62

Chapter -III

Financial system and

Non-Banking Financial Companies – The Structure and status profile.

63

CHAPTER FOCUS

The present chapter is designed to provide an insight into the Indian

Financial System in its composition, status, evolution, regulatory frame

work, functional arena besides the nexus between the financial system and

economical development. The operational profile, the growth focus, the

dimensions of business volume over the years and also the financial

performance of the NBFCs in India are also given a comprehensive focus to

provide vital background peripheral to the study. An insight has also been

given on recent financial sector reforms and its implications on the non

banking financial institutions.

64

Financial System – The Concept and Composition

The financial system facilitates transfer of funds, through financial institutions, financial

markets, financial instruments and services. Financial institutions act as mobilisers and

depositories of savings, and as purveyors of credit or finance. They also provide various

financial services to the community. They act as intermediaries between savers and

investors. All banks and many non-banking institutions also act as intermediaries, and are

called as non-banking financial intermediaries (NBFI). Financial institutions are divided

into the banking and non-banking ones. The distinction between the two has been

highlighted by characterizing the former as “creators” of credit, and the latter as mere

“purveyors” of credit.1 The banking system in India comprises the commercial banks and

co-operative banks. The examples of non-banking financial institutions are Life

Insurance Corporation (LIC), Unit Trust of India (UTI), and Industrial Development

Bank of India (IDBI). Financial markets provide facilities for buying and selling of

financial claims and services. The participants on the demand and supply sides of these

markets are financial institutions, agents, brokers, dealers, borrowers, lenders, savers, and

others who are inter-linked by the laws, contracts, covenants, and communication

networks of the land. Financial markets are sometimes classified as primary (direct) and

secondary (indirect) markets. The primary markets deal in new financial claims or new

securities and, therefore, they are also known as New Issue Markets. On the other hand,

secondary markets deal in securities already issued or existing or outstanding. The

primary markets mobilize savings and they supply fresh or additional capital to business

units. The secondary markets do not contribute directly to the supply of additional

capital; they do so indirectly by rendering securities issued on the primary markets liquid.

Stock markets have both the primary and secondary market segments.

More often financial markets are classified as money markets and capital markets. While

the money market deals in the short-term claims (with a period of maturity of one year or

1 Original source Sayers R.S. Modern Banking, Oxford University Press, Oxford ,1964.

65

less), the capital market does so in the long-term (maturity period above 1 year) claims2.

Commercial banks, for example, belong to both. While Treasury Bills Market, Call

Money Market, and Commercial Bills Market are examples of the money market, Stock

Market and Government Bonds Market are examples of the capital market. Financial

asset represent a claim to the payment of a sum of money sometime in future (repayment

of principal) and /or a periodic (regular or not so regular) payment in the form of interest

or dividend. The detailed list of Indian Financial system consisting of Financial

Institutions, Financial Markets, Financial Instruments and Financial Services is as under:

Financial Institutions (intermediaries) i) Banking: Reserve Bank of India (RBI), Commercial Banks, Co-operative Credit

Societies, Co-operative Banks, Post-office Saving Banks,

ii)Non-Banking: Provident and Pension Funds, Small Savings Organizations, Life

Insurance Corporation (LIC), General Insurance Corporation (GIC), Unit Trust of

India(UTI), Mutual Funds, Investment Trusts, Investment Companies, Finance

Corporations, Nidhis, Chit Funds, Hire-Purchase Finance Companies, Lease Finance

Companies, National Housing Bank (NHB), Housing and Urban Development

Corporation (HUDCO), Housing Development Finance Corporation (HDFC), and other

housing finance companies, Manufacturing companies accepting public deposits, Venture

Capital Funds and National Cooperative Bank of India(NCBI).

Financial Institutions (Special Development) Industrial Finance Corporation of India (IFCI or IFC), Industrial Credit and Investment

Corporation of India(ICICI), Industrial Development Bank of India(IDBI),Industrial

Reconstruction Bank of India(IRBI),Export and Import Bank of India(EXIM Bank),

National Bank for Agricultural and Rural Development(NABARD), Shipping Credit and

Investment Company of India (SCICI),Tourism Finance Corporation of India

(TFCI),Risk Capital and Technology Finance Corporation (RCTFC),Agricultural Finance

2 Sometimes, the analysts talk of the short-term (maturity period of a year or less), the medium-term (maturity period of 1, 3 or 5 years), and the long-term (maturity period of more than 3 or 5 years). The capital market, then, would be said to deal in medium and long-term claims.

66

Consultancy Ltd. (AFC), National Cooperative Development Corporation (NCDC),

Central Warehousing Corporation(CWC),State Warehousing Corporations (SWCs),

Rural Electrification Corporation(REC),National Industrial Development , Corporation

(NIDC), National Small Industries Corporation (NSIC) and Small Industries.

Financial Institutions i). Regulatory: Reserve Bank of India, Securities and Exchange Board of India (SEBI),

Board for Industrial and Financial, Reconstruction (BIFR), Board for Financial

Supervision, Insurance Regulatory Authority.

ii). Others: Deposit Insurance and Credit Guarantee Corporation (DICGC),Export Credit

and Guarantee Corporation (ECGC), Technical Consultancy Organizations (TCOs),Stock

Holding Corporation of India(SHCI),Credit Rating Information , Services of India

(CRISIL),Discount and Finance House of India(DFHI),Infra-structure Leasing and

Financial Services ,Ltd.(ISLFS), Technology Development and Information Company of

India(TDICI),Merchant Banks, Factoring Companies, Money Lenders, Indigenous

Bankers, Securities Trading Corporation of India(STCI),Primary Dealers, Investment

Information and Credit Rating Agency (ICRA),Depositories and Custodians.

