CHAPTER VI

SUMMARY OF FINDINGS, SUGGESTIONS

AND CONCLUSION
In this chapter, a summary of the major findings of the study on

various issues are presented and based on the analysis, conclusions are drawn.

Finally, a few suggestions for further improvement in the working of NBFCs

are made.

SUMMARY OF FINDINGS

The growth of the Indian financial system was unique even

before the reform process with the development of banks due to

nationalisation and the other financial institutions. The vast network of term-

financing, investment and insurance institutions was promoted at the all-India,

regional and state levels. The banking and the financial system planted

confidence, stability and certainty in the savers’ minds.

Therefore, India developed and promoted a financial system of a

high order which increased the household saving as financial assets, extended

vast investment and inventory credit to medium and large scale industries in

private and public sectors, promoted new entrepreneurship and attained

extensive credit reach to a great number of people. Increase in the number of

institutions and instruments and diversification were the highlights in the

money and capital markets during the post-nationalisation period. The eighties

were a period of gradual transition. Financial intermediaries performed the

important task of transferring the funds and claims from one sector to the

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other. This is very much reflected in the financial system of the country. In

1991, the finance ratio, intermediation ratio and inter-relation ratio reached a

peak level of 0.497, 2.922 and 0.806 respectively. During the same year i.e.

1991, the Narasimham Committee made recommendations, which reduced the

controlling measures for the banking sector as well as the other sub-sectors of

the financial sector.

Hence, beginning from 1991, Indian economy was going

through a period of finacialisation. The share of finance sector in the total

GDP increased considerably from 9.66 per cent in 1990-91 to 17.2 per cent in

2012-13 and same was the case with the financial sector GDP to the service

sector GDP which was increased from 23.82 per cent in 1990-91 to 45.19 per

cent in 2012-13. Historically, the Indian financial system grown rapidly and

experienced considerable stability over a period of time.

v The number of companies registered with Register of

Companies increased from 7,063 in 1981 to 24009 in 1990 and

further to more than 62,000 in 1999, later decreased to 12,225 in

2013. The number of companies reported to regulator in 1981

was 3,443 and a percentage of Reported to Registered showed

was 48.74 percentages. In 1990 it showed 32.42 percentages

further in 1998 it was decreased to 18.80 percentages. After

1998 it falls to single digit to just 2.11 percentages in 2012-13.

The growth rate in percentage of number of registered

companies also falls from 19.11 percentages in 1981-82 to -3.43

percentage in 2012-13. The gap between the number of NBFCs

registered with RBI and reported NBFCs was widening, as the

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 RBI was not in a position to track the status of those companies

which defaulted in submission of the annual returns and could

not get any information pertaining to companies which had

would up or changed their business activities.

v The aggregate deposits of NBFCs which stood at Rs. 1,475.70

crores from 1980-81 to Rs. 1,33,279.90 crores in 1996-97 and

within one year immediately it falls to Rs. 23,820 crores in

1997-98 further falls to Rs. 9,557 crores in 2012-13. Whereas in

the case of scheduled commercial banks it was Rs. 37,988 crores

in 1980-81 and went to Rs. 5,05,599 crores in 1996-97 and

gradually increased to Rs. 59,09,082 crores in 2012-13. For

NBFCs, the new concept called public deposits was introduced

with some tight regulations for raising public deposits in 1998.

v The aggregate deposits which stood at Rs. 3,161 crores as on

March 31st 1984 increased to a high level of Rs. 20,438 crores

as on 31st March 1992. The aggregate deposits of NBFCs

registered a sharp increase from Rs. 20,438 crore in 1991 – 92 to

Rs. 40,668.60 crores in 1992-93. This increase was due to the

inclusion of certain items like borrowings from foreign

governments, borrowings from banks and other financial

institutions and money raised by issue of secured or convertible

debenture in the deposits. Consequent upon the inclusion of

certain additional items viz., borrowings from banks and other

financial institutions in the coverage of aggregated deposit from

1992 by the NBFC from external sources, the aggregated

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 deposits of Rs. 20,438.50 crores in 1991-92 to Rs. 44,956 crores

in 1992-93 and further to Rs. 56,559in 1993-94. However,

revenue in the form of FDs grew at a higher rate as RBI relaxed

the ceiling on deposits in terms of NOFs. The aggregate deposit

of NBFCS declined from 1998 to 1999, despite the increase in

growth rate continues to fall due to the tightened regulatory

framework of 1998. After 1998-99 the deposits fell from

Rs. 23,820 crores in 1997-98to Rs. 9,557 crores in 2012-13 due

to the new concept of public deposits meaning deposits received

from public including shareholders in the case of public limited

companies and unsecured debenture/ bonds other than those

issued to companies, banks and financial institution was

introduced for the purpose of focused supervision of NBFCs

accepting such deposits.

v In the wake of liberalization, diversification of the financial

system – institutions and instruments during the mid-nineties

significantly enlarged the scope and activities of NBFCs. The

need for large role for the NBFCs as financial intermediaries

involved in efficient allocation of monetary resources slowly

became evident. The increasing emphasis on global integration

of the economy has created the need for structuring international

services offered by the NBFCs to our traditional markets.

