NON-BANKING FINANCIAL COMPANIES

SUBMITTED TO

MR. INDRANIL BANERJEE

(FACULTY OF BANKING LAW)

SUBMITTED BY

AMIT GROVER

BBA LLB(H)

SECTION B

A3221515130
 DECLARATION

I declare that the dissertation entitled “Concept of non-banking financial institution” is the
outcome of my own work conducted under the supervision of Mr. Indranil Banerjee
Assistant Professor of Law at Amity Law School, Amity University. Noida U.P.
I further declare that to the best of my Knowledge the dissertation does not contain any part
of any work, which has been submitted for the award of any degree either in this University
or in any other University/Deemed University without proper citation.

Amit Grover

Dated: 22th Oct, 2018

 ACKNOWLEDGMENT

I take this opportunity to express a deep sense of gratitude to my Banking Law teacher Mr.
Indranil Banerjee, for her cordial support, valuable information and guidance, which helped me
in completing this task through various stages.

Also, I thank the almighty, my parents and all those who have helped me for their constant
encouragement without which this assignment would not have been possible.
 CONTENTS

CHAPTER 1- INTRODUCTION

CHAPTER 2- MEANING OF NON-BANKING FINANCIAL COMPANY

CHAPTER 3- NBFC VS CONVENTIONAL BANKS

CHAPTER 4- CLASSIFICATION OF NBFC

CHAPTER 5- ROLE OF NON-BANKING FINANCIAL COMPANY

CHAPTER 6- SIGNIFICANCE OF NBFC IN INDIA

CHAPTER 7- EVOLUTION OF NBFC IN INDIA

CHAPTER 8- CONCLUSION
 CHAPTER 1
INTRODUCTION

We studied about banks, apart from banks the Indian Financial System has a large number of
privately owned, decentralized and small sized financial institutions known as Non-banking
financial companies. In recent times, the non-financial companies (NBFCs) have contributed to
the Indian economic growth by providing deposit facilities and specialized credit to certain
segments of the society such as unorganized sector and small borrowers. In the Indian Financial
System, the NBFCs play a very important role in converting services and provide credit to the
unorganized sector and small borrowers.

NBFCs provide financial services like hire-purchase, leasing, loans, investments, chit-fund
companies etc. NBFCs can be classified into deposit accepting companies and non-deposit
accepting companies. NBFCs are small in size and are owned privately. The NBFCs have grown
rapidly since 1990. They offer attractive rate of return. They are fund based as well as service
oriented companies. Their main companies are banks and financial institutions. According to
RBI Act 1934, it is compulsory to register the NBFCs with the Reserve Bank of India.

The NBFCs in advanced countries have grown significantly and are now coming up in a very
large way in developing countries like Brazil, India, and Malaysia etc. The non-banking
companies when compared with commercial and co-operative banks are a heterogeneous
(varied) group of finance companies. NBFCs are heterogeneous group of finance companies
means all NBFCs provide different types of financial services.

Non-Banking Financial Companies constitute an important segment of the financial system.

NBFCs are the intermediaries engaged in the business of accepting deposits and delivering
credit. They play very crucial role in channelizing the scare financial resources to capital
formation.

NBFCs supplement the role of the banking sector in meeting the increasing financial need of the
corporate sector, delivering credit to the unorganized sector and to small local borrowers. NBFCs
have more flexible structure than banks. As compared to banks, they can take quick decisions,
assume greater risks and tailor-make their services and charge according to the needs of the
clients. Their flexible structure helps in broadening the market by providing the saver and
investor a bundle of services on a competitive basis.

Non-Banking Finance Companies (NBFCs) are a constituent of the institutional structure of the
organized financial system in India. The Financial System of any country consists of financial
Markets, financial intermediation and financial instruments or financial products. All these
Items facilitate transfer of funds and are not always mutually exclusive. Inter-relationships
Between these are parts of the system e.g. Financial Institutions operate in financial markets and
are, therefore, a part of such markets.

NBFCs at present providing financial services partly fee based and partly fund based. Their fee
based services include portfolio management, issue management, loan syndication, merger and
acquisition, credit rating etc. their asset based activities include venture capital financing,
housing finance, equipment leasing, hire purchase financing factoring etc. In short they are now
providing variety of services. NBFCs differ widely in their ownership: Some are subsidiaries of
large Manufacturers (e.g., T.V. Motors T.V. Finances and Services Ltd). Many others are owned
by banks such as ICICI Banks, ICICI Securities Ltd, SBI Capital Market Ltd, Muthoot Bankers
Muthoot Financial Services Ltd a key player in Kerala financial services. Other financial
institutions are IFCIs IFCI Financial Services Ltd or IFCI Custodial Services Ltd (Devdas,
2005).
Non-banking Financial Institutions carry out financing activities but their resources are not
directly obtained from the savers as debt. Instead, these Institutions mobilize the public savings
for rendering other financial services including investment. All such Institutions are financial
intermediaries and when they lend, they are known as Non-Banking Financial Intermediaries
(NBFIs) or Investment Institutions.