Financial Instruments& Markets i). Instruments: Equity (ordinary) shares, Preference shares, Industrial debentures or

bonds, Capital gains bonds, Government (gilt-edged) securities or bonds, Relief bonds,

National development bonds, Indira Vikas Patra, Kisan Vikas Patra, National Savings

Scheme, National Savings Certificates, Deposits with banking institutions, Deposits with

companies, Insurance Plans, Units, Participation Certificates, Pass-through certificates,

Certificates of deposits(CDs), Commercial Papers(CPs), Treasury Bills, Commercial

Bills, Call and Notice Money, Hundis, Mortgages, National Savings Annuity Certificates,

Social Security Certificates, Trade Credit, Chits, Inter-corporate deposits, Repos &

Reverse Repos, Stock invest, Global Depository Receipts(GDRs),,Foreign Bonds,

Foreign Currency Convertible Bonds (FCCBs), Eurobonds & Euro notes, Floating Rate

67

Notes(FRNs), Futures, Options, Swaps and other financial derivatives, Zero coupon

bonds, Non-voting shares and Indexed bonds.

ii). Markets: Call Money Market, Treasury Bills Market, Commercial Bills Market,

Government Securities Market, Industrial Securities Market (Stock Market), Foreign

Exchange Market, Over-the-Counter Exchange (OTCE), Discount Market, Market for

Commercial Paper and Certificates of deposits, Mortgage Market, Market for Guarantees,

National Stock Exchange(NSE), Derivatives Markets, Bonds Market and Equities

Market.

Financial Services Financial Services consists of Hire-purchase and installment credit, Deposit insurance

and other insurance, Financial and performance guarantees, Acceptances, Merchant

banking, Factoring, Credit rating, Credit information, Technical and economic

consultancy, Stock holding, Discounting and Rediscounting, Refinancing, Underwriting,

Leasing, Technology development, Funds transfer, Credit cards, Safe deposit vaults,

Brokerage, Portfolio management, Deposit acceptance, Giving credit, Loan syndicating,

Managing capital issues, Market making, Custodial services and Depository services.

Financial system helps to increase output by moving the economic system towards the

existing production frontier. This is done by transforming a given total amount of wealth

into more productive forms. It induces people to hold fewer saving in the form of

precious metals, real-estate land, consumer durables, and currency and to replace these

assets by bonds, shares, units, etc. It also directly helps to increase the volume and rate

of saving by supplying diversified portfolio of such financial instruments, and by offering

an array of inducements and choices to woo the prospective saver. The growth of

“banking habit” helps to activate saving and undertake fresh saving. The saving is said to

be “institution-elastic” i.e., easy access, nearness, better return, and other favorable

features offered by a well-developed financial system lead to increased saving.

68

A financial system helps increase the volume of investment also. It becomes possible for

the deficit spending units to undertake more investment, because it would enable them to

command more capital. Without the transfer of purchasing power to an entrepreneur, he

cannot become the entrepreneur.3 Further, it encourages investment activity by reducing

the cost of finance and risk. This is done by providing insurance services and hedging

opportunities, and by making financial services such as remittance, discounting,

acceptance and guarantees available. Finally, it not only encourages greater investment

but also raises the level of resource allocation efficiency among different investment

channels. It helps to sort out and rank investment projects by sponsoring, encouraging,

and selectively supporting business units or borrowers through more systematic and

expert project appraisal, feasibility studies, monitoring, and by generally keeping a watch

over the executing and management of projects.

In a developing economy persons require an increasing number of alternative ways of

holding wealth. Similarly, individuals and business, private or public, require funds to

finance their activities. These activities may be again consumptive or productive

activities. The activities may require every day working capital for a small firm or the

capital needs of a sophisticated steel project involving an outlay of hundreds of crores of

rupees. Institutionalization of savings and investment process is a logical and rational step

in the economic expansion, development and capital formation process of a highly

industrialized society. Financial intermediation is the process through which the differing

needs of ultimate savers, investors and consumers are reconciled.

Financial system is linked to a reservoir. When the current consumption of householders

and the economic agents are short of their income, the resulting savings flow into the

reservoir. Business whose current expenditure exceeds their income borrows for meeting

their excess expenditure. Without these financial intermediaries the economy’s savings

and investing transactions would be fragmented. New forms of credit and new types of

financial institutions may increase the volume of capital of firms by facilitating the

mobilization of funds. Financial intermediaries are expected to play a very important role

in the development of large-scale industries in India. 3 Schumpeter, J.A., The Theory of Economic Development, Oxford University Press, London, 1934, p.102

69

The financial intermediaries perform the function of transferring funds from persons with

excess money to persons who require extra funds to fulfill their expenditure or

investment plans. They are responsible for channeling savings to investment and

consumption purposes and without them many of the funds in the economy would remain

idle. Economic growth is thus closely associated with the expansion and increased

sophistication of financial activity. Financial intermediaries such as the commercial

banks and public financial institutions including Life Insurance Corporation have been

transmitting funds from the investors to the industries. But the Non-Banking financial

intermediaries in the private sector have created major impact for innovation during the

last two decades in the post independence era.

Nexus between financial system and economic development

Capital formation is the most important factor of economic growth. The process of capital

formation involves three interdependent activities such as, a) Saving – The activity by

which claims to resources set aside and so become available for other purposes. b)

Finance – The activity by which claims to resources are either assembled from domestic

saving or obtained from abroad and placed in the hands of investors. c) Investment.—the

activity by which resources are actually committed to the production of capital goods.

There are five important distinctions which are important to the functional relation

between savings, capital formation and economic growth that can channel savings to the

most productive types of investment. They are Money and Barter, External and Internal,

Private and Public, Immediate and Intermediate and Security and Venture.

The activities of saving and Investment become extremely diversified and complex

during the process of economic growth and this causes the necessity of Intermediation

between these two important activities. Financial intermediaries play very important

role in a developing economy by performing multifarious activities in development

process. The financial intermediaries transform primary securities into indirect securities

which have low investment costs and are divisible into convenient units. With a

diversified portfolio, they can reduce the risk of investment to the minimum. Financial

70

Intermediaries increase the liquidity of securities by creating claims which are more

liquid than the securities they buy, and issue them to the savers. Thus they canalize more

savings into investment activity. The intermediaries can also facilitate the expansion of

markets through distributive techniques. These activities will be particularly important

for export promotion and marketing of machinery, producer goods, intermediary

products, etc.

