JAIIB IE and IFS Paper-1 Module-C Unit 6: Non-Banking Financial Companies (NBFCs)

18/07/2023

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JAIIB Paper 1 (IE and IFS) Module C Unit 6:Non-Banking Financial Companies (NBFCs) (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for JAIIB Exam 2023. Following the format of the current exam, JAIIB 2023 will have now four papers. The JAIIB Paper 1 (Indian Economy & Indian Financial System) includes an important topic called “Non-Banking Financial Companies (NBFCs)”. Every candidate who are appearing for the JAIIB Certification Examination 2023 must understand each unit included in the syllabus. In this article, we are going to cover all the necessary details of JAIIB Paper 1 (IE and IFS) Module C (INDIAN FINANCIAL ARCHITECTURE ) Unit 6 : Non-Banking Financial Companies (NBFCs), Aspirants must go through this article to better understand the topic, Non-Banking Financial Companies (NBFCs) and practice using our Online Mock Test Series to strengthen their knowledge of Banker Customer Relationship. Unit 6: Non-Banking Financial Companies (NBFCs)

Introduction

NBFC’s have been an important contributor to the growth of the Banking, Financial Services and Insurance (BFS) sector of the country.

Banking side:

They have emerged as a suitable alternative for banks, in terms of raising funds for businesses.
They offer credit facilities in remote locations and support those individuals who are often not serviced by the banks NBFCs underpins the weaker sections of the society, thereby bringing equilibrium to the economy.

What Is A Non-Banking Financial Company (NBFC)?

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 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 agricultural 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 NBFC).

Note: NBFCs are not a part of the payment and settlement system and as such, they cannot issue cheques drawn on itself and they cannot also borrow from the RBI.

According to the amendment of 1997 to the Reserve Bank of India Act, 1934, a Non-Banking Finance Company means:

A Financial Institution which is a company;
A non-banking institution which is a company and which has as its principal business the receiving of deposits under any scheme or arrangement or in any other manner or lending in any manner;
Such other non-banking institution or class of such institutions as the RBI may, with the previous approval of the Central Government, specify.

In terms of Section 45-IA of the RBI Act, a non-banking financial company can commence or carry on the business of non-banking financial institution subject to:

Obtaining a Certificate of Registration (CoR) from the Bank (RBI)
Having net owned funds of minimum of Rs 2 crores.

Evolution of NBFC In India

NBFCs commenced operations in a small way, in the 1960s, as an alternative for savers and investors, whose financial needs were not sufficiently met by the existing banking system.
The NBFCs initially operated on a limited scale, without making much impact on the financial industry.
They invited fixed deposits from investors and worked out leasing deals, for big industrial firms.
In the first stages of development, the Companies Act regulated NBFCs.
However, the unique and complex nature of operations and with financial companies acting as financial intermediaries, there was a call for a separate regulatory mechanism.
Chapter III B was added in the Reserve Bank of India Act, which assigned the RBI, with limited authorities, to regulate deposit-taking companies.
RBI has initiated measures to regulate the NBFC sector.
RBI: Hire purchase and leasing companies could accept deposits to the extent of their Net Owned Funds, as per the key recommendations of the James S. Raj Study Group (1975).
The NBFCs were also required to maintain liquid assets in the form of unencumbered approved government securities.
The number of NBFCs rose swiftly from a mere 7,000, in 1981, to around 30,000, in 1992, which made the RBI feel the need to regulate the industry, more effectively.
In 1992, RBI constituted a committee headed by Mr. A. C. Shah, former Chairman of Bank of Baroda, to suggest measures for effective regulation of the industry.
The Shah Committee’s recommendations included aspects ranging from compulsory registration to prudential norms.
In January 1997, major changes in the Reserve Bank of India Act, especially the Chapters Ill-B, Ill-C, and V of the Act, seeking to put in place, a complete regulatory and supervisory structure, which would protect the interests of NBFCs’ customers and also ensure the smooth functioning of NBFCs.
During the last 20 years, NBFCs have gained prominence and added depth to the financial sector.
In August 2016, the Government gave the go-ahead for foreign direct investment (FDI) under the Automatic Route, for the regulated NBFCs

Role Of NBDFCs In Promoting Inclusive Growth of India

Playing an important role in catering to the lowest strata of society, resulting in growth of trade and business in rural and semi-urban areas and providing a source of livelihood, to large number of people.
This has been possible, because of their strength of reach, proximity to customers, ability to understand the financial needs of rural and semi-urban people, particularly of concerned section and the ability to innovate products, which suit the demands of the concerned section of the people.
NBFCs provide competition to the banks, in the field of delivery of financial services and thus, create conditions for improved consumer orientation and efficiency of the entire system.
The Micro Finance Institutions (MFIs), which are largely the NBFCs, have been in the forefront of catering to the financial needs and creating livelihood sources of the so-called un-bankable masses, in the rural and semi-urban areas.