The term “Finance” is often understood as being equivalent to “money”. However, final exactly
is not money; it is the source of providing funds for a particular activity. The word system, in the
term financial system, implies a set of complex and closely connected or inter-linked Institutions,
agents, practices, markets, transactions, claims, and liabilities in the Economy. The financial
system is concerned about money, credit and finance. The three terms are intimately related yet
are somewhat different from each other:

 Money refers to the current medium of exchange or means of payment.

 Credit or loans is a sum of money to be returned, normally with interest; it refers to a debt
 Finance is monetary resources comprising debt and ownership funds of the state, company
or person.

CHAPTER 2

WHAT IS A NON-BANKING FINANCIAL COMPANY (NBFC)?

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act,
1956 engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or other
marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business
but does not include any institution whose principal business is that of agriculture activity,
industrial activity, purchase or sale of any goods (other than securities) or providing any services
and sale/purchase/construction of immovable property. A non-banking institution which is a
company and has principal business of receiving deposits under any scheme or arrangement in
one lump sum or in installments by way of contributions or in any other manner, is also a non-
banking financial company (Residuary non-banking company).1

Section 45I of the Reserve Bank of India Act, 1934 defines ‘‘non-banking financial company’’
as– (i) a financial institution which is a company;

(ii) 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;

1
https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92
(iii) such other non-banking institution or class of such institutions, as the Bank may, with the
previous approval of the Central Government and by notification in the Official Gazette, specify;

Hence in short an NBFC may be defined as a company registered under the Companies Act,
1956 and also registered under the provisions of Section 45-IA of the Reserve Bank of India Act,
1934 and which provides banking services without meeting the legal definition of bank such as
holding a banking license. NBFCs are basically engaged in the business of loans and advances,
acquisition of shares/stocks/bonds/debentures/securities issued by government or local authority
or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit
business but does not include any institution whose principle business is that of agricultural
activity or any industrial activity or sale, purchase or construction of immovable property.

CHAPTER 3

NBFCS VS. CONVENTIONAL BANKS

 An NBFC cannot accept demand deposits, and therefore, cannot write a checking facility.
 It is not a part of payment and settlement system which is precisely the reason why it
cannot issue cheques to its customers.
 Deposit insurance facility of DICGC is not available for NBFC depositors unlike in case
of banks.
 SARFAESI Act provisions have not currently been extended to NBFCs. Besides the
above, NBFCs pretty much do everything that banks do.
 CHAPTER 4

CLASSIFICATION OF NBFCS BASED ON THE NATURE OF ITS

BUSINESS

The NBFCs that are registered with RBI are basically divided into 4 categories depending upon
its nature of business:

 equipment leasing company

 hire-purchase company
 loan company
 investment company
 Infrastructure finance company

However, in terms of the NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 1988
with effect from December 6, 2006 the above NBFCs registered with RBI have been reclassified
as: ¾

 Loan Company (LC) - Loan company means any company which is a financial institution
carrying on as its principal business the providing of finance whether by making loans or
advances or otherwise for any activity other than its own but does not include an Asset
Finance Company. ¾
 Investment Company(IC) - Investment Company is a company which is a financial
institution carrying on as its principal business the acquisition of securities.

Investment Companies are further divided into following subcategories:

a) Core Investment Companies: The Reserve Bank of India added a new class of
NBFCs by the name of ‘Core Investment Companies’ (CIC). It generally means a
non-banking financial company carrying on the business of acquisition of shares and
securities.
b) Other Companies
  Asset Finance Company (AFC): AFC would be defined as any company which is a
financial institution carrying on as its principal business the financing of physical
assets supporting productive / economic activity, such as automobiles, tractors, lathe
machines, generator sets, earth moving and material handling equipments, moving on
own power and general purpose industrial machines. Financing of physical assets
may be by way of loans, lease or hire purchase transactions. Principal business for
this purpose is defined as aggregate of financing real/physical assets supporting
economic activity and income arising there from is not less than 60% of its total
assets and total income respectively.
 Mutual Benefit Financial Company (MBFC): Mutual Benefit Financial Company
means a company which is a financial institution notified by The Central
Government under section 620A of The Companies Act 1956.