Hence, the product profile changed with the NBFCs shifting

their focus from the traditional fund based activities to non-fund

(fee – based) activities. The new ventures by the NBFC were the

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 source of their survival and growth especially during the mid-

nineties. After 2007-08 there are different categories of

institutions Loan Company, Investment Company, Asset

Finance Company and Residuary NBFC are there, then they

were reduced to two categories like NBFC Loan Company and

Asset Finance Company.

v Having analyzed the sources of fund for the NBFC, it becomes

imperative to discuss the borrowing pattern of NBFCs and the

data relating to the same are presented in Table 4.5 which

indicates that the main sources of funds, fixed deposits

constitute the most important element of total borrowings. The

trend varies at different times, especially after 1996-97 it

reduced to single digit of total borrowings. Another important

element of borrowing is bank borrowing. In 1993, bank credit to

leasing and hire purchase companies was increased from 3 times

to 4 times of the net owned funds. In 1995 due to slackness, the

leasing and hire purchase companies with not less than 75 per

cent of their assets could borrow only 3 times instead of 4 times,

due to which bank borrowings were reduced to 25 per cent.

v A major role is played by the commercial papers, the CAGR of

which was 45.97 in 1998.It includes promissory notes issued by

borrowers to investor. Debentures and bonds are again important

sources of borrowing for NBFCs. It is noteworthy to mention

that during the period after 1994-95, it has shown an upward

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 increase, which consisted Non-Convertible Debentures (NCDs)

and these were tapped in a big way in later half of nineties.

v The stability and soundness of the NBFCs can be measured in

terms of their financial performance. For this study, data were

collected from the analytical study done by the RBI on Financial

and Investment companies every year. The period covered in the

study for 15 years from 1999 to 2013. The compound annual

average of borrowing to total assets (1.022), net worth to total

assets (0.975), debt to net worth (1.029), Profit after tax to Net

worth (1.19), Profit after tax to Total assets (1.175) and Profit

before Interest and taxes to Interest (1.02). Even the ratios of

borrowing to total assets and the debt to net worth are also

relatively more for NBFCs. The borrowing capacity of NBFCs

grew at a faster rate, especially when RBI started considering

loans to them as priority sector lending. In terms of profitability,

annual average rations of PAT to net worth and PAT to total

assets are 1.61 per cent to 15.53 percent and 0.36 per cent to

2.72 per cent from 1999 to 2013.

v The compound annual average of borrowing to total assets from

1999 to 2013(1.022), net worth to total assets (0.975), debt to

net worth (1.029), Profit after tax to Net worth (1.19), Profit

after tax to Total assets (1.175) and Profit before Interest and

taxes to Interest (1.02). Even the ratios of borrowing to total

assets and the debt to net worth are also relatively more for

NBFCs. The borrowing capacity of NBFCs grew at a faster rate,

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 especially when RBI started considering loans to them as

priority sector lending.

v The Net Profit to Total Assets ratio increased from 0.3 per cent

in the year 2000 to 2.7 per cent in the year 2013. Therefore

return on total assets employed is significant and the number of

reported companies is falling from 679 in the year 2000 to 251

in the year 2013 due to tight regulations by the apex institution.

The profitability ratio increased due to constant monitoring by

the regulator.

v The total borrowed fund for NBFCs increased from Rs. 30,117

crore in 1998 to Rs. 91,800crore in 2013 after the rating is

mandatory for raising funds from the above different sources

except public deposits which falls to Rs. 7,100crore from

Rs. 13,571 crores. The ultimate aim of the apex institution is to

protect the deposit holders from fraudulent financial institutions.

The result of this regression shows that the coefficient of

government source is negative. It implies that it affects loans

and advances negatively and the p value is also lesser than 5%

level. The external sources of financing is also negative

coefficient but the p value is more than 5% level therefore the

hypothesis is accepted. The banks and financial institutions role

is positive coefficient but the p value is lesser than 5% level.