The supply of funds depends upon aggregate savings and credit creation by the banking

system, while the need for funds depends upon demand for investment, consumer

durables, housing, and so on. The functions of a financial system are to establish a bridge

between savers and investors and thereby to encourage saving and investment, to provide

finance in anticipation of saving, to enlarge markets over space and time, and to allocate

financial resources efficiently for socially desirable and productive purposes. The

ultimate goal of the financial system is to accelerate the rate of economic development.

Financial markets accelerate development, they themselves, in turn, develop with

economic development. The relationship between economic development and financial

development is thus symbiotic. The efficient financial markets are characterized by the

absence of information-based gain, by correct evaluation of assets, by maximization of

convenience and minimization of transaction costs, and by maximization of marginal

efficiency of capital.

Evolution of Indian financial system The Indian Financial System was transpired from the traditional Barter system to the

money lenders, the Nidhis and Chit Funds. In the later stages the concept of cooperatives

was started and the same was introduced in India during 1904 by way of “Cooperative

Society Act” and it paves the way in introduction of cooperative banking institutions in

India.

The commercial banks were started and they occupied the prime role in Indian financial

system. In India Commercial Banks are broadly categorized into Scheduled Commercial

Banks and Unscheduled Commercial Banks. The Scheduled Commercial Banks have

71

been listed under the Second Schedule of the Reserve Bank of India Act, 1934. The

selection measure for listing a bank under the Second Schedule was provided in section

42 (60 of the Reserve Bank of India Act, 1934). The modern Commercial Banks in India

cater to the financial needs of different sectors. The main functions of the commercial

banks comprise, transfer of funds, acceptance of deposits, offering those deposits as loans

for the establishment of industries, purchase of houses, equipments, capital investment

purposes etc. The banks are allowed to act as trustees. On account of the knowledge of

the financial market of India the financial companies are attracted towards them to act as

trustees to take the responsibility of the security for the financial instrument like a

debenture. During 1969 and 1980 some banks were nationalized on public interest and

during later stages the Indian Banking industry has been opened to all and it led to

universal banking practices in the Indian financial system.

The concept of nidhis and chit funds are played key role in Indian financial system and it

worked as bridge between the age old financial practices and the modern banking system.

It is also stated that even today the chit fund industry is playing major role in reaching the

public and it has become a major substitute to the banks where ever the Bank is not able

to reach and cater their needs, such places the chit fund companies and nidhis are in

handy to them.

Non Banking Financial Companies (NBFCs) According to the Reserve Bank of India Amendment Act 1997 the Non Banking Finance

company was defined as under:-

⇒ A financial institution which is a company,

⇒ A non banking institution which is a company and whose principal business is to

receiving of deposits under any scheme/arrangement/in any other manner or

lending in any manner and

⇒ Other non banking institutions/class of institutions as the RBI may specify.

The directions apply to a NBFC which is defined to include only non-banking institution,

which is any hire-purchase finance, loan or mutual benefit financial company and an

equipment leasing company but excludes an insurance company/stock exchange/stock

72

broking company /merchant banking company. The RBI (Amendment) Act, 1997

defines NBFC’S as an Institution or company whose principal business is to accept

deposits under any scheme or arrangement or in any other manner, and to lend in any

manner. As a result of this new definition, a number of loan and investment Companies

registered under the Companies Act by Business houses for the purpose of making

investments in group of companies are now included as NBFCs4. The Financial

intermediaries in Indian Financial System are broadly characterized by Public owned,

Monopoly or Oligopoly or Monopolistic market structure and are centralized. The Indian

financial system has another part which comprises a large number of private owned,

decentralized, and relatively small sized financial intermediaries and which makes a more

or less competitive market. Some of them are fund based, and are called (NBFCs) and

some are provide financial services (NBFSCs) Both NBFIs, NBFCs are (1) Loan

companies (LCs) (2) Investment companies or ICs (3) Hire-Purchase finance

companies or HPFCs (4) Lease finance companies or LFCs (5) Housing finance

companies (or) HFCs (6) Mutual Benefit financial companies or MBFCs (7) Residuary

non-banking companies or RNBCs (8) Merchant Banks (9) Venture capital funds (10)

Factors (11) Credit Rating Agencies (12) Depositories and custodial services.

Classification of NBFCs Classification of NBFCs as given in the Reserve Bank Amendment Act 1997, 1)

Equipment leasing company (ELC): Carrying on as its Principal Business, the activity of

leasing of equipment. 2) Hire Purchase finance company (HPFC): Carrying hire

purchase transactions (or) financing of such transactions. 3) Housing finance company

(HFC). 4) Investment Company (IC): Carrying the business of acquisition of securities.

5) Loan Company (LC): Financing by making loans and advances. (Does not include

ELC, HPFC, HFC).6) Mutual Benefit companies (MBFC). 7) Residual non-banking

company (RNBC): Company which receives any deposit under any scheme or

arrangement, in one lump sum or in installments by way of contributions or subscriptions

or by sale of units or certificates or other instruments or in any other form according to

4 .Government of India, Report of the Banking Commission, 1972, pp.413-35.

73

definition of NBFC. 8) Miscellaneous non-banking companies (MNBC): Managing,

conducting or supervising as a promoter foreman or agent of any transaction or

arrangement. Ex: conducting any other form of Chit and Kuri which is different from

type of business mentioned above.

After the above classification the Non Banking Financial companies were re-classified

twice, during 1998 it was classified as four types they were 1) Equipment leasing, 2) Hire

Purchase, 3) Investment Company and 4) Loan Companies. During 2006 the NBFCs

were reclassified as three types they are 1) Asset Finance companies (in this both

Equipment Leasing and Hire Purchase companies were merged), 2) Investment

Companies and 3) Loan Companies Apart from those classifications, in order to operate

these NBFCs smoothly certain regulations/directions were issued they are a) Regulations

for deposits for NBFCs accepting deposits, b) Regulations for NBFCs not accepting

deposits and c) Regulations for core investment companies to smooth functioning of their

businesses as well as to give confidence to the participants as well as operators.