The above-mentioned types of NBFCs may be further classified into:

1. NBFCs accepting public deposit (NBFCs-D) and

2. NBFCs not accepting/holding public deposit (NBFCs-ND).

CHAPTER 5

ROLE OF NON- BANKING FINANCIAL COMPANIES

(1) Promoters Utilization of Savings:

Non- Banking Financial Companies play an important role in promoting the utilization of savings
among public. NBFC’s are able to reach certain deposit segments such as unorganized sector and
small borrowers were commercial bank cannot reach. These companies encourage savings and
promote careful spending of money without much wastage. They offer attractive schemes to suit
needs of various sections of the society. They also attract idle money by offering attractive rates
of interest. Idle money means the money which public keep aside, but which is not used. It is
surplus money.
(2) Provides easy, timely and unusual credit:

NBFC’s provide easy and timely credit to those who need it. The formalities and procedures in
case of NBFC’s are also very less. NBFC’s also provides unusual credit means the credit which is
not usually provided by banks such as credit for marriage expenses, religious functions, etc. The
NBFC’s are open to all. Every one whether rich or poor can use them according to their needs.

(3) Financial Supermarket:

NBFC’s play an important role of a financial supermarket. NBFC’s create a financial supermarket
for customers by offering a variety of services. Now, NBFC’s are providing a variety of services
such as mutual funds, counseling, merchant banking, etc. apart from their traditional services. Most
of the NBFC’s reduce their risks by expanding their range of products and activities.

(4) Investing funds in productive purposes:

NBFC’s invest the small savings in productive purposes. Productive purposes mean they invest
the savings of people in businesses which have the ability to earn good amount of returns. For
example – In case of leasing companies lease equipment to industrialists, the industrialists can
carry on their production with less capital and the leasing company can also earn good amount of
profit.

(5) Provide Housing Finance:

NBFC’s, mainly the Housing Finance companies provide housing finance on easy term and
conditions. They play an important role in fulfilling the basic human need of housing finance.
Housing Finance is generally needed by middle class and lower middle-class people. Hence,
NBFC’s are blessing for them.

(6) Provide Investment Advice:

NBFC’s, mainly investment companies provide advice relating to wise investment of funds as well
as how to spread the risk by investing in different securities. They protect the small investors by
investing their funds in different securities. They provide valuable services to investors by
choosing the right kind of securities which will help them in gaining maximum rate of returns.
Hence, NBFC’s plays an important role by providing sound and wise investment advice.

(7) Increase the Standard of living:

NBFC’s play an important role in increasing the standard of living in India. People with lesser
means are not able to take the benefit of various goods which were once considered as luxury but
now necessity, such as consumer durables like Television, Refrigerators, Air Conditioners,
Kitchen equipments, etc. NBFC’s increase the Standard of living by providing consumer goods on
easy installment basis. NBFC’s also facilitate the improvement in transport facilities through hire-
purchase finance, etc. Improved and increased transport facilities help in movement of goods from
one place to another and availability of goods increase the standard of living of the society.

(8) Accept Deposits in Various Forms:

NBFC’s accept deposits forms convenient to public. Generally, they receive deposits from public
by way of depositor a loaner in any form. In turn the NBFC’s issue debentures, units’ certificates,
savings certificates, units, etc. to the public.

(9) Promote Economic Growth:

NBFC’s play a very important role in the economic growth of the country. They increase the rate
of growth of the financial market and provide a wide variety of investors. They work on the
principle of providing a good rate of return on saving, while reducing the risk to the maximum
possible extent. Hence, they help in the survival of business in the economy by keeping the capital
market active and busy. They also encourage the growth of well- organized business enterprises
by investing their funds in efficient and financially sound business enterprises only. One major
benefit of NBFC’s speculative business means investing in risky activities. The investing
companies are interested in price stability and hence NBFC’s, have a good influence on the stock-
market. NBFC’s play a very positive and active role in the development of our country.
 CHAPTER 6