The role of debentures, other forms of sources like inter

corporate deposits and commercial paper also influenced the

coefficients positively and the p value is more than 5% level it is

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 also accepted. Whereas the coefficient of public deposits is

negative, the p value is more than 5% level therefore this

hypothesis is accepted.

v The bank credit to total assets of NBFCs is increased from

0.20 per cent in 1991-92 to 27.46 per cent in 2012-13 because

the banks concentrate on priority sector advances through

NBFCs.

v Presently, almost 97 per cent of NBFCs reported a Capital to

Risk-Weighted Assets Ratio (CRAR) of at least the stipulated

minimum of 12 per cent. It is noteworthy that 206 out of the

254 reporting NBFCs (82 per cent) had CRAR above 30 per

cent, 4 had CRAR of less than 12 per cent. The health of the

NBFCs continues to show a distinct improvement in recent

years facilitated by CRAR.

v NBFCs invest in mandatory (SLR) and Non-Mandatory (Non-

SLR) based investments as seen in their balance sheets every

year.

v The NPAs of NBFCs, in both gross and net term, as a

percentage of credit exposure, have been declining in recent

years. NPAs came down to 2.4 per cent in March 2013 from

12 per cent in March 1998. So the NPA of NBFCs is reduced.

v The purposes of regulatory measures were to streamline the

functioning of NBFCs that could place them in the right

perspective. The different committees made few recommendations

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 based on the objectives, however, it was felt by the committee

that the task of regulating NBFCs was a daunting one with a

hope of contributing to some extent in the evolution of a more

efficient and robust NBFCs.

v From the analysis made to assess the impact of financial sector

reforms and global crisis on NBFCs using multiple regression

model, it is observed that the reforms measures and crisis have

brought about changes in the number of reporting NBFCs,

increased growth of different forms of funds mobilized after the

introduction of credit rating mechanism, but have a muted

growth in the volume of deposits, investments, loans and

advances during the post-reform period and after crisis.

v There is a significant difference exists between the pre-reform,

post-reform period and global financial crisis in the number of

reported NBFCs which submitted report to the RBI.

v There is a significant difference existing in the deposits held by

the reported NBFCs during the pre-reform, post-reform period

and global financial crisis.

v There is no significant difference exists between the investments

of NBFCs during the pre-reform, post-reforms periods and

global financial crisis.

v There is no significant difference in the loans and advances of

NBFCs between the pre-reform, post-reforms periods and global

financial crisis.

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v In the specific study made on the select units using CAMEL

model, namely Shriram Transport Finance Ltd., and Mahindra

and Mahindra Finance Ltd., it is found that Shriram Transport

Finance Ltd., has shifted to the pan India player in vehicle

financing due to heavy competition from hire purchasing space.

The high provisioning norms as lay down by the regulatory

framework and downward trend in vehicle financing after crisis

due to high oil prices and inflationary situation in the country

has affected the business opportunities, as a result of which it

started diversifying its business activities into consumer finance

activities for electronic goods and gadgets.

v The another leading player in the hire purchase finance space

Mahindra and Mahindra Finance has showed tremendous

growth in terms of its business and efficient working during the

post crisis period. The high provisioning norms as laid down by

the regulatory framework affected the profitability of this giant

resulting in a declining business. The post reform period has

been witnessing an overall growth in the automobile sector but

after crisis it is falling. But after crisis the small light

commercial vehicles, tractors and multi utility vehicles has been

influencing the business of the company and has helped to

achieve the health growth in the disbursements of hire purchase

and hypothecation loans of the company. The company

maintained a healthy market share in the tractor and small light

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 commercial vehicles segment, despite intense competition from

NBFCs and banks. The improved performance of the

commercial vehicle sector during the post reform period,

especially late nineties, is due to the significant investments in

the infrastructure sector especially roads.

v The performance of hire purchase companies directly depends

upon the demand for automobiles. The hire purchase business

flourished during the first half of nineties as there was heavy

demand for trucks. Later, during the second half, the demand for

cars and small utility vehicles for cargo was higher than the

demand for trucks. Hence, hire purchase companies could

survive and sustain with their present level of demand for car

and automobiles. The companies like TVS, Ashok Leyland,

Mahindra and Mahindra, Bajaj Auto and TATA carry on with

manufacturing of automobiles along with vehicle loan finance

for their vehicles. Hence, hire purchase business has greater

scope for this steady and continuous demand for automobiles

and consumer goods.

v CAMEL provides a measurement of NBFCs current overall

financial, managerial, operational and compliance performance.

Thus the current study has been conducted to examine the

overall performance of Mahindra and Mahindra Financial

Services and Shriram Transport Finance Company.

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 v The study revealed that Shriram Transport Finance Company

excelled over M&M Financial Services in protecting the interest

of the creditors.

v Shriram Transport Finance Company proved to be good in Asset

Quality perspective.

v Shriram Transport Finance Company performed better than

M&M Financial services in case of TA/TD and proved to be

good in Profit per employee perspective.

v Shriram Transport Finance outperformed M&M Financial

Services in front of quality of earnings.

v The two sample NBFCs do not differ significantly in liquidity

position during the study period.

v The study also revealed that Shriram Transport Finance

Corporation was rated top on the basis of overall performance.

