Non Banking Financial Companies (NBFCs)

According to the Reserve Bank of India Amendment Act 1997 the Non Banking Finance
company was defined as under:-
A financial institution which is a company,
A non banking institution which is a company and whose principal business is to
receiving of deposits under any scheme/arrangement/in any other manner or
lending in any manner and
Other non banking institutions/class of institutions as the RBI may specify.
The directions apply to a NBFC which is defined to include only non-banking institution,
which is any hire-purchase finance, loan or mutual benefit financial company and an
equipment leasing company but excludes an insurance company/stock exchange/stock
broking company /merchant banking company. The RBI (Amendment) Act, 1997 defines
NBFCS as an Institution or company whose principal business is to accept deposits
under any scheme or arrangement or in any other manner, and to lend in any manner. As a
result of this new definition, a number of loan and investment Companies registered
under the Companies Act by Business houses for the purpose of making investments in
4
group of companies are now included as NBFCs . The Financial intermediaries in Indian
Financial System are broadly characterized by Public owned, Monopoly or Oligopoly or
Monopolistic market structure and are centralized. The Indian financial system has
another part which comprises a large number of private owned, decentralized, and
relatively small sized financial intermediaries and which makes a more or less
competitive market. Some of them are fund based, and are called (NBFCs) and some are
provide financial services (NBFSCs) Both NBFIs, NBFCs are (1) Loan companies (LCs)
(2) Investment companies or ICs (3) Hire-Purchase finance companies or HPFCs (4)
Lease finance companies or LFCs (5) Housing finance companies (or) HFCs (6) Mutual
Benefit financial companies or MBFCs (7) Residuary non-banking companies or RNBCs
(8) Merchant Banks (9) Venture capital funds (10) Factors (11) Credit Rating Agencies
(12) Depositories and custodial services.
Classification of NBFCs

Classification of NBFCs as given in the Reserve Bank Amendment Act 1997, 1)

Equipment leasing company (ELC): Carrying on as its Principal Business, the activity of
leasing of equipment. 2) Hire Purchase finance company (HPFC): Carrying hire purchase
transactions (or) financing of such transactions. 3) Housing finance company (HFC). 4)
Investment Company (IC): Carrying the business of acquisition of securities. 5) Loan
Company (LC): Financing by making loans and advances. (Does not include ELC,
HPFC, HFC).6) Mutual Benefit companies (MBFC). 7) Residual non-banking company
(RNBC): Company which receives any deposit under any scheme or arrangement, in one
lump sum or in installments by way of contributions or subscriptions or by sale of units
or certificates or other instruments or in any other form according to definition of NBFC.
8) Miscellaneous non-banking companies (MNBC): Managing, conducting or
supervising as a promoter foreman or agent of any transaction or arrangement. Ex:
conducting any other form of Chit and Kuri which is different from type of business
mentioned above.
After the above classification the Non Banking Financial companies were re-classified
twice, during 1998 it was classified as four types they were 1) Equipment leasing, 2) Hire
Purchase, 3) Investment Company and 4) Loan Companies. During 2006 the NBFCs
were reclassified as three types they are 1) Asset Finance companies (in this both
Equipment Leasing and Hire Purchase companies were merged), 2) Investment
Companies and 3) Loan Companies Apart from those classifications, in order to operate
these NBFCs smoothly certain regulations/directions were issued they are a) Regulations
for deposits for NBFCs accepting deposits, b) Regulations for NBFCs not accepting
deposits and c) Regulations for core investment companies to smooth functioning of their
businesses as well as to give confidence to the participants as well as operators.

In India, the non-banking financial sector comprises a multiplicity of institutions, which

are defined under Section 45I (a) of the Reserve Bank of India Act, 1934. These are
equipment-leasing companies (EL), hire purchase companies (HP), investment
companies, loan companies (LCs), mutual benefit financial companies (MBFC),
miscellaneous non-banking companies (MNBC), housing finance companies (HFC),
insurance companies (IC), stock broking companies (SBC), and merchant banking
companies (MBC). A non-banking company which conducts primarily financial business
and belongs to none of these categories is called a residuary non-banking company
(RNBC).
Development of Regulatory Frame Work for NBFCs

