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• Posted: Sun, Jul 20 2008. 11:45 PM IST

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• Economy and Politics

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The multiplicity of regulation on NBFCs

can be confusing
For foreign investment purposes, the government of India has specifically listed
certain categories of NBFCs that are eligible to receive foreign investments

Lawfully Yours | AZB and Partners

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Non-banking financial companies or NBFCs have become an integral part of India’s financial
system. In recent times, NBFCs have emerged as lenders to both companies and individuals.
When it comes to lending, NBFCs are generally regarded to
be complementary to banks and are often able to offer better
services and products to their customers.

Illustration by Malay Karmakar / MINT

An NBFC is pretty much what its name suggests, that is, a company (not being a
bank) carrying on financial activities. The Reserve Bank of India (RBI) Act, 1934,
defines the term “NBFC” and various regulations passed by RBI govern NBFCs in
India.

For foreign investment purposes, the government of India has specifically listed certain
categories of NBFCs that are eligible to receive foreign investments.

India’s foreign exchange laws regulate and govern foreign investment in certain categories of
financial service companies and the categories of activities which can be carried on by such
companies after they have received foreign direct investment (FDI), referred to as FDI
NBFCs.

FDI NBFCs are not necessarily the same as NBFCs defined under the RBI Act.

FDI under the automatic route (that is, without prior approval of the government) is permitted
in 18 identified financial service/sector activities (including merchant banking, underwriting,
portfolio management services, investment advisory services, financial consultancy, leasing
and finance, stockbroking, asset management and venture capital).

However, the requirement of approval of the Foreign Investment Promotion Board (FIPB)
would have to be tested against the provisions of Press Note 1, 2005, which under certain
circumstances requires a foreign investor that has an existing investment in the same sector,
as on 12 January 2005, to seek FIPB approval.

FDI is permitted in NBFCs subject to the prescribed minimum capitalization norms.

Minimum capitalization in a “fund-based” NBFC for FDI up to 51% is $0.5 million, which
has to be brought in upfront. For FDI above 51% and up to 75%, $5 million is the minimum
capitalization to be brought in upfront and for FDI above 75%, the minimum capitalization
required is $50 million, of which $7.5 million is to be brought in upfront and the balance
within 24 months. Irrespective of the level of shareholding in a “non-fund-based” FDI NBFC,
the minimum capitalization requirement is $0.5 million.

Press Note 12 of 1999 issued by the government of India identified investment advisory
services, financial consultancy, credit reference agencies, credit rating agencies, forex
broking and money-changing businesses as non-fund-based FDI NBFCs.

It is pertinent to note that the acquisition of existing shares of any FDI NBFC by a non-
resident investor, from a resident shareholder, requires the prior approval of RBI since shares
proposed to be transferred are shares of a financial sector company.

NBFCs may be regulated either by the Securities and Exchange Board of India (Sebi) or RBI,
depending on the nature of activity it is engaged in. RBI and Sebi generally avoid dual
regulation of the same entity, that is, an entity registered with and regulated by Sebi is
unlikely to be permitted to undertake activities that require registration with, and licensing
and regulation by, RBI, and vice versa.

RBI generally regulates NBFCs that are primarily engaged in lending, finance and leasing
activities. Such NBFCs are required to register themselves with RBI under the provisions of
the RBI Act.
Moreover, any company in which financial assets represent more than 50% of its total assets
and the income from such assets represents more than 50% of the company’s gross income is
also required to be registered with RBI as an NBFC. For an NBFC to be registered with RBI,
it should have a net owned fund of Rs2 crore.

RBI has, for regulation purposes, broadly categorized NBFCs into those accepting deposits
and those which do not. Deposits include any receipt of money by way of deposit or loan
other than share capital, capital contributed by partners of a firm or any amounts received
from any bank or banking company.

Broadly speaking, NBFCs are regulated by the RBI Act, the Non-Banking Financial
Companies (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve
Bank) Directions, 2007 (applicable to NBFCs that do not take deposits), Non-Banking
Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank)
Directions, 2007 (applicable to NBFCs that do take deposits). RBI further issues circulars,
guidance notes and policy papers from time to time in relation to the operations and
functioning of RBI NBFCs.

Further, NBFCs not accepting deposits but having an asset size of Rs100 crore or more as per
the last audited balance sheet are notified as “systemically important”. RBI governs NBFCs
depending on whether they are deposit-taking, non- deposit-taking or are systemically
important NBFCs.

Systemically important NBFCs are governed more strictly by RBI compared with other non-
deposit-taking NBFCs.

Systemically important NBFCs are required to comply with cash adequacy ratios, single
borrower limits, single investment exposure limits, etc., which are not applicable to NBFCs
not accepting public deposits.

Recently, Sebi included systemically important NBFCs and certain other types of NBFCs not
accepting public deposits as “qualified institutional buyer” for the purposes of the
Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002 (Sarfesi Act). This amendment would entitle these NBFCs to subscribe to security
receipts issued by securitization and reconstruction companies and would become entitled to
protections accorded to qualified institutional buyers under the Sarfesi Act.

The multiplicity of regulations, directions and certain overlapping categorizations has often
led to confusion. Given that NBFCs have emerged as a very important segment of the Indian
financial system, any form of rationalization and simplification of the regulatory framework
would be more than welcome by the industry.

Send your comments to lawfullyyours@livemint.com. This column is contributed by Niladri

Maulik of AZB & Partners, Advocates & Solicitors.