks. encourage non-banking finance companies to convert into banks. foreign banks may be allowed to enhance their presence in the banking system. allowing more entry to private well-governed deposittaking small finance banks with stipulation of higher capital adequacy norms, a strict prohibition on related party transactions, and lower allowable concentration norms



Minimum capital requirements for new banks and promoters contribution Minimum and maximum caps on promoter shareholding and other shareholders Foreign shareholding in the new banks Eligible Promoters Whether industrial and business houses could be allowed to promote banks Should Non-Banking Financial Companies be allowed conversion into banks or to promote a bank


The guidelines issued in 1993 for licensing of new banks in the private sector had prescribed Rs. 100 crore as minimum capital and the 2001 guidelines raised this to Rs. 200 crore to be increased to Rs.300 crore over three years from commencement of business. Taking into account the lapse of time since the last guidelines issued in January 2001 and inflation since then, there is a case to have the minimum capital requirement at more than Rs. 300 crore.



Having a low minimum capital requirement (but more than Rs.300 crore) Pros attract those who are serious about participating in financial inclusion to set up banks. may result in optimum utilization of capital from the beginning. Cons may result in many non-serious entities with inadequate financial backing seeking banking licenses. Small banks suffer from disadvantages in scale and scope and also face concentration risk making them more vulnerable. could lead banks to run out of capital early, leading to increased risk taking for showing higher profit to attract more capital. Large number of small banks lead to weakening of supervision in the sector by putting pressure on supervisory resources.


Having a high (say Rs.1000 crore) minimum capital requirement for new Banks Pros since licenses are given to only full-fledged bank, adequate minimum capital requirement may be necessary to ensure that the banks operate on a strong capital base. would evince interest from serious parties with sufficient financial backing. banks would be able to play a more meaningful role in financial inclusion, as they are able to invest resources in technology and partnerships for financial inclusion. Cons Promoters may not be seriously committed to financial inclusion as they are likely to be focused on more profitable large ticket size commercial banking.

Initial minimum capital may be prescribed at say Rs.500 crore with a condition to raise the amount to say Rs.1000 crore within a period of say 5 years. Pros enable applicants from a wider spectrum, i.e. those willing to focus on financial inclusion as well as those interested in more sophisticated commercial banking, to seek a banking licence. It would be easier to dilute the promoters' stake to a lower percentage of the total capital of the new bank as the bank grows. Cons Some of the newly licenced banks may not be able to fulfill this condition of scaling up the capital and level of operations


guidelines on entry of new private sector banks sought to reduce the control of functions of banks by the promoters,to avoid problems arising out of possible conflict of interests, such as connected lending the promoters have been allowed to bring in higher stake (minimum of 40 percent of the paid-up capital of the bank) at the time of licensing of banks with a lock-in period of 5 years. intention was to have a stable capital base, and strong professional management, but without any interference or control of management by the promoters. require promoters and other shareholders of the banks to divest/dilute their shareholding to a level of 10 percent or below of the banks share capital within a specified time frame. exceptional circumstances and where the ownership is that of a financial entity, that is well established, well regulated, widely held, publicly listed and enjoying good standing in the financial community, higher shareholding is permitted to a level of more than 10 percent up to 30 percent. Any acquisition or transfer of shares of private sector banks, taking the aggregate shareholding of an individual or group, either directly or indirectly to 5 percent or more of share capital, requires acknowledgement from the Reserve Bank of India



Retaining current option Pros Large shareholding by promoters in the initial stage would ensure that the bank has promoters stake in the development of the bank in the initial stages while the dilution requirement would lead to diversified holding without significant control on the functions of bank. Requiring dilution of shareholding upfront at the time of licensing would ensure that only promoters having no interest in exercising control over the banks would seek bank license. bank would be run professionally in the long run in the absence of any significant influence. Cons Serious promoters may find the dilution requirement to a very low level unattractive and could deter them from setting up a bank. In the absence of any serious promoter, the bank may lack the vision and direction a new bank may require. there would be difficulty in fixing accountability and responsibility for the affairs of the bank.