The regulatory frame work for NBFCs had been in existence since 1963 under the
provisions of Chapter III B of the Reserve Bank of India Act and the Directions issued.
The regulation of the deposit acceptance activities of the Non-Banking Finance
Companies (NBFCs) was initiated in the sixties with a view to safeguard depositors
interests and to ensure that the NBFCs function on healthy lines. Accordingly, in 1963, a
new Chapter III B was inserted in the Reserve Bank of India Act, 1934 to effectively
supervise, control and regulate the deposit acceptance activities of these institutions. The
Bhabatosh Datta Study Group (1971) set up to examine the role and operations of
NBFCs. Recommended that NBFCs should be classified into approved and non-
approved categories and the regulation should be centered primarily on the approved
(i.e. those which satisfy certain additional requirements such as adequate amount of
capital, reserves, liquid assets, etc.) NBFCs. Subsequently, the regulatory frame work
suggested by the James Raj Study Group (1974) aimed at keeping the magnitude of
deposits accepted by NBFCs within reasonable limits and ensuring that they were in
conformity with the objectives of monetary and credit policy.

The provisions of Chapter III B of the RBI Act, 1934, however, conferred very limited
powers on the Reserve Bank. The legislative intent was aimed at moderating the deposit
mobilization of NBFCs and thereby to providing indirect protection to depositors by
linking the quantum of deposit acceptance to Net Owned Fund. Thus, the directions were
restricted to the liability-side of the balance sheet, and too, solely to deposit acceptance
activities. It did not extend to the asset-side of the balance sheets of NBFCs.
Subsequently, several experts/working groups which examined the functioning of NBFCs
were unanimous about the inadequacy of the legislative frame work and reiterated the
need for enhancing the extant frame work. The Chakravarthy Committee, in its Report
submitted in 1985, recommended for the introduction of a system of licensing for NBFCs
in order to protect the interests of depositors. Thereafter, the Narasimham Committee
(1991) outlined a frame work for streamlining the functioning of NBFCs. The
Narasimham committee was of the view that, keeping in mind the growing importance of
NBFCs in the financial intermediation process and their resource to borrowing,
regulatory frame work to govern these institutions should be specified. Such frame work
should include, in addition to the existing requirements of gearing and liquidity ratios,
norms relating to capital adequacy, debt-equity ratio, credit concentration ratio, adherence
to sound accounting practices, uniform disclosure requirements and asset valuation.
Further, the committee argued that the supervision of these institutions should come
within the purview of the proposed agency to be set up for this purpose under the aegis of
the Reserve Bank of India. The introduction of suitable legislation was deemed as
essential not only for ensuring sound and healthy functioning of NBFCs, but also for
safeguarding the interests of depositors.

Recommendations of the Shah Committee

In the light of these developments, the Reserve Bank appointed a working group on
financial companies in 1992 under the chairman ship of Dr. A.C.Shah to make an in-
depth study of the role of NBFCs and to suggest regulatory and control measures to
ensure healthy growth of these companies. The working group, in its report submitted in
September 1992, made wide-ranging recommendations for ensuring the functioning of
NBFCs on sound lines. The Reserve Bank thereafter initiated a series of measures,
including (i) the widening of the definition of regulated deposits to include inter-
corporate deposits, deposits from shareholders and directors and the borrowings by issue
of debentures secured by immovable property, (ii) the introduction of a scheme of
registration of NBFCs having net owned fund of .50 lakh and above, (iii) the issuance of
guidelines on prudential norms so as to regulate the asset side of the balance sheet of
NBFCs. These measures relating to the registration and prudential norms could not be
given statutory backing at that time since the provisions of the Reserve Bank of India Act,
1934, did not confer it with adequate powers to make them mandatory.

In January 1997, an ordinance was issued by the Government effecting comprehensive

changes in the provisions of the RBI Act, 1934. This was subsequently replaced by the
Reserve Bank of India (Amendment) Act in March 1997. The salient features of the
amended provisions, based on the recommendations of the Shah Committee, pertain to
the entry point norm of . 25 lakh as minimum NOF, compulsory registration with the
RBI, maintenance of certain percentage of liquid assets in the form of unencumbered
approved securities, creation of reserve fund and transfer thereto every year an amount
not less than 20 per cent of net profit, determination of policy and issuing of directions by
the Bank on prudential norms, prohibition of NBFCs from accepting deposits and filing
of winding-up petitions for violation of directions. The company law board was
empowered to direct a defaulting NBFC to repay any deposits. Stringent penal provisions
were also included empowering the Reserve Bank to impose, interalia, and pecuniary
penalty for violation of the provisions of RBI Act.