In a very broad sense, NBFIs would include even financial institutions like insurance

companies, Life insurance Corporation of India, Unit Trust of India, Industrial Credit and

Investment Corporation of India Ltd., Industrial Finance Corporation of India and

Industrial Reconstruction Corporation of India Ltd., as also State Financial Corporations.

But for the purpose of our present study, the scope of the term is confined to the types of

financial companies enumerated in clause (p) of paragraph 2(1) of the Non-Banking

Financial Companies (Reserve Bank ) Directions, 1966, which mobilize savings of the

community by way of deposits or otherwise and utilize them for the purpose of lending or

investment. Thus the NBFCs that we shall discuss here are hire-purchase finance,

housing finance, investment, loan, miscellaneous financial or mutual benefit financial

companies but excluding insurance, stock exchange or stock broking companies.

Non-banking financial companies (NBFCs) encompass an extremely heterogeneous

group of intermediaries. They differ in various attributes, such as, size, nature of

incorporation and regulation, as well as the basic functionality of financial

intermediation. Notwithstanding their diversity, NBFCs are characterised by their ability

74

to provide niche financial services in the Indian economy. Because of their relative

organisational flexibility leading to a better response mechanism, they are often able to

provide tailor-made services relatively faster than banks and financial institutions.

The non-banking financial companies (NBFCs) flourished in India in the decade of the

1980s against the back drop of a highly regulated banking sector. While the simplified

sanction procedures and low entry barriers encouraged the entry of a host of NBFCs,

factors like flexibility, timeliness in meeting credit needs and low operating cost provided

the NBFCs with an edge over the banking sector.5 NBFCs proliferated by the early

1990s. This rapid expansion was driven by the scope created by the process of financial

liberalization in fresh avenues of operations in areas, such as, hire purchase, housing,

equipment leasing and investment. The business of asset reconstruction has recently

emerged as a green field within this sector following the passage of the Securitization and

Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)

Act, 2002.

NBFCs are financial intermediaries engaged primarily in the business of accepting

deposits delivering credit. They play an important role in channelising the scarce

financial resources to capital formation. NBFCs supplement the role of banking sector in

meeting the increasing financial needs of the corporate sector, delivering credit to the

unorganised sector &to small local borrowers. All NBFCs are under direct control of RBI

in India. A Non-Banking Financial Company (NBFC) is a company incorporated under

the Companies Act, 1956 and conducting financial business as its principal business. In

contrast, companies incorporated under the same Act but conducting other than Financial

business as their principal business is known as non-banking non-financial Companies.

NBFCs are different from banks in that an NBFC cannot accept demand deposits, issue

checks to customers, or insure deposits through the Deposit Insurance and Credit

Guarantee Corporation (DICGC). In India, the non-banking financial sector comprises a

multiplicity of institutions, which are defined under Section 45I (a) of the Reserve Bank

of India Act, 1934. These are equipment-leasing companies (EL), hire purchase

companies (HP), investment companies, loan companies (LCs), mutual benefit financial 5 .RBI, Report on Trend and Progress of Banking in India, 2007-08.

75

companies (MBFC), miscellaneous non-banking companies (MNBC), housing finance

companies (HFC), insurance companies (IC), stock broking companies (SBC), and

merchant banking companies (MBC). A non-banking company which conducts primarily

financial business and belongs to none of these categories is called a residuary non-

banking company (RNBC).

While most institutions of India’s non-banking financial sector are also found in other

countries financial systems, two of them, MBFCs and MNBCs, better known as Nidhis

and Chit Fund Companies, respectively, are genuinely Indian institutions and rarely

found outside South Asia. Inside India, they are most popular in TamilNadu and Kerala,

from where they have originated. A Nidhi does business only with its equity share

holders. Much like a cooperative bank, a Nidhi accepts deposits and makes loans, which

are mostly secured by jewelry. A chit fund, in Kerala also known as kuri, is a particular

form of a rotating savings and credit association (ROSCA), which is most easily

explained by means of an example. Twenty people, say, agree to contribute a fixed

amount of ì.1,000 every month . So the group Pools in ì.20,000 each month as prize

money. Every month an auction is held and in each auction, the bidder who offers the

highest discount is given the prize money 1 minus the discount. For example, when a

member bids ì.4,000, she/he will be paid ì.16,000. The discount of ì.4,000 is equally

shared by all members. In this example, each member thus earns a dividend of ì.200. The

winner of an auction continues to pay the monthly contribution but is not eligible to bid

in subsequent auctions. According to this system, after 20 months each member will

receive the prize exactly once, at which point the chit fund comes to an end. MNBC or

Chit Fund Company acts as commercial organizer of Chit Funds. Financial

intermediation in chit funds takes place instantly and members’ contributions do not

appear as deposits on Chit Fund Companies balance sheets. For 2004, the turnover in

registered chit funds is estimated at ì. 20,000 crore.

NBFCs are essential to a country’s financial system. NBFCs provide services not well

suited for banks. Banks primarily provide payment services and liquidity. Since banks

have to maintain the value of deposits, they tend to have mostly debt-type, as opposed to

equity-type, items on both side of their balance sheet. In contrast, NBFCs can finance

76

riskier borrowers and intermediate equity claims. They thus offer a wider range of risks

to investors, which encourage investment and savings, and create a market for risks.

Second, NBFCs unbundled services that are bundled within a universal bank, and thus

foster competition, which benefits customers. Third, through specialization, NBFCs can

gain informational advantages over banks in their narrowly- defined fields of operation.