CHALLENGES FACED BY NBFCs IN INDIA

Here are some of the challenges faced by NBFCs and their

impact on business model and profitability of NBFCs.

Dependence on Banks for Resources and Impact on Profitability

A shallow bond market has forced NBFCs to rely on banks for

their funding needs to a large extent. The analysis shows that over one third of

total liabilities of NBFCs were loans provided by banks. This ratio will be

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even higher for smaller NBFCs. It is ironical to an extent because, on one

hand, the NBFCs heavily rely on banks for the funds; while on the other hand,

they compete with same banks on originating assets. Till late 1990s, public-

deposits formed a substantial portion (27 per cent) of NBFCs’ liabilities.

However, some unfortunate events like series of defaults and misdemeanors

by a few NBFCs have led RBI to prescribe fairly restrictive guidelines on

acceptance of public-deposits by NBFCs. The resource crunch on one hand

and entry of banks in retail lending segment in a big way has had a deep

impact on the profitability of NBFCs. Growing competition from the banking

sector has impacted the core profitability of non-banking finance companies

(NBFCs). A number of NBFCs operate in businesses where banks have a

presence; also, of late, banks have acquired dominant positions in these

businesses, resulting in a contraction in business opportunities as well as

interest spreads for most NBFCs.

Banks are able to offer better returns to their shareholders than

NBFCs can; this is because banks have lower costs of funds, higher leverage

levels, and dominant market positions. However, the analysis reveals that

notwithstanding serious business handicaps, some NBFCs reported healthy

profitability by refocusing on business segments where banks are yet to

acquire a major presence.

No Access to Refinance

NBFCs face a high cost of funds compared to the banks partly

because of the fact that NBFCs do not have any access to refinance like banks

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and Housing Finance Companies (HFCs) have. Banks have access to

refinance limits from several state-run agencies like RBI, EXIM Bank,

NABARD and SIDBI. Similarly, HFCs regularly obtain refinance from

National Housing Bank (NHB), who is also the regulator for HFCs. The

refinance facilities help the banks and HFCs iron out any mismatch between

assets and liabilities.

NBFCS on the other hand, have to depend on their competitors,

banks, or the capital markets for raising resources at all points of time. This

situation is fraught with risks for the health of NBFC sector and can prove

detrimental to the sustainability of their growth as in the case of any distress,

flow of funds for them from above sources could dry up without much notice.

A really dependable remedy for such situations can only be a

state-run agency providing refinancing facility to NBFCs. As a starting point,

the refinance assistance can be provided to the NBFCs engaged in providing

credit to the sectors which are important for the economic growth viz.

infrastructure, transport, etc. Once the system stabilizes, it can also be

extended to other lending products.

It is pertinent to mention in this context that the Standing

Committee of the Parliament which was given the task of reviewing the

Financial Companies Regulation Bill, 2000 had strongly recommended to the

government to set up a separate refinancing institution for NBFCs on the lines

provided to housing finance companies.

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Access to ECB Funding for NBFC-AFCs

Both the banks and NBFCs had free access to External

Commercial Borrowing(ECB) earlier. However, currently there are

restrictions in accessing ECB for banks and NBFCs in that:

· Prior RBI approval is required

· RBI approval is given for ECB on a case to case basis only for

importing equipments for use in infrastructure projects. In other

words, such funding is not available for indigenously

manufactured equipments, which is a clear discrimination. Such

funding has to be for a minimum period of 5 years.

ECBs typically come for longer term and generally match the

length of the infrastructure projects(s) to fund which these are raised. Keeping

in view the non-availability of long term funds in adequate measure in India

and the requirements of infrastructure projects (estimated at US$475Bn), there

is clearly a very strong case for the Government to allow NBFC-AFCs in the

infrastructure project financing, vehicle financing and equipment financing

segments, to access External Commercial Borrowings (ECBs) in the same

manner as banks can. This would enable such NBFCAFCs to access long-

term funds at competitive rates from the global financial market and to

channelise those funds into financing of infrastructure projects and productive

assets, which in turn has a multiplier effect on employment generation.

No Access to SARFAESI for Recovery from Bad Loans

The Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest Act, 2002 (SARFAESI) empowered Banks /

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Financial Institutions to recover their non-performing assets without the

intervention of the Court. A CRISIL analysis on asset quality of banking

system indicates that the gross and net NPAs have continuously declined over

the last seven years in percentage as well as absolute terms. Gross NPAs have

declined to 2.5 per cent as on March 31, 2007 compared to GNPA of 8.8 per

cent and slippages of 3.4 per cent as at March 31,2003. Banks have actively

utilized SARFAESI since its enactment in 2002-03 for improving their

recoveries; recoveries through this route have increased from 1.7 per cent of

gross NPAs in 2003-04 to 6.6 per cent of gross NPAs in 2005-06.

