NON BANKING FINANCIAL INSTITUTIONS

NON-BANK FINANCIAL COMPANIES (NBFCS)

NBFC are financial institutions that provide banking services without meeting the legal definition of a 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. However this depends on the jurisdiction, as in some jurisdictions, such as New Zealand, any company can do the business of banking, and there are no banking licenses issued. Non-banking financial companies (NBFCs) are fast emerging as an important segment of Indian financial system. It is an heterogeneous group of institutions (other than commercial and co-operative banks) performing financial intermediation in a variety of ways, like accepting deposits, making loans and advances, leasing, hire purchase, etc. They raise funds from the public, directly or indirectly, and lend them to ultimate spenders. They advance loans to the various wholesale and retail traders, small-scale industries and self-employed persons. Thus, they have broadened and diversified the range of products and services offered by a financial sector. Gradually, they are being recognised as complementary to the banking sector due to their customer-oriented services; simplified procedures; attractive rates of return on deposits; flexibility and timeliness in meeting the credit needs of specified sectors; etc. The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI) within the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and the directions issued by it under the Act. As per the RBI Act, a 'non-banking financial company' is defined 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; (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.

Under the Act, it is mandatory for a NBFC to get itself registered with the RBI as a deposit taking company. This registration authorises it to conduct its business as an NBFC. For the registration with the RBI, a company incorporated under the Companies Act, 1956 and desirous of commencing business of non-banking financial institution, should have a minimum net owned fund (NOF) of Rs 25 lakh. The term 'NOF' means, owned funds (paidup capital and free reserves, minus accumulated losses, deferred revenue expenditure and other intangible assets) less, (i) investments in shares of subsidiaries/companies in the same group/ all other NBFCs; and (ii) the book value of debentures/bonds/ outstanding loans and advances, including hire-purchase and lease finance made to, and deposits with, subsidiaries/ companies in the same group, in excess of 10% of the owned funds. The registration process involves submission of an application by the company in the prescribed format along with the necessary documents for RBI's consideration. If the bank is satisfied that the conditions enumerated in the RBI Act, 1934 are fulfilled, it issues a 'Certificate of Registration' to the company. Only those NBFCs holding a valid Certificate of Registration can accept/hold public deposits. The NBFCs accepting public deposits should comply with the Non-Banking Financial Companies Acceptance of Public Deposits ( Reserve Bank) Directions, 1998, as issued by the bank. Some of the important regulations relating to acceptance of deposits by the NBFCs are: They 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. They cannot offer interest rates higher than the ceiling rate prescribed by RBI from time to time. They cannot offer gifts/incentives or any other additional benefit to the depositors. They should have minimum investment grade credit rating. Their deposits are not insured. The repayment of deposits by NBFCs is not guaranteed by RBI.

TYPES OF NBFCs:
The types of NBFCs registered with the RBI are: Equipment leasing company:- is any financial institution whose principal business is that of leasing equipments or financing of such an activity. Hire-purchase company:- is any financial intermediary whose principal business relates to hire purchase transactions or financing of such transactions. Loan company:- means any financial institution whose principal business is that of providing finance, whether by making loans or advances or otherwise for any activity other than its own (excluding any equipment leasing or hire-purchase finance activity). Investment company:- is any financial intermediary whose principal business is that of buying and selling of securities. Now, these NBFCs have been reclassified into three categories: Asset Finance Company (AFC) Investment Company (IC) and Loan Company (LC). Under this classification, 'AFC' is defined as a financial institution whose principal business is that of financing the physical assets which support various productive/economic activities in the country.

Services provided
NBFCs offer all sorts of banking services, such as loans and credit facilities, private education funding, retirement planning, trading in money markets, underwriting stocks and shares, TFCs and other obligations. These institutions also provide wealth management such as managing portfolios of stocks and shares, discounting services e.g. discounting of instruments and advice on merger and acquisition activities. The number of non-banking financial companies has expanded greatly in the last several years as venture capital companies, retail and industrial companies have entered the lending business. Non-bank institutions also frequently support investments in property and prepare feasibility, market or industry studies for companies. However they are typically not allowed to take deposits from the general public and have to find other means of funding their operations such as issuing debt instruments.

CLASSIFICATION:
Depending upon their nature of activities, non- banking finance companies can be classified into the following categories: 1. 2. 3. 4. 5. 6. 7. Development finance institutions Leasing companies Investment companies Modaraba companies House finance companies Venture capital companies Discount & guarantee houses

1.