Fourth, NBFCs diversify the financial sector, which may alleviate a systemic crisis. Are

the functions performed by NBFCs important for economic growth? Recent research with

cross-country data sets has established that development of the financial sector has the

potential to accelerate economic growth. However, no research on the particular role of

NBFCs in this process has yet been undertaken. Nevertheless, international comparisons

show that economies with lower per capita income tend to have a smaller range of equity-

type claims and a smaller market share of NBFCs relative to banks. An important and

widely-discussed issue in the context of financial institutions is regulation. NBFCs are

particularly important for facilitating storage of value and intermediation of risk.

Moreover, like other financial institutions, they are sensitive to runs and herding

behaviour. If the financial sector does not work smoothly, high transaction costs, lack of

confidence and short-sightedness of economic actors, as well as a culture of corruption

may result.

The objectives of financial sector regulation are protection against systemic risks (like

depositor runs), consumer protection, efficiency enhancement, and social objectives. The

regulations may be structured either institutional or functional level. Under the former,

each financial institution has its own regulatory agency, e.g. one for each category of

NBFC. Under the latter, there are separate agencies for each function of an NBFC, e.g.

one for deposit-taking activities, one for lending, one for market-conduct etc. India’s

legislators have chosen a mix between these two models. RBI regulates ELs, HPs,

Investment Companies, LCs and RNBCs. Similarly, HFCs, ICs, SBCs and MBCs report

to the National Housing Bank, the Insurance Regulation and Development Agency

(IRDA), and the Stock and Exchange Board of India (SEBI), respectively. All these are

instances of institutional regulation. In contrast, Nidhis report to the Department of

Company Affairs (DCA) and Chit Fund Companies to the State Registrar of Chit Funds

77

for their general operations, as well as to RBI for their deposit-taking activities, an

instance of functional regulation.

To achieve the objectives of efficiency enhancement and protection against systemic

risks, regulation has to be neutral. This means that institutions providing the same or

similar services should be subject to identical regulatory requirements. Regulatory

neutrality fosters efficiency-enhancing competition between institutions as each service

will be provided by the institution which can provide it at the lowest cost. Deviations

from regulatory neutrality, on the other hand, likely cause efficiency losses. Suppose that

two institutions can provide a particular service at the same cost under regulatory

neutrality but that, for no apparent reason, one of the two institutions is regulated less

strictly. If regulatory requirements are costly to firms, that institution obtains a regulatory

comparative advantage and will drive the more regulated one out of the market, an

example of regulatory arbitrage. Moreover, if differences in regulatory requirements are

big, less regulated institutions may drive out more efficient ones. In this worst case, the

outcome will be both inefficient and fragile, as institutions which meet the lowest among

all regulatory standards dominate the market.

Much of the history of NBFCs in India over the last fifty years can serve as a case study

of non-neutral regulation and consequent regulatory arbitrage. Before 1997, RBI’s

supervision of NBFCs was limited to prescription of prudential norms and thus the

structure of NBFCs. assets. No requirements were in place regarding minimum capital,

amount and term structure of deposits, and interest rates on deposits and loans. At the

same time the banking sector was heavily regulated through excessive statutory liquidity

requirements, directed lending initiatives, and interest rate caps. NBFCs, which were not

subject to any of these rules, thus enjoyed a substantial regulatory comparative advantage

for several bank-type activities, most notably lending and deposit taking. Consequently,

between 1981 and 1996, the number of NBFCs grew more than seven-fold and the share

of non-bank deposits 4 increased from 3.1 to 10.6 per cent. Several companies were

extremely leveraged and deposits-to-Net owned funds (NOF) ratios in excess of 40 not

uncommon. Numerous bankruptcies of NBFCs in the early 1990.s prompted RBI to take

action. The measures sanctioned in 1997, most notably minimum NOF and a maximum

78

deposits-to-NOF ratio of 1.5 and 4 (depending on the company’s rating), brought NBFC

standards closer to those of the banking sector. Subsequently the number of registered

NBFCs shrank by seventy per cent between 1997 and 2003. Nevertheless, NBFCs

continue to enjoy regulatory privileges. The 1997 provisions were not applied uniformly

across NBFCs. In particular, Nidhis as well as RNBCs were exempt from maximum

deposits-to-NOF ratios and, partly, from interest rate ceilings. As it stands, substantial

deviations from regulatory neutrality and resulting inefficiencies continue to be common

features of the NBFC sector. While the regulatory measures implemented over the last

ten years are steps into the right direction, regulators still have to go long ways to create

an environment in which banking and non-banking financial institutions compete on even

grounds.

Evolution of Non-Banking Financial Companies India soon after independence launched on a programme of rapid industrialization which

needed long term investment in capital assets. Industries which were essential and

required huge investments were setup by the Government of India in the public sector.

The government also extended guarantees whenever loan was obtained by the public

sector industries from the foreign agencies. Public financial institutions were established

for instance, the Industrial Development Bank of India and the statutory Finance

Corporations. The development banks have been providing large and medium industrial

concerns direct finance assistance and small and medium industrial concerns through the

State Financial Institutions. These corporations issue bonds and debentures and also

accept deposits from the public. But the private sector had to rely mostly on the

commercial banks which were also not grown to such a scale as to provide corporate

funds required by the promoters. Traditionally banks have been financing manufacturing

activity by providing working capital. With the shortage of financial resources against

expanding activities the companies were mostly depending on credit deals. Capital goods

such as machinery, equipment etc., were imported on deferred payment terms.

With the inadequacy of the financial institutions and the services provided by them

companies were set up in the private sector under the Companies Act whose main

79

business was to do non-banking financial business. To set up a non-banking financial

company is a very attractive proposition. There is no gestation period. The capital

investment in equity is also not huge as in the case of manufacturing companies. In most

of the companies the equity was built up on long term by successful operation. The

advantages of securing additional assets through non-banking financial companies came

to be realised in the seventies. Acquisition of equipment and capital assets through

leasing was favoured to overcome the disabilities arising out of the MRTP Act which

prescribed asset qualification for declaration of an undertaking as a giant. The MRTP Act

declared any undertaking having ì.100 crore assets as disclosed in the balance sheet as an

MRTP company. As assets secured on lease are owned by the lessor company and not by

the lessee and are not also in theory transferable to the lessee the leased equipment or

assets did not form the constituent of gross block of the borrowing manufacturing

company. Many industrial groups or manufacturing companies set up non banking

financial companies as associate finance companies. There are no special advantages

derived under the MRTP Act now as the concept of MRTP company has lost its

significance when the pre-entry sanctions under that Act were removed.