Retain the general threshold for the shareholders at 5 percent of the capital but raise the threshold for promoters and other significant shareholders to say 20 percent in the long run. Pros could invite serious promoters as well as serve the purpose of diversified shareholding. promoters would be interested in formulating long term vision and goals, provide direction, take keen interest in improving business and profitability in order to protect their reputation. promoters would be interested in infusing capital into the bank in times of distress to protect their reputation. fixing responsibility and accountability becomes easier Cons change would also have to be implemented for other existing banks. promoters and other shareholders may not consider the level of shareholding significant enough for committing resources and energies.


Allow promoters to hold their initial shareholding of 40 percent Pros ensure continuing stake of promoters in the bank with all the attendant benefits of providing direction, commitment and resources. Cons lead to concentrated shareholding in banks, which in the Indian context is found to be detrimental to depositors interests in the long run. promoters would gain control on the functioning of banks, which may lead to diversion of depositors' funds, lending within the group on non-commercial terms, connected lending, etc.

no restriction on ownership up to 5 / 10 percent with permission to hold up to 40 percent of capital in banks with shareholders' equity up to say Rs. 1000 crore, 30 percent of capital in banks with shareholders' equity more than say Rs. 1000 crore and up to say Rs. 2000 crore, and permitted maximum holding (10 percent or 20 percent) in banks with shareholders' equity of more than say Rs. 2000 crore. Pros The promoters support and direction would be available to the bank in the formative years, with the advantage of ensuring long term vision, goals and direction for the bank. Once the bank grows to a substantial size and has the potential of creating an impact in the financial system, this model ensures that the bank is run professionally and that there is no controlling shareholder influencing the functions of the bank. Cons could induce the promoters to expand their business very slowly so as to have control for a longer period and thus underperform from the economys perspective. there may be some resistance to giving up their control and shareholding, leading to possible non transparent shareholding.


NBFCs conversion to Banks

The 2001 guidelines on entry of new banks in the private sector permitted NBFCs with a good track record for conversion into a bank it satisfied the specific criteria relating to minimum net worth, not promoted by a large industrial house, AAA (or its equivalent) credit rating in the previous year capital adequacy of not less than 12 percent net NPA ratio of not more than 5 percent


Permitting conversion of NBFCs into banks Pros NBFCs are already regulated by RBI and have a track record NBFC model particularly those in lending activities has been successful in expanding the reach of financial system and thus by converting to banks, this model could be scaled up to better leverage the benefits and achieve the objective of financial inclusion. sectoral credit issues, such as infrastructure and microfinance, could be better addressed if NBFCs specializing in the specified sectors can better leverage their competence by converting to banks and having access to low-cost funds. Cons NBFCs are not, as yet, subject to regular onsite inspections. a light-touch regulatory framework for non-deposit taking NBFCs ability of the NBFC to run a bank under a heavier regulation cannot be extrapolated from this experience. NBFCs may not fulfill the well established and well regulated criteria and hence the track record of an NBFC cannot be taken as an automatic eligibility criterion for conversion into banks. Conversion of NBFCs into bank would require folding up of large number of branches and withdrawal from many segments of businesses as well as disinv estment from subsidiaries/affiliates not engaged in businesses permitted to banks. Migration of stronger NBFCs will not strengthen the banking space while the NBFCs space will be weakened. The maturity mix of the asset portfolio is also skewed towards long term and the asset mix may not be compatible to the banking liabilities. If NBFCs are converted into banks they may take a long time to align themselves to banking. continued dependence on wholesale deposits and short term borrowings to sustain even their existing business operations would raise financial stability issues.


Permitting standalone (i.e. those not promoted by Industrial / Business Houses) NBFCs to promote banks In addition to the PROS and CONS before, the following are also relevant Pros The expertise of the NBFC in the financial sector could flow into the bank if NBFCs are allowed to promote banks . could retain their niche space and yet contribute to the financial sector through the bank NBFCs already being regulated would have a verifiable track record The operations of the NBFCs may not be liquidity constrained and hence possibilities of diversion of funds may be less. Possibility of improved governance in banks due to ownership by entities experienced in the financial sector.