On the other hand, NBFCs have traditionally been able to

achieve superior results than banks in maintaining a better asset quality

despite not having any access to effective recovery tools like SARFAESI; this

has been because NBFCs are primarily driven by better credit appraisal and

underwriting standards. As discussed in previous chapters, as NBFCs

primarily provide credit to economically weaker sections of the society, which

will be the first to be affected in case of any economic downturn, there is a

compelling case for extending the benefits of potent recovery tools like

SARFAESI uniformly to NBFCs as well.

This is all the more necessary considering the spate of court

pronouncements, of late, against the repossession of assets by banks and

NBFCs.

Debt Recovery Tribunals (DRTs)

Further, the Asset Finance Corporations (AFCs) need to be

granted access to DRTs to enable speedier realization of their dues.

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Government may consider increasing the number of DRTs if the existing

setup is found inadequate. This would be necessary to strengthen the recovery

mechanism for NBFCs which are already resource strapped.

No Insurance for Public Deposits Held by NBFCs

Deposits kept in banks are insured by a state-run agency,

Deposit Insurance and Credit Guarantee Corporation (DICGC). DICGC

insures the depositor upto a maximum of Rs 1,00,000 and it will be liable to

pay if either the bank is liquidated or it is reconstructed or amalgamated /

merged with another bank. Deposit-taking NBFCs (NBFCs-D) do not enjoy

any such advantage. Non-banking finance institutions in the US are treated at

par with the banks on this aspect as deposits of both are insured by insurance

agencies. Given the fact that NBFCs in India are lending to sectors which are

important for overall economic growth, there is a strong case for comparable

institutional support being extended to the NBFCs as well in order to protect

their competitiveness and to provide support and sustenance in times of

distress.

Limited Capital Enhancing Options

RBI has provided banks with various capital-enhancing options

in recent past. In February 2006, banks were allowed to issue several forms of

hybrid capital – both as Tier I and Tier II capital. More recently, banks have

been allowed to issue preference shares to further augment their capital base.

As entities which are competing with banks for originating the same assets,

NBFCs have not been provided level-playing field for raising capital. The

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only way in which NBFCs can raise core capital is through equity capital or

Tier II bonds.

The global players having NBFC subsidiaries in India have

regularly pumped in capital as RoE offered by these subsidiaries are

comparable to that of any of their other businesses worldwide. Also, some of

the larger NBFCs which do not enjoy parent support have regularly tapped

global capital markets though American Depository Receipt (ADR) and

Global Depository Receipt (GDR) issues or have roped in private equity /

venture capital partners. It needs to be noted that all the above capital raising

options have high cost attached to them and put immense pressure on NBFCs

to take risks and deliver supernormal returns to the shareholders. On the other

hand, the banks have been provided capital enhancing options which are

comparatively less costly and let the banks focus on the core business

activities rather than taking excessive risks.

Registration of NBFCs under State Money Lender Laws by some of

the State Governments is Retrograde

Despite being subject to the comprehensive and a constantly

evolving, regulatory and supervisory scheme of Reserve Bank of India, in

some of these states, NBFCs are now being asked to register under their

money lenders act apart from registration with RBI. This is acting as a

hindrance for efficient functioning of the NBFC’s and is resulting in our

member NBFCs suffering from complexities, and contradictions, of multiple

regulations and having to comply with differing legislations of each of these

states.

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 Legislations for controlling the activities of money lending by

private moneylenders were enacted by states of India as part of their

legislative domain with a view to preventing their exploitative money lending

practices and to thus protect farmers and other vulnerable sections of society,

particularly in rural areas. To equate the role of NBFCs with private

moneylenders is not appropriate in view of significant role played by NBFCs

in financial inclusion and economic development.

NBFCs offer credit and financing for development purposes

rather than merely lending money to earn interest income unlike the private

moneylenders. Their products are based on risk and credit parameters and

each product therefore also does not carry the same rate of interest. The

pricing of each product is based on an assessment of the 25 associated costs,

market segment and returns. Thus there is a need for setting a different

interest rate in each state, for each product or lending.

NBFC’s need to take into account their individual actual cost of

funds, borrowings, capital, credit, risk, operating expenses, and a minimum

margin to cover regulatory requirement of provisioning /capital charge and

profit margin. It is therefore not possible to stipulate a ceiling on interest, or

fix a standard rate of interest, for all NBFCs and/or for all types of facilities

and credit that NBFCs provide. Appreciating this, the Reserve Bank of India,

just as in the case of banks, has deemed it appropriate to not regulate the

interest rates of NBFCs but has advised NBFCs to ensure transparency and

appropriate internal principles and norms.