Exercising the powers derived under the amended Act and in the light of the experience
in monitoring of the activities of NBFCs, a new set of regulatory measures was
announced by the Reserve Bank in January 1998. As a result, the entire gamut of
regulation and supervision over the activities of NBFCs was redefined, both in terms of
the trust as well as the forces. Consequently, NBFCs were classified into three categories
for purposes of regulation, viz, (i) those accepting public deposits, (ii) those which do not
accept public deposits but are engaged in the financial business, and (iii) core investment
companies which hold at least 90 per cent of their assets as investments in the securities
of their group/holding/subsidiary companies. While NBFCs accepting public deposits
will be subject to the entire gamut of regulations, those not accepting public deposits
would be regulated in a limited manner. Therefore, the regulatory attention was focused
primarily on NBFCs accepting public deposits. In respect of new NBFCs (which are
incorporated on or after April 20, 1999 and which seek registration with the Reserve
Bank), the minimum NOF has been raised to .2 crore.

Consequent on the amendment to RBI Act, the liquidity requirement for the NBFCs was
enhanced. Accordingly, loan and investment companies, which were earlier maintaining
liquid assets at 5.0 per cent were directed to maintain 7.5 per cent and 10.0 per cent of
their deposits in Government and other approved securities, effective January 1 and April
1 , 1998, respectively. For other NBFCs, the percentage of assets to be maintained by
them as statutory reserves was increased to 12.5 per cent and 15.0 per cent of their
deposits respectively, to be effective from the above mentioned dates. Besides, with a
view to ensuring that NBFCs can have recourse to such liquid assets in times of
emergency, the custody of these assets with designated commercial banks was also
prescribed. Keeping in mind the risk profile of NBFCs, the capital adequacy ratio was
also raised in a phased manner to 10.0 per cent and 12.0 per cent by end-March 1998 and
1999, respectively.

Regulations over NBFCs accepting Public Deposits

The regulatory attention has been utilized to enable intensified surveillance of NBFCs
accepting public deposits. The Reserve Bank issued directions relating to acceptance of
public deposits prescribing, (a) the quantum of public deposits (b) the period of deposits
which should not be less than 12 months and should not exceed 60 months, (c) the rate of
interest payable on such deposits subject to a ceiling of 16 per cent, (d) the brokerage fees
and other expenses amounting to a maximum of 2 per cent and 0.5 per cent of the
deposits, respectively, and, (e) the contents of the application forms as well as the
advertisement for soliciting deposits.

The companies which accept public deposits are required to comply with all the
prudential norms on income recognition, asset classification, accounting standards,
provisioning for bad debts, capital adequacy, credit/investment concentration norms, etc.
The capital adequacy ratio has been fixed at 12 per cent and above, in accordance with
the eligibility criteria for accepting public deposits. The credit and investment
concentration norms have been fixed at 15 per cent and 25 per cent of the owned funds,
depending on whether the exposure is to a single borrower to a borrower group, while the
totality of loans and investment has been subject to a ceiling of 25 per cent and 40 per
cent of the owned fund, respectively, depending on whether the exposure is to a single
party or to an industry group.

Regulations over NBFCs not accepting public deposits

The NBFCs not accepting public deposits would be regulated in a limited manner. Such
companies have been exempted from the regulations on interest rates, period as well as
the ceiling on quantum of borrowings. The ceiling on the aforesaid factors for NBFCs
accepting public deposits is expected to act as a benchmark for NBFCs not accepting
public deposits. However, prudential norms having a bearing on the disclosure of true and
fair picture of their financial health have been made applicable to ensure transparency in
the financial statements to these companies, excepting those relating to capital adequacy
and credit concentration norms.

Chit Fund Companies

Operations of chit funds companies are governed under the Chit Fund Act, 1982, which is
administered by State Governments. However, their deposit taking activities are regulated
by the Reserve Bank and they are allowed to accept a miniscule amount of deposits, i.e. ,
up to 25 per cent of their NOF from the public and up to 15 per cent from their share
holders. The concerns regarding the protection of depositors interests are further
minimized to a great extent as the chit fund companies usually accept deposits from their
chit subscribers. MNBCs were prohibited with effect from August 18, 2009 from
accepting deposits from public except from the shareholders, which was subjected to the
conditions specified in the MNBC (RBI) Directions 1977. Any deposit accepted and held
by the MNBCs other than from its shareholders as on date shall be repaid on maturity and
shall not be eligible for renewal.