Development finance institutions:

Development finance institution (DFI) is generic term used to refer to a range of alternative financial institutions including many microfinance institutions, community development financial institution and revolving loan funds. These institutions provide a crucial role in providing credit in the form of higher risk loans, equity positions and risk guarantee instruments to private sector investments in developing countries. DFIs are backed by states with developed economies. In 2005, total commitments (as loans, equity, guarantees and debt securities) of the major regional, multilateral and bilateral DFIs totalled US$45 billion DFIs have a general mandate to provide finance to the private sector for investments that promote development. The purpose of DFIs is to ensure investment in areas where otherwise, the market fails to invest sufficiently. DFIs aim to be catalysts, helping companies implement investment plans and especially seek to engage in countries where there is restricted access to domestic and foreign capital markets and provide risk mitigation that enables investors to proceed with plans they might otherwise abandon. DFIs specialise in loans with longer maturities and other financial products. DFIs have a unique advantage in providing finance that is related to the design and implementation of reforms and capacitybuilding programmes adopted by governments.

2.

Leasing Company:

Leasing is a process by which a firm can obtain the use of a certain fixed assets for which it must pay a series of contractual, periodic, tax deductible payments. The lessee is the receiver of the services or the assets under the lease contract and the lessor is the owner of the assets. The consideration for the lease is called rent. A gross lease is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from lawnmowers and washing machines to handbags and jewellery. The company doing this leasing activity or the lessor is the leasing company.

3.

Investment Company:

An investment company is a company whose main business is holding securities of other companies purely for investment purposes. The investment company invests money on behalf of its shareholders who in turn share in the profits and losses.

4.

Modaraba Company:

Modaraba means a business in which the subscriber (Zarib) participates with his money and another (Modarab) with his efforts or skill or both his efforts and skill and shall include Unit Trusts and Mutual Funds by whatever name called. The profit earned during the year is distributed among financiers and the entrepreneurs according to the agreed ratio. In case of loss, it is shared among the financiers in proportion to the capital invested in the business, if losses occur due to the negligence of modaraba (managing trustee) or there is a branch of the terms of agreement by him, then the losses will also be borne by him. Modaraba is an effective device for rising of large amounts of resources for productive purposes in place of joint stock companies. A Modaraba is a legal person. It can sue and be sued in its name through the modaraba company. The government of Pakistan promulgated the Modaraba Companies and Modaraba (Floatation and Control) Ordinance in 1980. Types of Modaraba: Modarabas listed on Stock Exchanges are multipurpose and multi dimensional. The broad categories of modarabas are (1) Finance (2) Ad and Investment Management Services (3) Under writing (4) Venture capital (5) Leasing (6) Investment (7) Resource Mobilization.

5.

House Finance Companies:

An enterprise engaged in the loan of money against collateral to lower & middle class Indian.

6.

Venture Capital Company:

Venture capital (VC) is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology, IT, software, etc. The typical venture capital investment occurs after the seed funding round as growth funding round (also referred as Series A round) in the interest of generating a return through an eventual realization event, such as an IPO ortrade sale of the company. Venture capital is a subset of private equity. Therefore all venture capital is private equity, but not all private equity is venture capital. Venture capital is attractive for new companies with limited operating history that are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. In exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company's ownership (and consequently value).

7.

Discount & Guarantee Houses: paper, etc.

Firm that buys and discounts bills of exchange,banker' acceptance, commercial

Discount houses also tender for treasury bills, deal in short-dated government bonds, and are an important part of the short-term money markets & is also called bill broker.

Difference between NBFCs & Banks:

NBFCs perform functions similar to that of banks; however there are a few differences in that an NBFC cannot accept demand deposits; an NBFC is not a part of the payment and settlement system and as such, an NBFC cannot issue cheques drawn on itself; and deposit insurance facility of the Deposit Insurance and Credit Guarantee Corporation is not available for NBFC depositors, unlike banks.

Guidelines provided by RBI:

1. Registrations and Net Owned Funds:

With effect from January 1997, in order to commerce (new company)/ carry on (existing company) the business of a NBFC, an NBFC must obtain a certificate of registration from the RBI. Moreover, its minimum net owned funds must be Rs 25 lakh or such other amount not exceeding Rs 200 lakh, as specified by the RBI.

2.

Power to collect information from NBIs:

The RBI can issue direction to the NBIs to furnish information relating to, or concerned with, deposits. The information may relate to aspects such as amount of deposits, its period and purpose, rates of interest and other terms and conditions on which deposits are received.

3.

