Financial Services Non-bank financial companies (NBFCs) are financial institutions that provide banking services without meeting

the legal definition of bank, i.e. one that does not hold a banking license. These institutions are not allowed to take deposits from the public. Nonetheless, all operations of these institutions are still exercised under bank regulation. Non Banking Financial Companies or NBFC in India are registered companies conducting business activities similar to regular banks. Their banking operations include making loans and advances available to consumers and businesses, acquisition of marketable securities, leasing of hard assets like automobiles, hire-purchase and insurance business. Though they are similar to banks, they differ in a couple of ways. NBFCs cannot accept demand deposits (deposits that can be withdrawn at immediate notice), they cannot issue checks to customers and the deposits with them are not insured by the DICGC (the India equivalent of FDIC in the US system). Either the RBI (Reserve Bank of India) or the SEBI (Securities and Exchange Board of India) or both regulate NBFCs. Though the NBFCs have been around for a long time, they have recently gained popularity amongst institutional investors, since they facilitate access to credit for semi-rural and rural India where the reach of traditional banks has traditionally been poor. NBFCs are doing functions akin to that of banks, however there are a few differences: (i) a NBFC cannot accept demand deposits (demand deposits are funds deposited at a depository institution that are payable on demand -- immediately or within a very short period -- like your current or savings accounts.) (ii) it is not a part of the payment and settlement system and as such cannot issue cheques to its customers; and (iii) deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks. Is it necessary that every NBFC should be registered with RBI?

Initially, there were four different categories of companies for the purpose of acceptance of deposits by Non Banking Financial Companies ("NBFCs") namely:

Equipment Leasing company - any financial institution which carried on the activity of leasing equipment, as its principal business;

Hire Purchase company - any financial institution which carried on the activity of hire purchase transactions, as its principal business;

Investment Companies - any financial institution which carried on the acquisition of securities, as its principal business; and

Loan Companies - any financial institution which provided finance whether by making loans or advances or otherwise for any activity other than its own but does not include an equipment leasing company or a hire purchase finance company. Some of the important regulations relating to acceptance of deposits by NBFCs are as under: i) The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months. They cannot accept deposits repayable on demand. ii) 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 interest may be paid or compounded at rests not shorter than monthly rests. iii) NBFCs cannot offer gifts/incentives or any other additional benefit to the depositors.
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Deposit Taking Activity by Non-Banking Finance Companies 3.34 The non-banking finance companies (NBFCs) are a heterogeneous lot, in terms of activity and size. The NBFCs, an integral part of the Indian financial system, perform an important financial intermediation role contributing to economic development. These companies offer tailor-made services to both borrowers and savers in the wholesale and retail segments. The common feature of the diverse segment is acceptance of deposits from the public, borrowing from banks and accessing the capital market, in the case of companies organized as public limited companies. Definition of Non-Banking Finance Companies According to the Reserve Bank (Amendment Act), 1997: 'A Non-banking Finance Company (NBFC) means

a financial institution which is a company; a non-banking institution which is a company and which has as its principal business the receiving of deposits under any scheme or arrangement or in any other manner or lending in any manner; such other non-banking institution or class of such institutions as the Bank may with the previous approval of the Central Government specify.' The definition excludes financial institutions and institutions, which carry on