Regulators Of NBFCs

In terms of powers given to RBI, under the Reserve Bank of India Act, it regulates a section of the NBFCs. However, in order to obviate dual regulation, certain categories of NBFCs as mentioned below, which are supervised by other regulators, are exempted from the requirement of registration with RBI.

These are:

Venture Capital Funds/Merchant Banking companies/Stock Broking companies, registered with the SEBI
Insurance company holding a valid Certificate of Registration, issued by the IRDAI
Nidhi companies as notified under section 620A of the Companies Act, 1956, regulated by the Ministry of Corporate Affairs
Chit companies, as defined in section 2(b) of the Chit Funds Act, 1982, regulated by the respective State Governments
Housing finance companies regulated by the NHB, and Stock Exchange or a Mutual Benefit Company, regulated by SEBI.

Classification Of NBFCs

NBFCs have 3 broad classifications, based on the kind of

Liabilities they access,
The type of activities the pursue and
Their perceived systemic importance

Liabilities Based Classification

NBFC-Ds are now subject to requirements of capital adequacy, liquid assets maintenance, exposure norms (including restrictions on exposure to investments in land, building and unquoted shares), Assets & Liability Management (ALM) discipline, regulatory reporting requirements, etc.

Activity Based Classification

NBFCs are classified in terms of activities into following categories, viz.,

Asset Finance Companies (AFCs),
Loan Companies (LCs),
Investment Companies (ICs),
Infrastructure Finance Companies (IFCs),
Systemically Important Core Investment Companies (CICs-ND-SI)
Infrastructure Debt Fund Companies (IDF-NBFC)
NBFC Microfinance Institutions (NBFC-MFI)
Residuary NBFC (RNBFC)
NBFC – Factors
NBFC Non-Operating Financial Holding Companies (NOFHC)
Mortgage Guarantee Companies (MGC) NBFC Account Aggregator (NBFC-AA), and
NBFC Peer-to-Peer Lending Platform (NBFC-P2PL)

Size Based Classification

At present, non-deposit taking NBFCs, with assets of Rs 500 crores and above, are termed as Systemically Important Non-Deposit taking NBFCs (NBFCs-ND-SI), and prudential regulations such as capital adequacy requirements, exposure norms along with reporting requirements are applicable to them.

Regulatory Oversight By RBI On NBFCs

Amendments to the RBI Act in 1997, bestowed comprehensive powers on RBI, to regulate and supervise NBFCs.

The salient features of the amendments made to Chapter III-B of the RBI Act in 1997 include the following:

Making it mandatory for NBFCs, to obtain a Certificate of Registration (CoR) from RBI and to maintain a minimum level of Net-Owned Funds (NOF);
Requiring deposit taking NBFCs, to maintain a certain percentage of assets in unencumbered approved securities;
Requiring all NBFCs to create a reserve fund and to transfer a sum, which is not less than 20% of their profits every year;
Empowering RBI to prescribe policies for adherence by NBFCs, with regard to income recognition, accounting standards, etc.;
Empowering RBI to issue directions to NBFCs or their auditors, with regard to their preparation of balance sheets, profit and loss account, disclosure of liabilities, etc.;
Empowering RBI to order a special audit of NBFCs;
Empowering RBI to prohibit NBFCs from alienating assets, and
Empowering RBI to file winding up petitions against NBFCs.

A Fair Practices Code for lending was prescribed in 2006, directed towards ensuring transparency in pricing of loans and ethical behaviour towards borrowers, and
a Corporate Governance framework was introduced in 2007, to ensure more professionalism in NBCs.
Additional regulatory measures were introduced in a measured manner, to reflect the RBI’s emerging focus on non-deposit taking NBFCs and systemic risk related issues.