Reserve Fund:

Every NBFC must create a reserve fund to which at least 20 per cent of its net profits must be transferred before the declaration of any dividend. The reserve fund can be used/ appropriately only for purpose specified by the RBI from time to time. Every appropriation should be reported to it within 21 days from the date of withdrawal.

4.

Repayment of Deposit/Nomination by Depositors:

The deposits accepted by the NBFC should be repaid in accordance with the relevant terms & conditions or renewed. If a NBFC fails to repay any deposit, the Company Law Board is empowered to order the repayment of deposit immediately/within a specified time and subject to the specified conditions.

5.

Penalties:

In case any prospectus/advertisement inviting deposit from the public knowingly makes a false statement in any material particular knowing it to be false or omits to make a material statement, the person responsible would be punishable with imprisonment for a term up to three years and would also be liable to a fine.

6.

Power of RBI to Impose Fine:

Where the above defaults are committed by a NBFC, the RBI is authorized to impose: A penalty not exceeding Rs 5000 Where the contravention relates to the requirement of registration & net owned funds or

receipts of any deposit/compliance with any direction given/order made, a penalty of Rs 5 lakh or twice the amount involved in such contravention. In case of continuation of the violation, a further penalty up to Rs 25000 for every day, after the first, during which the default continues.

The penalty imposed by the RBI is payable within 30 days from the date on which the notice demanding payment is served on the NBFC. In the event of non-payment, the RBI may obtain a direction from a court specifying, in a certificate, the sum payable by the NBFC.

7.

Periods of Deposits:

NBFCs cannot accept deposits payable on demand. They can accept /renew deposits for a minimum period of 12 months to a maximum of 60 months from the date of acceptance/ renewal.

8.

Ceiling on Quantum of deposits:

An AFC having a minimum NOF of more than 25 lakhs but less than 200 lakh without credit rating & having a capital adequacy ratio of at least 15% as per the last audited balance sheet, is permitted to accept / renew public deposits equal to its NOF.

9.

Down Grading of Credit Rating:

In the event of downgrading of credit rating below the minimum investment grade, the excess deposit should be regularized in the manner specified: An AFC must immediately stop accepting deposits and report the position within 15 working days to the RBI and reduce, within three years from the date of such downgrading of credit rating.

10.

Ceiling on the Rate of Interest:

There is a ceiling on the rate of interest on deposits. It may be paid or compounded at rests not shorter than monthly rests. The ceiling is currently 12.5%.

11.

Renewal of Deposits:

NBFCs can permit existing depositors to renew their deposits before maturity to avail the benefits of a higher rate of interest provided: The deposit is renewed in accordance with the other provisions of these directions and for a longer duration than the remaining period of the original contract and The interest on the expired period of the deposit is reduced by 1% from the rate that the NBFC would have ordinarily paid had the deposit been accepted for the period for which it has run; any interest paid earlier in excess of such reduced rate is recovered/adjusted. In this context, a depositor means any person who has made a deposit with a company or a heir, legal representative, administrator or assignee of the depositor.

12.

Payment of Interest on Overdue Deposits: The directions permit NBFCs to pay interest, at their discretion, on overdue public deposits/or a portion of it from the date of maturity if: The total amount/part of the overdue deposit is renewed from the date of maturity till some future date according to the other provisions of these directions and The interest should be appropriate rate operative on the date of maturity of such overdue deposits, which would be payable only on the amount of renewed deposits.

If the NBFC fails to repay the deposit along with interest on maturity, following a claim made by the depositor, it would be liable to pay interest from the date of claim till the date of repayment, at the rate as applicable to the deposit.

RBI relaxes norms for NBFCs:NBFCs registered with the Reserve Bank of India may take part in the insurance agency business on a fee basis and without risk participation or the need to seek the bank's approval. In a notification issued, the RBI said such NBFCs should obtain permission from the Insurance Regulatory and Development Authority and comply with IRDA regulations for acting as a "composite corporate agent" with insurance companies. Exemptions granted to NBFCs engaged in microfinance activities: The Task Force on Supportive Policy and Regulatory Framework for Microfinance setup by NABARD in 1999 provided various recommendations. Accordingly, it was decided to exempt NBFCs which are engaged in micro financing activities, licensed under Section 25 of the Companies Act, 1956, and which do not accept public deposits, from the purview of Sections 45-IA (registration), 45-IB (maintenance of liquid assets) and 45-IC (transfer of profits to the Reserve Fund) of the RBI Act, 1934.

SUBMITTED BY:Shivprakash, Palak, Ankita