The non banking financial sector in India has recorded marked growth in the recent

years, in terms of the number of Non-banking financial companies (NBFCs), their

deposits and so on. Keeping in view the growing importance of NBFCs, the banking laws

(misce- llaneous provisions) act, 1963 was introduced to regulate them. To enable the

regulatory authorities to frame suitable policy measures, several committees have been

appointed from time to time to conduct an in depth study of these institutions and make

suitable recommendations for their healthy growth, within the given regulatory frame

work. The suggestions/recommendations made, by them in the context of the

contemporary financial scenario, formed the basis of the formulation of policy measures

by the regulatory authorities/Reserve Bank of India (RBI). The committees that deserve

specific mention in this regard are the:Bhabatosh Datta study group (1971), James Raj

study Group (1975), Chakravarthy Committee (1985), Vaghul committee (1987),

Narasimham Committee on Financial systems (1991) and Shah committee 1992)). The

Shah committee, as a follow-up to the Narasimham committee, was the first to suggest a

80

comprehensive regulatory framework for NBFCs. While, in principle, endorsing the Shah

Committee’s frame work of regulations for NBFCs, the RBI had implemented a number

of its recommendations and incorporated them in the RBI Directions that regulate and

supervise the working and operations of such companies. The Khanna Group, 1996, had

suggested a supervisory framework for NBFCs. In pursuance of its recommendations, the

RBI Act was amended in January 1997. As a further follow-up, the RBI Acceptance of

public deposits directions, the RBI NBFCs Prudential norms directions and the RBI

NBFCs auditors report directions were modified /issued in January 1998. The RBI

acceptance of public deposits directions were modified in December 1998, as

recommended by the Vasudev Task Force Group.

Development of Regulatory Frame Work for NBFCs

The regulatory frame work for NBFCs had been in existence since 1963 under the

provisions of Chapter III B of the Reserve Bank of India Act and the Directions issued.

The regulation of the deposit acceptance activities of the Non-Banking Finance

Companies (NBFCs) was initiated in the sixties with a view to safeguard depositors’

interests and to ensure that the NBFCs function on healthy lines. Accordingly, in 1963, a

new Chapter III B was inserted in the Reserve Bank of India Act, 1934 to effectively

supervise, control and regulate the deposit acceptance activities of these institutions. The

Bhabatosh Datta Study Group (1971) set up to examine the role and operations of

NBFCs. Recommended that NBFCs should be classified into ‘approved’ and ‘non-

approved’ categories and the regulation should be centered primarily on the ‘approved’

(i.e. those which satisfy certain additional requirements such as adequate amount of

capital, reserves, liquid assets, etc.) NBFCs. Subsequently, the regulatory frame work

suggested by the James Raj Study Group (1974) aimed at keeping the magnitude of

deposits accepted by NBFCs within reasonable limits and ensuring that they were in

conformity with the objectives of monetary and credit policy.

The provisions of Chapter III B of the RBI Act, 1934, however, conferred very limited

powers on the Reserve Bank. The legislative intent was aimed at moderating the deposit

mobilization of NBFCs and thereby to providing indirect protection to depositors by

81

linking the quantum of deposit acceptance to Net Owned Fund. Thus, the directions were

restricted to the liability-side of the balance sheet, and too, solely to deposit acceptance

activities. It did not extend to the asset-side of the balance sheets of NBFCs.

Subsequently, several experts/working groups which examined the functioning of NBFCs

were unanimous about the inadequacy of the legislative frame work and reiterated the

need for enhancing the extant frame work. The Chakravarthy Committee, in its Report

submitted in 1985, recommended for the introduction of a system of licensing for NBFCs

in order to protect the interests of depositors. Thereafter, the Narasimham Committee

(1991) outlined a frame work for streamlining the functioning of NBFCs. The

Narasimham committee was of the view that, keeping in mind the growing importance of

NBFCs in the financial intermediation process and their resource to borrowing,

regulatory frame work to govern these institutions should be specified. Such frame work

should include, in addition to the existing requirements of gearing and liquidity ratios,

norms relating to capital adequacy, debt-equity ratio, credit concentration ratio,

adherence to sound accounting practices, uniform disclosure requirements and asset

valuation. Further, the committee argued that the supervision of these institutions should

come within the purview of the proposed agency to be set up for this purpose under the

aegis of the Reserve Bank of India. The introduction of suitable legislation was deemed

as essential not only for ensuring sound and healthy functioning of NBFCs, but also for

safeguarding the interests of depositors.

Recommendations of the Shah Committee In the light of these developments, the Reserve Bank appointed a working group on

financial companies in 1992 under the chairman ship of Dr. A.C.Shah to make an in-

depth study of the role of NBFCs and to suggest regulatory and control measures to

ensure healthy growth of these companies. The working group, in its report submitted in

September 1992, made wide-ranging recommendations for ensuring the functioning of

NBFCs on sound lines. The Reserve Bank thereafter initiated a series of measures,

including (i) the widening of the definition of regulated deposits to include inter-

corporate deposits, deposits from shareholders and directors and the borrowings by issue

82

of debentures secured by immovable property, (ii) the introduction of a scheme of

registration of NBFCs having net owned fund of ì.50 lakh and above, (iii) the issuance of

guidelines on prudential norms so as to regulate the asset side of the balance sheet of

NBFCs. These measures relating to the registration and prudential norms could not be

given statutory backing at that time since the provisions of the Reserve Bank of India

Act, 1934, did not confer it with adequate powers to make them mandatory.