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Incompatible and Differential Treatment on Matters Relating to

Taxation

a. Sec.36 (1) (viia) / 43D Of the Income Tax Act, 1961 - Benefits

allowed to the banks and housing finance companies, but NBFC-

AFCs left out

Under the existing provisions u/s 36(1)(viia) of the Income-Tax

Act, a provision for bad and doubtful debts made by banks and financial

institutions is allowed as a deduction to the extent of 7.5% from the gross total

income. Alternatively, such banks and FIs have been given an option to claim

a deduction in respect of any provision made for assets classified by the RBI

as doubtful assets or loss assets to the extent of 10% (increased from 5%) of

such assets.

NBFC-AFCs are also compulsorily required to make provisions

for Non-Performing Assets (NPAs). However, provisions made by NBFC-

AFCs in line with such prudential norms fixed by RBI are disallowed by tax

authorities when assessing their income tax liabilities. These provisions made

against NPAs are in the nature of business expenses incurred wholly and

exclusively for business operations by an NBFC-AFC as mandated by the

regulator.

Banks / HFCs / FIs enjoy tax benefit on income deferred as per

RBI directives on NPA. NBFC-AFCs are also required to follow these

prudential norms as per RBI directives, but they are the only segment of the

financial sector denied this tax benefit.

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b. Exemption to NBFC-AFCs from TDS Requirements U/s 194A (3)

(iii) of The I.T. Act - Benefit allowed to banks, but NBFC-AFCs left

out

As per Section 194A of the Income Tax Act 1961, tax has to be

deducted out of the interest payments made by specified borrowers to the

lender at the rates in force. The rates vary depending on the constitution of the

payee (lender). For the category of domestic companies in which NBFC-

AFCs fall, the rate of TDS is presently 22.44% including surcharge of 10%

and education cess of 2%.

Banking companies, Cooperative societies engaged in banking

business, public financial institutions, LIC, UTI, Insurance companies and

some other notified institutions are exempted from the purview of this section,

implying that if the payment of interest is made to these entities, the borrower

is not required to deduct TDS out of the interest payment. This is not available

to NBFC-AFCs even though they are in similar lending activities.

Consequently, their margins and cash flow are severely affected.

c. TDS on Financial Lease Rental Payments Under Section 194 -I of

Income Tax Act – Gross Lease Rental Subjected to TDS and not the

Interest Portion Alone

Section 194-I of the Income Tax Act, deals with TDS on rent

payments. The present TDS rate is 22.44% (20% TDS + 10% surcharge + 2%

education cess). In this section, the definition of ‘rent ’ has been enlarged to

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include lease, sub-lease, tenancy or any other agreement or arrangement for

use of machinery, plant, equipment etc. besides land and buildings.

NBFC-AFCs operate on very thin margins. On that, if a 20%

TDS is applied on gross lease rentals, this will result in negative cash flows. It

must be pointed out that unlike renting, leasing is a mode of financing and

major portion of lease rentals includes repayment of principal just like a loan

repayment. If TDS is deducted on entire lease rental, it means not only will

the TDS be deducted on the interest, but also on the principal amount. This

can spell disaster for the NBFC-AFC sector in India leading to its extinction.

Indirect Tax Issues

a. Service Tax on Hire Purchase/ Lease Transactions - 90% of

Finance Charges/ Interest Exempt From Service Tax

Service tax on the interest component of Lease/HP transactions

though has been removed to the extent of 90%, 10% of the interest component

in a Lease/Hire-Purchase transaction still continues to be subject to levy of

service tax whereas the basic objective was to bring parity between a simple

loan transaction and a Lease/Hire-Purchase transaction. Levy of service tax @

12.24%, even on the 10% of interest component makes Lease/Hire-Purchase

costlier to the borrower and so economically unfavourable as compared to a

loan transaction where 100% of the interest component is exempted from the

levy of service tax.

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b. Treatment of Hire Purchase & Lease Transactions – Multiplicity

of Taxes

· As per the 46th Amendment to the Constitution of India, Hire

Purchase & Lease Transactions are defined as deemed ‘sale’

activities. As such, they were subject to sales tax @ 4 to 14% in

different states and are now subject to Value Added Tax (VAT) in

all the states.

· Finance Act, 2001 defined Hire Purchase & Lease Transactions as

“service” and as such, the interest component in these transactions

is subject to service tax @ 12.24%.

· The Lease Rentals /Hire Purchase transactions are also subject to

Tax Deduction at Source (TDS).

· The Income Tax Department looks at all lease transactions with

suspicion. As such, depreciation benefits to the lessor (who is the

owner of the asset) are often denied.

At various instances, the same transaction is being treated as

Sale Transaction, Finance and Service simultaneously. This anomaly and

confusion has created enough regulatory problems, which will compound

further in future and will be severely detrimental to the interest of every player

in the economy.