Differences between NBFCs and Banks

The difference between banks and NBFCs is mainly in the nature of the liabilities of the
two and, to some extent, in the structure of their assets. While the liabilities of
commercial banks usually consist of demand and time deposits, those of NBFCs do not
ordinarily include demand deposits, the mutual benefit financial companies, commonly
known as Nidhis, being notable exceptions. Since demand deposits which are withdrawal
by cheque are considered to be a component of money, it is the degree of money ness of
the liabilities of the two types of institutions which constitutes a major difference between
the two. From the point of view of assets held, it may be said that commercial banks hold
a wide variety ranging from short-term and medium-term to long term credits and they
also use various credit instruments like overdrafts, cash credits, bills, etc. On the other
hand, the assets of NBFCs are more specialized. For instance, hire purchase finance
companies confine their operations mainly to the financing of transport operations and
consumer credit while housing finance companies make loans for housing purpose. It
may, however, be stated that the difference in the nature of assets held by commercial
banks on the one hand and those held by NBFCs on the other does not clearly demarcate
the respective fields of the two because commercial banks are also, of late, making
advances in fields like transport and consumer credit, which were earlier considered as
out of their purview.

Many activities and functions of NBFCs are similar to those of banks. The distinction
between them has become considerably blurred. It is true that NBFCs, unlike banks, are
still not a part of payments mechanism. They cannot create money but in many other
respects, they are substitution and complementary with banks.

NBFCs are doing functions akin to that of banks; however there are a few differences:

(i) An NBFC cannot accept demand deposits;

(ii) An NBFC is not a part of the payment and settlement system and as such an
NBFC cannot issue cheque drawn on itself; and
(iii)Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation
is not available for NBFC depositors unlike in case of banks.

The Resources of NBFCs

The resources of NBFCS are derived from deposits (regulated and exempted), and
ne net owned funds.

Deposits means, any money received by a non-banking company by way of a

deposit or loan or in any other form.(apart from usual deposits, i.e. interoperate
loans, borrowing by Pvt.limited NBFCS from their shareholders.

Regulated deposit means, a deposit which is subject to certain ceiling and other
restrictions imposed by regulatory measures. It includes (a) nonconvertible
debentures (b) deposits received by companies from their shareholders(c) deposits
guaranteed by directors (d) fixed deposits etc. received from the public.
(e)interoperate deposits.

Exempted deposits signify those types of deposits/borrowings which are outside

the scope of the regulatory measures. It includes (a) borrowings from banks and
 specified financial institutions.(b)money received from central/state/foreign
governments.(c)security deposits. (d) Advances received against orders (e)
convertible debentures.

And net-owned funds means the aggregate of paid up capital and free reserves.

Role of NBFCs

NBFCs like banks and other financial institutions act as intermediaries between the
ultimate savers and the ultimate borrowers. The rationale of their existence derives from
the fact that in an economy there are surplus units which save and deficit units which are
in need of such savings and a mechanism is needed to bring the two together. Surplus
units (savers) can lend to the deficit units (borrowers) directly. This, however, is normally
inconvenient to both the savers and borrowers and is certainly not the most efficient
means of flow of funds between the units. With the mediation of financial institutions,
there is a reduction in the degree of risks involved and there is also a more efficient
utilization of the resources in the economy. Financial intermediaries can provide a more
economical service because of the economies of scale, their professional expertise and
their ability to spread the risk over a large number of units. Thus, their operations give to
the saver the combined benefits of higher return, lower risk and liquidity. The borrowers
on the other hand also get a wider choice on account of intermediation of financial
institutions. It may be of relevance to note that while the loans granted by commercial
banks are, by and large, for industrial, commercial and agricultural purposes, those
granted by NBFCs are generally for transport, trading, acquisition of durable consumer
goods, purchase and repair of houses or just for plain consumption. Since their activities
are not controlled by monetary authorities to the same extent as those of commercial
banks, the credit extended by NBFCs may not necessarily be in consonance with national
objectives and priorities. The major function of financial intermediaries is to transfer the
savings of surplus units to deficit units; hence, they can play a useful role in the economy
of the country. To the extent that they help in monetizing the economy and transferring
unproductive financial assets into productive assets, they contribute to the countrys
economic development. In fact, the nature and diversity of financial institutions
themselves have become measures of economic development of a country. The Reserve
Bank of India expert committees identified the need of non banking financial companies
in the following areas:

Development of sectors like transport and infrastructure

Substantial employment generation
Help and increase wealth creation
Broad base economic development
Irreplaceable supplement to bank credit in rural segments
Major thrust on semi-urban, rural Areas and first time buyers/users
To finance economically weaker sections.
Huge contribution to the state exchequer.