In January 1997, an ordinance was issued by the Government effecting comprehensive

changes in the provisions of the RBI Act, 1934. This was subsequently replaced by the

Reserve Bank of India (Amendment) Act in March 1997. The salient features of the

amended provisions, based on the recommendations of the Shah Committee, pertain to

the entry point norm of ì. 25 lakh as minimum NOF, compulsory registration with the

RBI, maintenance of certain percentage of liquid assets in the form of unencumbered

approved securities, creation of reserve fund and transfer thereto every year an amount

not less than 20 per cent of net profit, determination of policy and issuing of directions by

the Bank on prudential norms, prohibition of NBFCs from accepting deposits and filing

of winding-up petitions for violation of directions. The company law board was

empowered to direct a defaulting NBFC to repay any deposits. Stringent penal provisions

were also included empowering the Reserve Bank to impose, interalia, and pecuniary

penalty for violation of the provisions of RBI Act.

Exercising the powers derived under the amended Act and in the light of the experience

in monitoring of the activities of NBFCs, a new set of regulatory measures was

announced by the Reserve Bank in January 1998. As a result, the entire gamut of

regulation and supervision over the activities of NBFCs was redefined, both in terms of

the trust as well as the forces. Consequently, NBFCs were classified into three categories

for purposes of regulation, viz, (i) those accepting public deposits, (ii) those which do not

accept public deposits but are engaged in the financial business, and (iii) core investment

companies which hold at least 90 per cent of their assets as investments in the securities

of their group/holding/subsidiary companies. While NBFCs accepting public deposits

will be subject to the entire gamut of regulations, those not accepting public deposits

would be regulated in a limited manner. Therefore, the regulatory attention was focused

83

primarily on NBFCs accepting public deposits. In respect of new NBFCs (which are

incorporated on or after April 20, 1999 and which seek registration with the Reserve

Bank), the minimum NOF has been raised to ì.2 crore.

Consequent on the amendment to RBI Act, the liquidity requirement for the NBFCs was

enhanced. Accordingly, loan and investment companies, which were earlier maintaining

liquid assets at 5.0 per cent were directed to maintain 7.5 per cent and 10.0 per cent of

their deposits in Government and other approved securities, effective January 1 and April

1 , 1998, respectively. For other NBFCs, the percentage of assets to be maintained by

them as statutory reserves was increased to 12.5 per cent and 15.0 per cent of their

deposits respectively, to be effective from the above mentioned dates. Besides, with a

view to ensuring that NBFCs can have recourse to such liquid assets in times of

emergency, the custody of these assets with designated commercial banks was also

prescribed. Keeping in mind the risk profile of NBFCs, the capital adequacy ratio was

also raised in a phased manner to 10.0 per cent and 12.0 per cent by end-March 1998 and

1999, respectively.

Regulations over NBFCs accepting Public Deposits

The regulatory attention has been utilized to enable intensified surveillance of NBFCs

accepting public deposits. The Reserve Bank issued directions relating to acceptance of

public deposits prescribing, (a) the quantum of public deposits (b) the period of deposits

which should not be less than 12 months and should not exceed 60 months, (c) the rate of

interest payable on such deposits subject to a ceiling of 16 per cent, (d) the brokerage fees

and other expenses amounting to a maximum of 2 per cent and 0.5 per cent of the

deposits, respectively, and, (e) the contents of the application forms as well as the

advertisement for soliciting deposits.

The companies which accept public deposits are required to comply with all the

prudential norms on income recognition, asset classification, accounting standards,

provisioning for bad debts, capital adequacy, credit/investment concentration norms, etc.

The capital adequacy ratio has been fixed at 12 per cent and above, in accordance with

84

the eligibility criteria for accepting public deposits. The credit and investment

concentration norms have been fixed at 15 per cent and 25 per cent of the owned funds,

depending on whether the exposure is to a single borrower to a borrower group, while the

totality of loans and investment has been subject to a ceiling of 25 per cent and 40 per

cent of the owned fund, respectively, depending on whether the exposure is to a single

party or to an industry group.

Regulations over NBFCs not accepting public deposits

The NBFCs not accepting public deposits would be regulated in a limited manner. Such

companies have been exempted from the regulations on interest rates, period as well as

the ceiling on quantum of borrowings. The ceiling on the aforesaid factors for NBFCs

accepting public deposits is expected to act as a benchmark for NBFCs not accepting

public deposits. However, prudential norms having a bearing on the disclosure of true

and fair picture of their financial health have been made applicable to ensure

transparency in the financial statements to these companies, excepting those relating to

capital adequacy and credit concentration norms.

Chit Fund Companies Operations of chit funds companies are governed under the Chit Fund Act, 1982, which is

administered by State Governments. However, their deposit taking activities are regulated

by the Reserve Bank and they are allowed to accept a miniscule amount of deposits, i.e. ,

up to 25 per cent of their NOF from the public and up to 15 per cent from their share

holders. The concerns regarding the protection of depositors’ interests are further

minimized to a great extent as the chit fund companies usually accept deposits from their

chit subscribers. MNBCs were prohibited with effect from August 18, 2009 from

accepting deposits from public except from the shareholders, which was subjected to the

conditions specified in the MNBC (RBI) Directions 1977. Any deposit accepted and held

by the MNBCs other than from its shareholders as on date shall be repaid on maturity and

shall not be eligible for renewal.