As a result of multiple taxation, hire purchase/ leasing, which

has a critical role to play in the Indian economy, is being killed by making

such transactions economically unviable. This can only nullify the

government’s efforts to increase tax revenues from this segment.

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 The challenges for NBFCs are thus quite a few. It is however

noteworthy that many of these can be addressed by just providing them a level

playing field with the other players in the game. In most cases no new law,

concessions, arrangements or institutions need be created specially for the

NBFCs and all that needs to be done is that the existing arrangements for and

the support structure provided to the other participants in the same system be

extended to them as well without any differentiation.

Roadblocks

However, for NBFCs to contribute effectively in future, the

regulatory framework needs to address the roadblocks to growth of the NBFC

sector. These are highlighted below:

· Absence of any refinancing agency for the sector, combined with

restrictive caps on banks’ lending to the NBFC sector.

· Limited access to ECB funding, which would help address funding

cost and tenure issues

· Restrictions on issuing hybrid financial instruments for meeting

regulatory capital needs

· No access to SARFAESI and Debt Recovery Tribunals for recovery

of bad loans

· Multiplicity of taxes combined with differential and discriminatory

tax treatment of the sector

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SUGGESTIONS

Looking ahead, the objectives of financial inclusion and

balanced economic growth pose significant challenges for the financial sector

given the size and uniqueness of the Indian economy. The relative

underdevelopment of rural and semi-urban segments; low investment in

agriculture; the need to develop self-employment opportunities; the need to

create equal opportunities and economic empowerment for women and

backward groups are amongst the many challenges that require quick and

innovative solutions.

As a huge emerging economy, India offers unprecedented

challenges as well as exciting opportunities for players in the financial sector.

Addressing customer needs and providing credit and financial services to

large segments of the un-banked and underserved population will require

unique and innovative solutions, which NBFCs are well placed to provide.

There is a space in the market and there is a market in such space. The act of

discovery does not lie in looking for new lands alone, but also looking with

new eyes. Ancient Indian wisdom says, ‘when you shut one eye, you don’t

hear everything’.

Some of the specific suggestions that will form an increasingly

large part of NBFC activities in future will be

· Acting as a Distribution Backbone for Insurance Companies

With low insurance penetration in India, customised products

are needed for low-income groups in the semi-urban and rural market who

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typically, are NBFC customers. As with banks, NBFCs are likely to evolve

synergistic models with insurance companies, whereby they not only provide

distribution services, but also offer their customer base and provide feedback

on product performance and customer needs.

· Distribution of Mutual Fund Products

Given the rapid growth in the mutual fund industry, MF

products will percolate into the semi-urban markets initially and seep into

rural markets at a later point in time to tap investible surpluses. These markets

are challenging and will require innovation in product offerings; NBFCs are

well placed to work as partners with mutual funds in developing these

markets.

· Providing Collection Services for Portfolios Originated by Banks

and Other NBFCs

Typically, NBFCs have robust collection mechanisms while

banks generally depend on third party service providers for support in

collection. As both set of players are regulated by the RBI, it is healthy for the

financial sector (given the problems in enforcing operating guidelines for

multifarious agencies operating in this area) that NBFCs and banks develop a

collaborative relationship in collections, to the extent limited or partial

recourse guarantees are provided by the collecting party. This also helps the

originating party in rating its assets and in securitisation.

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· Buyout and Servicing of Retail NPA’s

This is at a nascent stage in India. The asset buyout and

restructuring business is focused almost entirely on corporate assets; however,

the rapid growth in retail asset portfolios creates a similar need for entities that

will acquire and generate a yield from stressed asset portfolios. As low-cost

operators, NBFCs are better suited to play this role, which is critical in

maintaining the health of the retail financial sector. This activity plays a vital

role in freeing up capital for lending institutions, which can be used

productively. However, as a pre-requisite, the current restrictions placed on

NBFCs in accessing the legal and judicial framework for recoveries need to

be removed.

· Providing a Single-Window for Meeting the Borrowing and

Investment Needs of Individuals and SME Enterprises

With 50% of the population not having bank accounts and

lacking access to organised credit, the ability of NBFCs to address the needs

of low-income groups and small businesses supplements the role of banks. By

expanding their own product offerings as well as acting as distributors for

larger financial institutions, NBFCs have been able to serve customer needs

while generating a fee-based income stream for themselves, which also helps

in de-risking their operating models. Typically the relationship between the

NBFCs and banks would be that of ‘Retailer-Wholesaler’, where the retailer

would provide last mile delivery in a more effective manner than banks,

particularly in semi-urban and rural markets.