SIGNIFICANCE OF NBFCS IN INDIA

According to the Economic Survey 2010-11, it has been reported that NBFCs as a whole account
for 11.2 per cent of assets of the total financial system. With the growing importance assigned to
financial inclusion, NBFCs have come to be regarded as important financial intermediaries
particularly for the small-scale and retail sectors. In the multi-tier financial system of India,
importance of NBFCs in the Indian financial system is much discussed by various committees
appointed by RBI in the past and RBI has been modifying its regulatory and supervising policies
from time to time to keep pace with the changes in the system. NBFCs have turned out to be
engines of growth and are integral part of the Indian financial system, enhancing competition and
diversification in the financial sector, spreading risks specifically at times of financial distress
and have been increasingly recognized as complementary of banking system at competitive
prices. The Banking sector has always been highly regulated, however simplified sanction
procedures, flexibility and timeliness in meeting the credit needs and low cost operations resulted
in the NBFCs getting an edge over banks in providing funding. Since the 90s crisis the market
has seen explosive growth, as per a Fitch Report2 the compounded annual growth rate of NBFCs
was 40% in comparison to the CAGR of banks being 22% only. NBFCs have been pioneering at
retail asset backed lending, lending against securities, microfinance etc and have been extending
credit to retail customers in under-served areas and to unbanked customers.

CHAPTER 7

EVOLUTION OF NBFCS IN INDIA

 It is more than three decades since RBI has started regulating and supervising the
functioning of the NBFC sector in India. The evolution, phases of growth, reasons for rapid
increase in number of entities and volume of resources at their command, and importance

2
Non-Bank Financial Institutions in India: Performance Trends and Outlook, Fitch Friday Presentation, Ananda
Bhoumik & Arshad Khan, December, 2008 Report
 of this sector in the Indian financial system have been amply elucidated by various
Committees appointed by RBI and the Government of India in the past. Similarly, RBI has
also been responsive to various phases of development of this sector and it has been
modifying its regulatory policy and supervisory strategy from time to time keeping in tune
with the changing panorama. It is now well appreciated by all concerned that presently the
two most important agenda of the RBI’s policy are: (i) providing indirect protection to the
depositors, and (ii) creating an environment wherein the NBFCs will be functioning on
sound lines.3.2

 In Indian multi-tier financial system, the NBFC sector stands apart for more than one
reason. Though the sector is essentially doing the job of financial intermediation, it is still
not fully comparable with the other segments of the Indian financial system. This is so in
view of the wide variations in the profile of the players in this sector in terms of their nature
of activity (lending, investment, lease, hire purchase, chit fund, pure deposit mobilisation,
fee based activity, etc.), the volume of activity, the sources of funding they rely on (public
deposits and non-public deposits), method of raising resources, deployment pattern, etc.
This has naturally resulted in the creation of multifarious categories of NBFCs and
therefore, diverse regulatory dispensation by RBI. While there are no two opinions on the
desirability of bringing in a sort of homogenity among the players in the sector, the
Committee appreciates that it has to be primarily triggered by the market requirements. In
fact, the Working Group headed by Shri A.C.Shah, way back in 1992, had observed that
classifying NBFCs into various categories had become out of date and it was time to bring
in uniform regulations as far as possible for all NBFCs. This Committee is aware that RBI
is seized of this issue and it is hoped that after the completion of the present consolidation
process a concrete picture in this regard would emerge in this sector.3.3

 With the amendment of RBI Act, 1934 in the year 1997 and subsequent framing of
directions under the enhanced powers relating to deposits, prudential norms and statutory
 audit, the regulatory role of the RBI has become more pronounced than ever in the past.
While the deposit directions have been rationalized substantially with more focus on
regulation of acceptance of public deposits, another set of directions has been issued to the
NBFCs with regard to prudential norms on income recognition, asset classification,
provisioning for bad and doubtful debts, capital adequacy ratio, etc., to bring in more
transparency and to strengthen the financial position of the NBFCs. A direction has also
been issued to the statutory auditors of the NBFCs (under the recently acquired powers
through the 1997 amendments to RBI Act) to report on regulatory compliance by
NBFCs.3.4

 The deposit directions issued by RBI in January 1998 have introduced several new
approaches to the regulation of acceptance of public deposits by NBFCs. It broadly
segregates NBFCs into two categories viz. ‘public deposit taking’ and ‘non-public deposit
taking’. The companies belonging to the latter type are exempted from all the provisions
of the deposit directions. All NBFCs (excluding the Residuary Non-Banking Companies)
having net owned fund (NOF) of less than Rs. 25 lakh have been prohibited from accepting
public deposits. Minimum investment grade credit rating for fixed deposit from any of the
four accredited rating agencies (CARE, CRISIL, ICRA and Duff & Phelps) was made
compulsory for accepting public deposits. This, however, has been subsequently relaxed
in respect of Equipment Leasing and Hire Purchase Finance Companies. The deposit
ceilings have been rationalized substantially and revised ceilings have been fixed with
respect to public deposits. Sufficient time has also been given to NBFCs to bring down the
excess deposits within the revised ceilings.3.5