Regulation of NBFCs

While NBFCs have been rendering many useful services, several advances, unhealthy
features of their working also have been observed. At present all NBFCs except HFCs are
regulated by the RBI. With enactment of RBI (Amendment) act 1997, all of them with
net owned funds of .25Lakhs and above have to register with the RBI now. The BFS
with the help of department of supervision of the RBI began supervising NBFCs from
July 1995. HFCs are regulated by NHB. The major regulatory provisions are:-

(i) The minimum net worth funds of 25 Lakh and the NBFC should achieve
the minimum net worth norm in 3 years or extended 3years more at the
discretion of RBI.
(ii) NBFCs have to maintain 10%and15% of their deposits in liquid assets.
(iii) They have to create reserve fund and transfer not less than 20% of
their net deposits to it every year.
(iv)The RBI directs them on issues of disclosures, prudential norms, credit,
investments etc.
(v) Nomination facility is available to depositors of these companies.

89
 (vi)Unincorporated bodies engaged in financial activity cannot accept deposits
from the public from April, 1997.
(vii) They have to achieve a minimum capital adequacy norm of 8% by
March, 1996.
(viii) They have to obtain a minimum credit rating from any one of 3
credit rating agencies.
(ix)A ceiling of 15% interest on deposits has been prescribed for MBFCs or
Nidhis.
(x) The interest rate ceiling on deposits as also the ceiling on quantum of
deposits for NBFCs (other than Nidhis) have removed, subject to
compliance with the RBI directions and guidelines.

With a view to protecting the interests of depositors, the regulatory attention was mostly
focused on NBFCs accepting public deposits (NBFS-D) until recently. Over the last few
years however, this regulatory framework has undergone a significant change, with
increasingly more attention now being paid to non-deposit taking NBFCs (NBFCs-ND)
as well. This change was necessitated mainly on account of a significant increase in both
the number and balance sheet size of NBFCs-ND segment which gave rise to systemic
concerns to address this issue. NBFCs-ND with asset size of .100 crore and above was
classified as systemically important NBFCs (NBFCs-ND-SI) and are subjected to
limited regulations. The changing regulatory policy also recognized that those activities
of NBFCs which are asset creating must be given special consideration. Accordingly in
December 2006, a reclassification of NBFCs was effected. In terms of the new
classification, companies financing real/physical assets for productive/economic activity
are classified as asset finance companies (AFC), subject to the fulfillment of certain
norms. The prudential norms for AFCs vary from the norms for other NBFCs. The
revised NBFC classification now comprises of AFCs, loan companies (LCs) and
investment companies (ICs) instead of equipment leasing, hire purchase, loan companies
and investment companies earlier.

90
 Figure -3.1
Regulatory Focus in Respect of NBFCs in India

Type of NBFC Name of the Regulatory Authority

Equipment Leasing Companies [EL] Reserve Bank of India

Hire Purchase Finance Companies [HP] Reserve Bank of India

Loan Companies Reserve Bank of India

Investment Companies Reserve Bank of India

Residuary Non-Banking Companies Reserve Bank of India

Miscellaneous Non-Banking Companies Reserve Bank of India* and Registrars of Chits

(Chit Fund) of the concerned States

Mutual Benefit Finance Companies

Department of Company Affairs of GOI
(Nidhis and Potential Nidhis)

Micro financial companies Department of Company Affairs of GOI

Housing Finance Companies National Housing Bank

Insurance Regulatory and Development

Insurance Companies
Authority

Stock Broking Companies Securities and Exchange Board of India

Merchant Banking Companies Securities and Exchange Board of India

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai various issues

Protection of Depositors Interest: With a view to protecting the interests of the

depositors further, the Reserve Bank initiated steps for creating a charge on the SLR
securities in favour of the depositors. Accordingly, NBFCs accepting/holding public
deposits were advised in January 2007 to create floating charge on the statutory liquid
assets in favour of their depositors, through the mechanism of Trust Deed. The charge is
required to be registered with the Registrar of Companies and the information in this
regard is required to be furnished to the Trustees and the Reserve Bank. Furthermore,

91
with a view to containing the systemic risk relating to NBFCs-D, measures were initiated
to ensure that only finally sound NBFCs accept deposits. It was, therefore, prescribed in
June 2008 that NBFCs having net owned funds (NOF) of less than ` 200 lakh may freeze
their deposits at the level than held by them. Asset Finance companies(AFC) having
minimum investment grade credit rating and CRAR of 12 per cent 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 lever equal to their NOF by March 31 2009.

