Policies & practices regarding mobilization & management of funds in NBFCs, their performance

Financial activity as principal business is when a company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income. A company which fulfils both these criteria will be registered as NBFC by RBI. The term ‘principal business’ is not defined by the Reserve Bank of India Act. The Reserve Bank has defined it so as to ensure that only companies predominantly engaged in financial activity get registered with it and are regulated and supervised by it. Hence if there are companies engaged in agricultural operations, industrial activity, purchase and sale of goods, providing services or purchase, sale or construction of immovable property as their principal business and are doing some financial business in a small way, they will not be regulated by the Reserve Bank. Interestingly, this test is popularly known as 50-50 test and is applied to determine whether or not a company is into financial business.

The Reserve Bank has been given the powers under the RBI Act 1934 to register, lay down policy, issue directions, inspect, regulate, supervise and exercise surveillance over NBFCs that meet the 50-50 criteria of principal business. The Reserve Bank can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by RBI under RBI Act. The penal action can also result in RBI cancelling the Certificate of Registration issued to the NBFC, or prohibiting them from accepting deposits and alienating their assets or filing a winding up petition.

NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:

• NBFC cannot accept demand deposits;
• NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
• Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

The Bank has issued detailed directions on prudential norms, vide Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007, Non-Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015 and Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015. Applicable regulations vary based on the deposit acceptance or systemic importance of the NBFC.

The directions inter alia, prescribe guidelines on income recognition, asset classification and provisioning requirements applicable to NBFCs, exposure norms, disclosures in the balance sheet, requirement of capital adequacy, restrictions on investments in land and building and unquoted shares, loan to value (LTV) ratio for NBFCs predominantly engaged in business of lending against gold jewellery, besides others. Deposit accepting NBFCs have also to comply with the statutory liquidity requirements.

Sources of business funding for NBFCs

Non-Banking Financial Companies can raise funds through various sources with deposits; some of them include:

• Long term loans at low-interest rates: Once NBFC creates an amount required for deployment in its course of operations, it can apply for a long term loan from the bank. It is beneficial for NBFC’s as banks lend at much lower interest rates owing to the nature of CASA deposits. Such type of loans can be secured or unsecured through Government Securities and its repayment can be made in a structured or bullet schedule. NBFC must record the repayment of long term loans in the Balance Sheet along with the asset section. NBFC’s must have a good credit rating to raise a large sum of funds at competitive interest rates.
• Foreign Direct Investment (FDI): One of the best funding options for NBFC is foreign investment. In 1991, the era of post-liberalization in the Indian economy, a tremendous increase of foreign investors in the NBFC was perceived. Recently, up to 100%, foreign investment is permitted under the automatic route in FDI. Thus, foreign investors don’t require approval from RBI or FIPB and invest directly in NBFC’s.
• Issue Commercial Paper for small-term loans: Non-Banking Financial Companies can raise the required funds by issuing Commercial Paper. It is a short term unsecured Promissory Note issued by the financial Companies that have tenure of 3 to 12 months. NBFC’s with a minimum net worth of INR100 crores are eligible to list Commercial Papers as per Reserve Bank of India.
• Issue Bonds: NBFC’s can avail considerable money at the lowest costs by issuing Bonds. It is a common practice that helps to reduce the rate on the sources of funds. The coupon rate on the Bonds is selected to reflect the rating profile of NBFC. The maturity profile of Bonds corresponds to the repayment of interest schedules made by the NBFC’s. Bonds can also be issued to the retail investors, which is a huge advantage for NBFC’s during Bond placement.
• Securitization of loans: NBFC’s have raised INR 2.36 lakh crore between the period of October 2018 and September 2019 by selling their loans in the market through Securitization. HFC’s and NBFC’s heavily rely upon Securitization as an effective tool to manage liquidity, raise funds and correct ALM mismatch.

NBFCs that can avail automatic route in FDI

Non-Banking Financial Companies that offer the following services can have an access to the automatic route in FDI:

• Merchant Banking
• Asset Management
• Factoring
• Underwriting
• Portfolio Management Services
• Stock Broking
• Venture Capital
• Custodian Services
• Leasing & Finance
• Housing Finance
• Credit Card Business
• Financial Consultancy
• Micro and Rural Credit
• Non-fund based activities
• Investment Advisory Services
• Forex Broking
• Credit Rating
• Money Changing Activities