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· Leasing

Flawed policies relating to taxation on leasing transactions has

driven the leasing industry into a comatose situation. An emerging economy

needs a vibrant leasing sector, as this stimulates the growth of SME

enterprises. Typically, smaller enterprises that lack capital use operating

leases as a tool to overcome the investment barrier to growth. NBFCs have a

large role in this segment, as they better understand the needs of smaller

enterprises.

· Improving Corporate Governance Standards

To become real game changers, business transparency is

inevitable for any financial entity. In the case of NBFCs, there is an

imperative for adopting good corporate governance practices. RBI has already

prescribed a governance code for NBFCs as part of their best practices; these

include constitution of risk management, audit and nomination committees,

disclosure and transparency. When due diligence was undertaken on

significant shareholders and directors at the time of registration it was

observed there are no prescriptions for qualifications for directors, change in

directors, etc.

· Customer Protection Issues

Protection of customers against unfair, deceptive or fraudulent

practices has become top priority internationally after the crisis. Incidentally,

the Bank has received and is receiving number of complaints against charging

of exorbitant interest rates, raising of surrogate deposits under the garb of non-

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convertible debentures, various types of preference shares, Tier II Bonds, etc.

Aggressive practices in re-possessing of automobiles in the case of auto loans

and improper/opaque practices in selling the underlying gold jewellery in the

case of gold loans are the two categories in which relatively more complaints

are received and are being received by the Reserve Bank. NBFCs are often

found not to practice Fair Practices Code (FPC) in letter and spirit.

Developing a responsive and proper grievance redressal mechanism is the

more important agenda in the context of this action point.

· Greater Innovation

Although NBFCs have been designing innovative products to

suit the client and market conditions, the sophistication of financial services

has been gradually increasing in the recent past. There is an imperative need

for NBFCs to aggressively involve in designing innovative products to

become real game changers in the economy.

In this context, a cue may be taken from the description of daily

financial lives of poor people given in detail in “Portfolios of the Poor,” a

prominent investigation into the everyday problems which they face (Collins,

Kulkarni and Gavron, 2009). It is stated therein that typical low income

families used some 10 different financial instruments, several channels of

transport for money and multiple ways of keeping money safe. Their

fundamental protection against financial risk is diversification, knowledge

about counterparties and the judicious exploitation of relationships that are

expected to last. NBFCs should closely study such behaviour of poor people

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taking advantage of the last mile connectivity which they do possess, to craft

innovative products.

White Label ATMs

As NBFCs already have significant business presence in semi-

urban and rural centres, there is a case for them to explore business potential

by establishing white label ATMs in such areas.

Need for a Supportive Legal Infrastructure

Supporting laws such as those governing accounting rules,

property rights and contract enforcement will be of prime importance to the

future growth of NBFCs. A study done by the World Bank (Levine, Loayza

and Beck -1999:28) on the relationship between legal infrastructure and

financial development finds that “Countries with

· Laws that give a high priority to secured creditors,

· Legal system that rigorously enforce contracts, and

· Accounting standards that produce comprehensive and comparable

corporate financial statements tend to have better-developed

financial intermediaries.”

Fast track recovery mechanism, like repossession of assets in

case of default will hold the key. With huge backlog of pending cases before

various courts across the country leading to long delays, a system of

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repossession using “private” means within the country’s legal framework will

ensure a healthy recovery trend.

CONCLUSION

NBFCs are already game changers, as can be seen from the

analysis earlier in areas of financial inclusion, especially micro finance,

affordable housing, second hand vehicle finance, gold loans and infrastructure

finance. NBFCs can play a vital role going forward, in closing the loop as

regards financial inclusion for individuals and MSMEs. As regards

individuals, NBFCs can after various financial products offered by the

securities industry, viz., shares, mutual funds, depository services etc., as also

insurance products both life and non-life together with their current product

offerings. As regards MSMEs, NBFCs can become game changers by

providing factoring and bill payment service which are of critical importance

at the present juncture.

The way forward is to ensure that both the NBFI sector and all

the concerned regulators play an active part in attending on the imperatives

mentioned at above. The complimentary role of the financial sector and all the

regulators hardly needs overemphasis in the context of NBFCs morphing as

game changers for providing the last mile connectivity and closing the loop as

regards financial inclusion. In this context, NBFCs have a special

responsibility against the background of the need to improve the customer

service by conducting their operations as per the best practices of corporate

governance.

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 In the ultimate analysis, adhering to best corporate governance

and ethical practices is the only way for gaining the confidence of their

customers in particular, and the society in general. Consequently, the NBFC

sector would be able to garner greater trust of both its customers and the

society. That would provide the springboard for increasing their business

levels in the process of fulfilling their role as game changers in the areas

mentioned above. NBFCs becoming true game changers would be a sweetener

for financial inclusion efforts in our country.

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