Transparency in Operations of the NBFCs: Along with measures for enhancing the
financial strength of NBFCs, initiatives to inculcate fair corporate governance practices
and good treatment of customers were also undertaken. The Reserve Bank issued
guidelines on Fair Practices Code for NBFCs in September 2006; NBFCs were advised to
invariably furnish a copy of the loan agreement along with a copy each of all enclosures
quoted in the loan agreement to all borrowers at the time of sanction/ disbursement of
loans. Deposit taking NBFCs with deposits of `20 Crore and above and NBFCs-ND-SI
have been advised to frame internal guidelines on corporate governance which should
include, inter alia, constitution audit committee, nomination committee and risk
management committee, among others. Certain disclosure and transparency practices
have also been specified for them. NBFCs have been advised to lay down appropriate
internal principles and procedures for determining interest rates and processing and other
charges, even though interest rates are not regulated by the Reserve Bank. In order to
ensure that only NBFCs which are actually engaged in the business of NBFI hold
Certificate of Registration (COR), it has been decided that all NBFCs should obtain and
submit an annual certificate from their statutory auditors to the effect that they continue
to undertake the business of NBFI to be eligible for holding of COR.

To strengthen their financial viability, NBFCs were permitted in December 2006 to

undertake fee based business to augment their income, subject to certain norms. The
diversification business that may be permitted include, marketing and distribution of
mutual fund products as agents of mutual funds and issuing co branded credit cards with

92
scheduled commercial banks, without risk sharing, with prior approval of the Reserve
Bank, for an initial period of two years and a review thereafter.

Foreign Direct Investment (FDI) in NBFC sector: In view of the interest evinced in FDI
participation in the NBFC sector, regulatory measures have also been undertaken in
respect of foreign direct investment (FDI) in the NBFCs sector, FDI under automatic
route is permitted in respect of 18 NBFC activities, subject to prescribed minimum
capitalization norms. While allowing FDI in NBFCs, the Reserve Bank takes into
consideration fit and proper criteria of directors, information about the overseas regulator
of the companies bringing the FDI into India and inter-regulatory views. Bank is
monitoring minimum capitalization norms as regards FDI with a view to ensuring that
NBFC activities are limited to permissible activities.

Monitoring of Frauds in NBFCs: In March 2008 all deposit taking NBFCs (including
RNBCs) were advised that the extant instructions with regard to monitoring of frauds
were revised and as such cases of negligence and cash shortages and irregularities in
foreign exchange transactions were to be reported as fraud if transactions were to be
reported as fraud if the intention to cheat/ defraud was suspected/proved. However, in
cases were fraudulent intention was not suspected/ proved at the time of detection but
involve cash shortages of more than ten thousand rupees and cases where cash shortages
more than five thousand rupees were detected by management/auditor/inspecting officer
and not reported on the occurrence by the persons handling cash, then such cases may
also be treated as fraud and reported accordingly.

Prevention of Money Laundering Act, 2002 Obligation of NBFCs: It was reiterated in

August 2008 that NBFCs, as a part of transaction monitoring mechanism, are required to
put in place an appropriate software application to throw alerts when the transactions are
inconsistent with risk categorization and updated profile of customers. In the case of
NBFCs, where all the branches are not yet fully computerized, the Principal Officer of
the NBFC should cull out the transaction details from branches which are not
computerized and suitably arrange to feed the data into an electronic file with the help of
the editable electronic utilities of cash transaction report (CTR) and suspicious

93
transaction reports (STR) as have been made available by Financial Intelligence Unit-
India (FIU-IND) on their website. It was further clarified that cash transaction reporting
by branches/offices of NBFCs to their Principal Officer should invariably be submitted
on a monthly basis and the Principal Officer, in turn, should ensure to submit CTR for
every month to FIU-IND within the prescribed time schedule.