Due to the maturity differences of the assets and liabilities of the NBFCs and banks, there may be possibilities of the bank funds being utilized to meet the NBFC liabilities and also of indulgence in regulatory arbitrage. NBFC Groups engaged in activities that are not permitted to banks would be a source of concern and contagion. Their experience in the financial sector would not be adequate enough to be a source of strength in promoting banks. NBFCs may not have the financial strength or parentage to support banks capital needs particularly in periods of stress

(NBFCs or its subsidiaries / Associates should not be engaged directly or indirectly in real estate activities for being considered eligible to promote banks. )


Business Model
Status- quo could be maintained where new banks could be licensed under the usual conditions. Pros This would enable the new banks to compete in a level playing field. This could avoid having differential supervision and regulation for the new banks. Uniform norms could be applied to all banks, old and new, for their compliance. Cons This approach would not further the objective of licensing new banks for achieving accelerated financial inclusion.


Considering the thrust on financial inclusion, a business model oriented towards this objective could be preferred. The business model could be required to clearly articulate the strategy and the targets for achieving significant outreach to clientele in Tier 3 to 6 centers (i.e. in populations less than 50000) especially in the underbanked regions of the country either through branches or branchless models. Pros This would induce the new banks to participate in financial inclusion in a big way. This would also encourage banks to adopt latest and innovative methods and leverage information technology. As the micro finance companies have already proved that the financial inclusion business model is viable, banks may not face problems relating to viability of the models. Cons The business model heavily oriented towards financial inclusion may not be able to provide commensurate returns to banks to enable them to compete with other private sector banks in the country. It will create uneven playing field vis--vis the existing banks with its attendant negative consequences for such banks. In case the bank deviates substantially from its proposed business model particularly if its earnings are low threatening its viability, there may not be any regulatory remedy. The thrust on financial inclusion will thus be lost in such cases.


NBFC is not part of the payments system; nor does it have access to the Reserve Bank of India's (RBI) lender-of-last-resort facility, at least not directly. Partly as a consequence of this, the RBI's oversight over NBFCs has also been marked by a lighter touch. the line between banks and NBFCs is blurred thus there can be no case for a lighter touch when it comes to regulating NBFCs. Especially when the steady increase in bank credit to NBFCs in recent years raises the very real possibility of risks being transferred from the more lightly-regulated NBFC sector to the banking sector. thrust of the recommendations is to bridge the bank-NBFC regulatory gap- non-deposit taking NBFCs have no cash reserve ratio (CRR) requirement, nor are they required to maintain a statutory liquidity ratio (SLR). There are no restrictions on branch expansion or on financing activities. deposit-taking NBFCs are subject to some restrictions on branch expansion, exposure to capital market and real estate, they benefit from regulatory forbearance in the form of a lower SLR: 15% against 24% for banks.



Though the capital adequacy ratio for NBFCs is higher at 15% compared to 9% for banks, the period for classifying loans as nonperforming assets (NPAs) in case of NBFCs is higher at 180/360 days against 90 days for banks. differences in the provisioning framework as well regulatory framework for ownership and governance is also very different consequence of the lighter regulatory regime for NBFCs was regulatory arbitrage with NBFCs, including bank-sponsored NBFCs, engaging in activities that were out of bounds for banks. The danger inherent in this was dramatically brought home during the subprime crisis in the West when non-banks no less than banks held the system to ransom and had to be bailed out with taxpayer money. their dependence on bank borrowing poses an ever-present risk. bringing NBFCs under the purview of the Sarfaesi Act so that they are able to recover bad debts faster and extending beneficial tax treatment for regulatory provisions of NBFCs.



The finance ministry has sought strict norms for non-banking finance companies, or NBFCs, that want to convert into banks or promote banks. The move threatens to upset plans of several finance companies that are keen to enter the banking space. The ministry is currently examining the draft guidelines on the new banking licenses submitted by RBI. The RBI's discussion paper on conditions for entry of new banks had invited arguments for and against allowing NBFCs to convert into banks. In the guidelines sent to the government, the RBI has favoured both the options. It has even proposed that if an NBFCs converts itself into a bank, its existing branches in Tier III to Tier VI cities should get a branch status automatically. One of the major initiatives for new banking licenses is financial inclusion. NBFCs which have already set up their base in smaller cities are more competent to take the cause of financial inclusion.