Type of NDFCs

Asset Finance Company
Loan Company
Mortgage Guarantee Company
Investment Company
Core Investment Company
Infrastructure Finance Company
Micro Finance Company
Housing Finance Company

Guidelines prescribed by the Reserve Bank of India (RBI) that are to be followed by the Non-Banking Financial Corporations (NBFC):

The functions of the NBFCs in India are supervised by the Reserve Bank of India (RBI). Hence, the NBFCs have to abide by the guidelines put forward by the RBI in Chapter III B of the RBI Act of 1934. The regulations prescribed by the RBI are as follows:

NBFCs cannot accept demand deposits from public depositors or investors as it is not authorised by law.
The minimum time period for which the public deposits can be taken by the company is 12 months, while the maximum tenure can be 60 months.
The Reserve Bank of India will not guarantee the repayment of any amount which is taken by the NBFCs.
The Company cannot charge an interest rate which is more than the rate prescribed by the Reserve Bank of India.
NBFCs can issue cheques to their customers in order to make payments or settlements.
The company has to furnish a record of the statutory return on the deposits taken by the company in the form NBS- 1 every year.
The company has to furnish a quarterly return on the liquid assets of the company.
The audited balance sheet of the company has to be submitted every year.
The company has to ascertain its credit ratings every 6 months and submit the same to the RBI.
The companies which have a Public Deposit of Rs.20 Crore or more or have assets worth Rs.100 Crore or more will have to submit a half-yearly ALM return.
The depositors of the NBFCs cannot avail the securing facility of the Deposit Insurance and Credit Guarantee Corporation (DICGC).
Only the NBFCs that have been duly rated and matches the recommended Minimum Investment Grade Credit (MIGC) rating, are eligible to accept conditional deposits from public depositors.
The RBI has restricted the NBFCs from providing additional benefits, extra incentives, or gifts to the customers or depositors, than those which are offered by the banks.
The company has to maintain a minimum of 15% of the Public Deposits in its Liquid Assets.

Bank Finance to NBFCs (RBI MC 5^th January 2022)

In terms of section 45-lA of the RBI Act, 1934, all NBFCs have to mandatorily register with RBI.
While RBI has deregulated credit related matters and bestowed greater
Operational freedom to banks in the matter of credit dispensation to NBFCs, yet in view of the sensitivities attached to financing of certain types of activities undertaken by NBFCs, restrictions on financing such activities continue to be in force

Bank Finance to NBCs not Requiring Registration with RBI

In respect of NBFCs which do not require to be registered with RBI, viz.,

Insurance companies registered under section 3 of the Insurance Act, 1938
Nidhi Companies notified under section 620A of the Companies Act, 1956
Chit fund companies carrying on Chit Fund Business as their principal business as per explanation to clause (vii) of Section 45-1 (bb) of RBI Act, 1934
Stock Broking Companies/Merchant Banking Companies registered under section 12 of the SEBI Act,
Housing Finance Companies regulated by NHB, which have been exempted from registration by RBI, banks may take their credit decision on merits of the case and on the basis of factors like purpose of credit, nature and quality of underlying assets, repayment capacity of borrowers as well as risk evaluation of the proposal.
Bank finance to NBFCs by way of direct finance and subscription to their non-convertible debentures and certificates of deposits

Applicability Of Ombudsman Scheme To NBFCs

RBI has issued guidelines on Integrated Ombudsman Scheme, 2021 which inter alia covers the Non- Banking Finance Companies.
The Scheme shall apply to the services provided by a Regulated Entity in India to its customers, under the provisions of the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007.

“Non-Banking Financial Company” (NBFC) means

An NBFC as defined in Section 45-1 (f) of the Reserve Bank of India Act, 1934 and registered with the Reserve Bank, to the extent not excluded under the Scheme,
But does not include a Core Investment Company (CIC), an Infrastructure Debt Fund-Non Banking Financial Company (IDF-NBFC), a Non-Banking Financial Company Infrastructure Finance Company (NBFC-IFC), a company in resolution or winding up/liquidation, or any other NBFC specified by the Reserve Bank;
(Explanation: The terms CIC and IDF-NBFC shall have the same meaning assigned to them under the RBI Directions.)
In a major change, the Executive Director of RBI has now been appointed as appellate authority in place of Deputy Governor, under the scheme.

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