Facility of Liquidity Support for NBFCs: On October 15, 2008 the Reserve Bank
announced, purely as temporary measure, that banks may avail of additional liquidity
support exclusively for the purpose of meeting the liquidity requirements of mutual funds
(MFs) to the extent of up to 0.5 per cent of their NDTL. Further, it was decided, on a
purely temporary and ad hoc basis, subject to review, to extend this facility and allow
banks to avail liquidity support under the LAF through relaxation in the maintenance of
SLR to the extent of up to 1.5 per cent of their NDTL. This relaxation in SLR is to be
used exclusively for the purpose of meeting the funding requirements of NBFCs and
MFs. Banks can apportion the total accommodation allowed above between MFs and
NBFCs flexibly as per their business needs.

Policy Initiatives for NBFCs-ND-SI: The number, product variety and size of NBFCs-
ND-SI have witnessed substantial growth in recent years and as a result the operations of
these companies have increasingly assumed systemic implications. As a response to these
developments, the minimal regulatory regime that existed for these companies has been
transformed into limited regulatory regime by the Reserve Bank. In line with the
growing focus on NBFCs-ND-SI in recent years, certain important policy initiatives were
undertaken in 2007-08.

Supervisory Framework
Various entry-level norms for new and existing NBFCs have been laid down. Among the
various measures introduced was compulsory registration of NBFCs engaged in financial
intermediation, prescription of minimum level of Net Owned Funds (NOF), maintenance
of certain percentage of liquid assets, creation of reserve fund and transfer thereto every
year a certain percentage of profits to reserve fund. The regulations also provide for

94
measures like credit rating for deposits, capital adequacy, income recognition, asset
classification, compulsory credit rating provision for bad and doubtful debts, exposure
norms and other measures to keep a check on their financial solvency and financial
reporting. While the regulatory framework has been dovetailed primarily towards NBFCs
accepting/holding public deposits, the supervisory mechanism for NBFCs is based on
three criteria, viz., (a) the size of the NBFC, (b) the type of activity performed, and (c) the
acceptance or otherwise of public deposits. Towards this end, a four-pronged supervisory
setup consisting of on-site examination, off-site surveillance, exception reporting by
NBFCs' statutory auditors and market intelligence system has been instituted.

95
 Figure-3.2
Non-Banking Financial Companies - Principal Business
Non-Banking Financial Principal Business
Companies
Non-Banking Financial Company In terms of the Section 45-I(f) of the RBI Act, 1934 as amended in
1997, their principal business is that of a financial institution as
defined in Section 45 I(c) or that of receiving deposits under any
scheme or lending in any manner.
Equipment leasing company (EL) Equipment leasing or financing of such activity.
Hire purchase finance company Hire purchase transaction or financing of such transactions.
(HP)
Investment company (IC) Acquisition of securities and trading in such securities to earn a
profit.
Loan company (LC) Providing finance by making loans or advances, or otherwise for any
activity other than its own; excludes EL/HP/HFCs.
Mutual benefit financial company Means any company which is notified by the Central Government
(MBFC) i.e. Nidhi Company under Section 620A of the Companies Act 1956 (1 of 1956).
Miscellaneous non-banking Managing, conducting or supervising as a promoter, foreman or
company (MNBC) i.e. Chit Fund agent of any transaction or arrangement by which the company
Company enters into an agreement with a specified number of subscribers that
every one of them shall subscribe a certain sum in installments over
a definite period and that every one of such subscribers shall in turn,
as determined by lot or by auction or by tender or in such manner as
may be provided for in the agreement, be entitled to the prize
amount.
Residuary non-banking company Company which receives deposits under any scheme or arrangement,
(RNBC) by whatever name called, in one lump-sum or in installments by way
of contributions or subscriptions or by sale of units or certificates or
other instruments, or in any manner. These companies are NBFCs
but do not belong to any of the categories as stated above.
Non-banking non-financial Means an industrial concern as defined in the Industrial
company (NBNFC) Development Bank of India Act, 1964, or a company whose
principal activity is agricultural operations or trading in goods and
services or construction/sale of real estate and which is not classified
as financial or miscellaneous or residuary non- banking company.
Housing finance company (HFC) The financing of the acquisition or construction of houses including
the acquisition or development of plots of land. These companies are
supervised by the National Housing Bank.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai, 2006-07.