agricultural operations as their principal business. 3.35 NBFCs are broadly of eight types: (i) equipment leasing companies, (ii) hire-purchase finance companies, (iii) loan companies, (iv) investment companies, (v) mutual benefit financial companies (Nidhis), (vi) miscellaneous non-banking companies, (chit funds), (vii) residuary non-banking companies, and (viii) housing finance companies. Regulation of Deposit Taking Activities of Non-Banking Companies 3.36 The scheme of regulation of the deposit taking activities of the non-banking companies was conceived in the sixties not only as a supplement to the monetary and credit policy but also to provide an indirect protection to the depositors. Accordingly, RBI was vested with certain powers to supervise, control and regulate the deposit acceptance activities of these institutions. The focus of the regulation was on the acceptance of deposits and related matters. In pursuance of the powers conferred under the RBI Act, 1934, separate directives were issued by RBI in 1966 to NBFCs and Non-banking Non-financial Companies (NBNFCs) relating to the acceptance of deposits and governing their period, quantum, rate of interest, etc. In 1973, directions were issued to the miscellaneous non-banking companies (conducting chits and related business) as well. Subsequently, in 1975, NBNFCs were exempted from the application of the RBI directions and instead, brought under the regulatory ambit of the Department of Company Affairs under (Acceptance of Deposits) Rules 1975 framed under Section 58A of the Companies Act. Inadequacy of Legislative Framework prior to the 1997 Amendment 3.37 The provisions of Chapter III B of the RBI Act, 1934 vested very limited powers in RBI in as much as RBI was only empowered to regulate or prohibit issue of prospectus or advertisement soliciting deposits, collect information as to deposits and to give directions on matters relating to receipt of deposit. For violation of directions, RBI could issue orders prohibiting erring companies from accepting further deposits. So long as the directions relating to deposit acceptance were complied, no stringent action could be initiated on other adverse features found out, if any, during inspection. The legislative intent and the focus were, thus, mainly aimed at moderating the deposit mobilization by NBFCs and thereby providing indirect protection to the depositors by linking the quantum of deposit to their Net Owned Fund (NOF). Thus, the directions were restricted to the liability side, that to solely to deposit acceptance activities. It did not extend to the asset side of the balance sheets of NBFCs. Several expert/working groups, which thereafter examined the functioning of NBFCs, were unanimous about the inadequacy of the legislative framework and recommended introduction of suitable legislation not only for ensuring sound and healthy functioning of NBFCs but also to safeguard interest of depositors. The Joint Parliamentary Committee, which went into irregularities in securities transactions in 1992, had also observed in paragraph 6.61 of the Report that the Government should examine whether the provisions in Chapter III B of the RBI Act were sufficiently wide to cover the necessary regulation. If not, the question of reinforcing the existing legislation or to enact a separate legislation for NBFCs be examined. 3.38 In the light of these developments, RBI appointed in 1992 a Working Group on Financial Companies (Chairman: 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 wideranging recommendations for ensuring sound functioning of NBFCs. 3.39 Accordingly, RBI initiated a series of measures including: (i) widening of the definition of regulated deposits to include inter-corporate deposits, deposits from shareholders and directors and borrowings by issue of debentures secured by immovable property (April 1993), (ii) introduction of a scheme of registration of NBFCs having NOF of Rs.50 lakh and above (April 1993), (iii) the issuance of guidelines on prudential norms so as to regulate the asset side of the balance sheet of NBFCs (June 1994). The measures relating to registration and prudential norms could not be given statutory backing at that time since the provisions of the RBI Act 1934 did not confer adequate powers to make them mandatory. Amendments to RBI Act 1934 3.40 An ordinance was issued by the Government in January 1997 effecting comprehensive changes in the provisions of the RBI Act, 1934. This was subsequently replaced by the RBI (Amendment) Act, 1997. The salient features of the amended provisions, based on the Shah Committee recommendations, pertain to the entry point norm of Rs.25 lakh as minimum NOF (which has been raised to Rs.2 crore effective from April 21, 1999), compulsory registration with RBI, maintenance of certain percentage 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 the net profit, determination of policy and issuing directions by RBI on prudential norms, prohibition of NBFCs from accepting deposits and seeking winding applications for violation of directions. Unincorporated bodies were prohibited from issuing any advertisement for soliciting deposits. The Company Law Board was empowered to direct the defaulting NBFCs to repay any deposit. Stringent penal provisions were also included empowering RBI to impose, inter alia, pecuniary penalty for violation of the provisions of the RBI Act. 3.41 Insurance companies, housing finance companies, stock broking companies and stock exchange companies were granted exemptions from certain provisions of the amended Act. Nidhi companies and chit funds were also exempted from certain core stipulations including maintenance of percentage of assets and reserve funds. 3.42 In May 1997, certain malpractice pertaining to a NBFC came to light. This consequently raised a number of questions including the ones of extending deposit insurance and of bringing about stronger supervisory mechanisms on these companies. New Regulatory Framework 3.43 Exercising the powers derived under the amended Act and in the light of the experience in monitoring the activities of NBFCs, a new set of regulatory measures was announced by RBI 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 thrust and the enforcement. The salient features of the new framework are as under:

NBFCs have been classified into three categories for purposes of regulation, namely, those accepting public deposits

those, which do not accept public deposits but are engaged in the financial business, and 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 are subject to the entire gamut of regulations, those not accepting public deposits are regulated in a limited manner. Therefore, the regulatory attention is focussed primarily on NBFCs accepting public deposits. Borrowings by way of inter-corporate deposits, issue of secured debentures/bonds, deposits from shareholders by a private limited company and deposits from directors by both public as well private limited companies have been excluded from the purview of the public deposits. The RBI regulation on quantum, rate of interest, period of deposit are applicable only with respect to public deposits. The term public deposit was defined on the lines of the definition provided by the Companies (Acceptance of Deposits) Rules, 1975 framed under the Companies Act 1956 and RBI Act 1934. Public deposits include fixed, recurring, etc. deposits received from public, deposit received from relatives and friends, deposits from shareholders by a public limited company and the money raised by issue of unsecured debentures/bonds. The overall ceiling on borrowing by NBFCs has been removed and sought to be decided on the basis of capital adequacy requirement.

3.48. It is also expected that during the three-year period, NBFCs could obtain/improve their credit rating, improve their NOF, substitute public deposits by other forms of debt, and arrange for alternative sources of funds. NBFCs have been debarred from charging an interest rate exceeding 16 per cent per annum and a brokerage fee of over 2 per cent on public deposits. NBFCs accepting public deposits only are required to submit to RBI annual statutory returns and financial statements. NBFCs ot accepting public deposits are exempted from this requirement. For the first time, prudential norms have been prescribed for NBFCs for mandatory compliance under the statutory powers vested with RBI. The companies, which accept public deposits, are required to comply with all the norms pertaining to income recognition, accounting standards, asset classification, provisioning of bad and doubtful debts, capital adequacy, credit/investment concentration norms, etc. 3.49 To improve the liquidity of NBFCs, the proportion of liquid assets required to be maintained by them has been enhanced from 12.5 per cent to 15 per cent April 1, 1999. 3.50. With regard to the risk profile of the assets of NBFCs, capital adequacy ratio has been enhanced from 8 per cent to 10 per cent w.e.f. April 1, 1998 and further to 12 per cent w.e.f. April 1, 1999. The loan/investment companies accepting/holding public deposits must have a CRAR of 15% effective from December 18, 1998. 3.51. NBFCs not accepting public deposits have been exempted from the regulations on interest rates, period, ceiling on quantum of borrowings. However, prudential norms, which have a bearing on the true and fair status or the financial health of these companies as reflected in their balance sheets, have been made applicable to these companies except those relating to capital adequacy and credit investment concentration norms. Core investment companies are exempt from all the regulation of RBI except registration and reserve fund. The responsibility of ensuring compliance of these regulations has been

entrusted to the statutory auditors of these companies, and RBI has issued directions to the statutory auditors for this purpose. Statutory auditors of NBFCs are required to report by exception to RBI any irregularity or violation of the RBI regulation on acceptance of public deposits and prudential norms. 3.52. The contents of the deposit application forms have been further modified to make the depositors aware of the forums for redressal of their grievances and also to give them a proper perspective regarding the role and responsibility of the regulatory authority. The deposit taking companies were directed to certify the correctness of the financial position to state that their operations complied with the RBI directions. NBFCs were also required to disclose the levels of their rating and the names of the rating agency in their application forms. The depositors were also enjoined to satisfy themselves about the financial details of the company before placing their deposits and to declare in their deposit application forms that they had gone through the declarations made by the company regarding its conformity with the RBI regulations. As a move towards greater disclosure and transparency, NBFCs accepting public deposits have been asked to furnish certain essential information regarding their financial activities in their forms for application for deposits and advertisement for soliciting deposits. Depositors have been cautioned not to be lured by offered interest rate alone and be careful to understand the financial position of the concerned company.