 Although the deposit directions were well intended with main thrust at protecting the
depositors, there was a perception in a section of the industry that the regulatory
prescriptions were somewhat over-restrictive and stunted the growth of reasonably good
and healthy NBFCs. To look into the issues arising out of this feeling and other related
 issues, Government of India had appointed a Task Force (Chairman:Shri C.M.Vasudev).
In pursuance of the recommendations of the Task Force, RBI, on December 18, 1998, has
made certain relaxations, especially in respect of Equipment Leasing and Hire Purchase
Finance Companies, with regard to ceilings on deposits and compulsory credit rating. RBI
also accepted the other recommendations of the Task Force and implemented them
including those which are structural in nature. It is understood that RBI is in dialogue with
Government of India for bringing in certain legislative changes required to give effect to
other recommendations of the Task Force.3.6

 After the passage of the RBI (Amendment) Act of 1997 and the introduction of the revised
deposit directions, there are signals suggesting negative growth in the level of outstanding
public deposits with NBFCs. A quick survey of deposits with NBFCs as of March 31, 1998
reveals that 1724 reporting NBFCs had public deposit of Rs. 20,237 crore constituting 3.3
per cent of the aggregate public deposits held by the banks 3.7

 This Committee has been informed that the mandatory prior registration and minimum
NOF requirements prescribed in the Amendment Act and tightening of regulatory
prescriptions under the deposit directions have resulted in substantial reduction in the
number of new NBFCs entering this sector. Further, the statutory requirement of minimum
net owned fund of Rs.25 lakh in terms of the RBI (Amendment) Act, 1997 for obtaining a
Certificate of Registration from the RBI for commencing the business of an NBFC, has
since been raised to Rs. 200 lakh. This would further restrict new NBFCs entering the
system. Thus, RBI’s objective of consolidating the NBFC sector through these measures
has been set in motion. Similarly, the Committee has also been informed that RBI is also
initiating necessary measures to further consolidate the existing NBFCs. As on June 30,
1999, out of 37,445 applications for registration received by the Bank, only 10,399 forming
27.89 per cent of the applications received had NOF of Rs. 25 lakh and above; RBI took
up processing of such applications (i.e., applications with NOF of Rs. 25 lakh and above)
 and as at the end of June 1999, it has approved applications for Certificates of Registration
in respect of 7,661 companies (including 607 deposit-taking companies) and rejected
applications in respect of as many as 1,104 companies. The companies, which are having
NOF of less than Rs. 25 lakh, have been advised to increase the same to the minimum level
by January 8, 2000, which is the deadline prescribed in the RBI Act. The above measures
are expected to result in the strengthening of not only the individual NBFCs but also the
Indian financial system.3

CHAPTER 8
CONCLUSION

NBFCs are gaining momentum in last few decades with wide variety of products and
services. NBFCs collect public funds and provide loan able funds. There has been
significant increase in such companies since 1990s. They are playing a vital role in the
development financial system of our country. The banking sector is financing only 40 per
cent to the trading sector and rest is coming from the NBFC and private money lenders.
At the same line 50 per cent of the credit requirement of the manufacturing is provided by
NBFCs. 65 per cent of the private construction activities was also financed by NBFCs.
Now they are also financing second hand vehicles. NBFCs can play a significant role in
channelizing the remittance from abroad to states such as Gujarat and Kerala.

NBFCs in India have become prominent in a wide range of activities like hire purchase
finance, equipment lease finance, loans, investments, and so on. NBFCs have greater
reach and flexibility in tapping resources. In desperate times, NBFCs could survive
owing to their aggressive character and customized services. NBFCs are doing more fee-
based business than fund based. They are focusing now on retailing sector-housing
finance, personal loans, and marketing of insurance.
Many of the NBFCs have ventured into the domain of mutual funds and insurance.
NBFCs undertake both life and general insurance business as joint venture participants in
insurance companies. The strong NBFCs have successfully emerged as ‘Financial

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 Institutions’ in short span of time and are in the process of converting themselves into
‘Financial Super Market’.
The NBFCs are taking initiatives to establish a self-regulatory organization (SRO). At
present, NBFCs are represented by the Association of Leasing and Financial Services
(ALFS), Federation of India Hire Purchase Association (FIHPA) and Equipment Leasing
Association of India (ELA). The Reserve Bank wants these three industry bodies to come
together under one roof. The Reserve Bank has emphasis on formation of SRO
Particularly for the benefit of smaller NBFCs.

BIBLIOGRAPHY
 http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=159
 https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=49