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Unincorporated Bodies: After the RBI (Amendment) Act, 1997, they cannot receive
deposits except from relatives as specified in Section 45-S of RBI Act, if such bodies are
engaged, wholly or partly in any of the activities specified in clause (c) of Section 45-I of
the Act, ibid or principal business is that of receiving deposits or lending. Miscellaneous
non-banking companies covered by the Miscellaneous Non-Banking Companies (Reserve
Bank) Directions, 1973 are of two types they are, (a) Those conducting prize chits,
benefit/ savings schemes, lucky draws, etc; (b) Those conducting conventional or
customary chit funds where under the foremen companies enter into agreements with a
specified number of subscribers that every one of them shall subscribe a certain sum in
installments over a definite period and that every one of such subscriber shall in his turn,
as determined by lot or by auction or by tender or in such other manner as may be
provided for in the agreements, be entitled to the prize amount. This prize amount is
arrived at by deduction from out of the total amount subscribed at each installment by all
subscribers, (i) the commission charged by the company service charges as a promoter or
a foreman or an agent and (ii) discount, i.e, any sum which a subscriber agrees to forego,
from out of the total subscriptions of each installment in consideration of the balance
being paid to therm.

Financial Performance of NBFCs

The financial performance of NBFCs suffered a setback during 2005-06. While income
earned by NBFCs declined marginally, expenditure increased sharply. As a result,
operating profit and net profit declined sharply. It is evident from the Table-3.5, financial
performance of NBFCs in terms of income and net profit improved during 2008-09. Both
fund based income and fee based income registered robust growth. The financial
performance of NBFC-D witnessed improvement as reflected in the increase in their
operating profits during 2010-11. This increase in profit was mainly on account of growth
in income (fund based) while expenditure declined marginally. The operating profit along
with an increase in tax provision resulted in almost doubling of net profit during 2010-11.

Non Performing Assets:

Table 3.6 shows that, Gross NPAs (as a percentage of gross advances) as well as net
NPAs (as per cent of net advances) of reporting NBFCs, as a group, registered a steady
decline between end-March 2001 and end-March 2004 and further to 0.7 per cent in 2011
and stood at 2.1 per cent in 2012. While gross NPAs continued to decline during the year
ended March 2005, net NPAs increased significantly. Gross NPAs (as a per cent of gross
advances) as well as net NPAs (as per cent of net advances) of reporting NBFCs
registered a sharp decline during the year ended March 2012. In continuation of the trend
witnessed during the last few years, gross NPAs (as per cent of gross advances) as well as
net NPAs (as per cent of net advances) of reporting NBFCs declined further during the
year ended March 2012. The gross NPAs (as per cent of gross advances) of equipment
leasing and investment companies increased during 2006-07, while those of loan
companies and hire purchase companies declined. Net NPAs (as per cent of net advances)
also showed a decline in the case of equipment leasing and loan companies. The gross
NPAs of equipment leasing and hire purchase companies increased during 2007-08, due
to reclassification of NBFCs, while those of asset finance companies and loan companies
declined. Net NPAs (as per cent of net advances) increased marginally in case of asset
finance companies, hire purchase companies and investment companies, while those of
equipment leasing companies, and loan companies improved further. Gross NPAs (as

percentage of gross advances) of asset finance companies, equipment leasing companies

and investment companies and hire purchase companies declined during 2008-09. Net
NPAs (as percentages of net advances) increased marginally in case of asset finance
companies and hire purchase companies, while those of equipment leasing and
investment companies decreased. NPAs of loan companies remained negative during
2008-11.

Capital Adequacy Ratio

Capital to risk weighted assets ratio (CRAR) norms were made applicable to NBFCs in
1998, in terms of which every deposit-taking NBFC is required to maintain a minimum
capital consisting of Tier-1 and Tier-II capital of not less than 12 per cent (15 per cent in
case of unrated deposit-taking loan/investment companies) of its aggregate risk
weighted assets and of risk-adjusted value of off-balance sheet items. Total of Tier-II
capital, at any point of time, is required not to exceed 100 per cent of Tier-I capital.
It is noteworthy that the NBFC sector is witnessed a consolidation process in the last few
years, wherein the weaker NBFCs are gradually exiting, paving the way for a stronger
NBFC sector. It is clear from the Table-3.7 that, all NBFCs with minimum CRAR 12% to
above 30% at the end March 2011, declined gradually.

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