85

Differences between NBFCs and Banks The difference between banks and NBFCs is mainly in the nature of the liabilities of the

two and, to some extent, in the structure of their assets. While the liabilities of

commercial banks usually consist of demand and time deposits, those of NBFCs do not

ordinarily include demand deposits, the mutual benefit financial companies, commonly

known as Nidhis, being notable exceptions. Since demand deposits which are withdrawal

by cheque are considered to be a component of ‘money’, it is the degree of money ness of

the liabilities of the two types of institutions which constitutes a major difference

between the two. From the point of view of assets held, it may be said that commercial

banks hold a wide variety ranging from short-term and medium-term to long term credits

and they also use various credit instruments like overdrafts, cash credits, bills, etc. On the

other hand, the assets of NBFCs are more specialized. For instance, hire purchase finance

companies confine their operations mainly to the financing of transport operations and

consumer credit while housing finance companies make loans for housing purpose. It

may, however, be stated that the difference in the nature of assets held by commercial

banks on the one hand and those held by NBFCs on the other does not clearly demarcate

the respective fields of the two because commercial banks are also, of late, making

advances in fields like transport and consumer credit, which were earlier considered as

out of their purview.

Many activities and functions of NBFC’s are similar to those of banks. The distinction

between them has become considerably blurred. It is true that NBFCs, unlike banks, are

still not a part of payments mechanism. They cannot create money but in many other

respects, they are substitution and complementary with banks.

NBFCs are doing functions akin to that of banks; however there are a few differences:

(i) An NBFC cannot accept demand deposits;

(ii) An NBFC is not a part of the payment and settlement system and as such an

NBFC cannot issue cheque drawn on itself; and

86

(iii) Deposit insurance facility of Deposit Insurance and Credit Guarantee

Corporation is not available for NBFC depositors unlike in case of banks.

Current Scenario of NBFCs  Global credit crisis followed by increase in interest rates in October and November 2008

resulted in widespread crisis of confidence. Chain of events after the collapse of Lehman

Brothers is still fresh in the minds of investors. Non-Banking Finance Companies

(NBFCs) in India were severely impacted due to economic slowdown coupled with fall in

demand for financing as several businesses deferred their expansion plan. Stock prices of

NBFCs’ crashed on the back of rising non-performing assets and several companies

closed their operations. International NBFCs’ still continue to close down or sell their

back end operations in India.

The positive news however is that, this crisis has forced NBFCs to improve their

operations and strategies. Industry experts opine that they are much more mature today

than they were during the last decade. Timely intervention of RBI helped reduce the

negative effect of credit crunch on banks and NBFCs. In fact, aggressive strategies

helped LIC Housing Finance to grab new customers (including customers of other banks)

and increase its market share in national mortgage market. Surprisingly it was able to

maintain its profitability in 2009 (around 37%). HDFC, the largest NBFC in India,

however experienced a slowdown in customer growth due to stiff competition, especially

from LIC Housing Finance and tight monetary conditions. Other NBFCs that were stable

during this period of credit crunch are Infrastructure Development Finance Company

(IDFC) Power Finance Corporation (PFC) and Rural Electrification Corporation (REC).

Growth prospects are strong for these companies given the acute shortage of power in the

country and expected increase in demand for infrastructure projects. The segment which

was hit hardest was Vehicle Financing. Companies financing new vehicle purchases

experienced a drastic reduction in new customer numbers. Fortunately, since vehicle

finance is asset-based business, their asset quality did not suffer as against other

consumer financing businesses. Contrary to this, Shri ram Transport Finance, the only

NBFC which deals in second-hand vehicle financing was able to maintain its growth

87

primarily due to its business model which does not entirely depends on health of the auto

industry.

There are thousands of market players in the NBFCS sector. About 41,000 NBFCS were

there during 1997. The majority of the NBFCS are private limited companies and rest

being public limited companies. The number of NBFCS which regularly report or submit

returns to the RBI/NHB is quite small in relation to the total number of companies at

work. The important reasons for the growth of non banking finance companies are a)

they provide tailor made services to the clients; b) there has been a comprehensive

regulation of NBFCS; c) customers have been attracted to them by their higher level of

customer-orientation, lesser ore/post sanction requirements, simplicity and speed of their

services; d) the monetary and credit policies have created an unsatisfied fringe of

borrowers, i.e. the borrowers out side the purview of banks. The NBFCS have catered to

the needs of this section of borrowers; e) the relatively higher interest rates offered by

them on deposits have attracted a large number of small savers towards them.

The Resources of NBFCs

• The resources of NBFCS are derived from deposits (regulated and exempted), and

ne net owned funds.

• Deposits means, any money received by a non-banking company by way of a

deposit or loan or in any other form.(apart from usual deposits, i.e. interoperate

loans, borrowing by Pvt.limited NBFCS from their shareholders.

• Regulated deposit means, a deposit which is subject to certain ceiling and other

restrictions imposed by regulatory measures. It includes (a) nonconvertible

debentures (b) deposits received by companies from their shareholders(c) deposits

guaranteed by directors (d) fixed deposits etc. received from the

public.(e)interoperate deposits.

• Exempted deposits signify those types of deposits/borrowings which are outside

the scope of the regulatory measures. It includes (a) borrowings from banks and

88

specified financial institutions.(b)money received from central/state/foreign

governments.(c)security deposits. (d) Advances received against orders (e)

convertible debentures.

• And net-owned funds means the aggregate of paid up capital and free reserves.

Role of NBFCs NBFCs like banks and other financial institutions act as intermediaries between the

ultimate savers and the ultimate borrowers. The rationale of their existence derives from

the fact that in an economy there are surplus units which save and deficit units which are

in need of such savings and a mechanism is needed to bring the two together. Surplus

units (savers) can lend to the deficit units (borrowers) directly. This, however, is normally

inconvenient to both the savers and borrowers and is certainly not the most efficient

means of flow of funds between the units. With the mediation of financial institutions,

there is a reduction in the degree of risks involved and there is also a more efficient

utilization of the resources in the economy. Financial intermediaries can provide a more

economical service because of the economies of scale, their professional expertise and

their ability to spread the risk over a large number of units. Thus, their operations give to

the saver the combined benefits of higher return, lower risk and liquidity. The borrowers

on the other hand also get a wider choice on account of intermediation of financial

institutions. It may be of relevance to note that while the loans granted by commercial

banks are, by and large, for industrial, commercial and agricultural purposes, those

granted by NBFCs are generally for transport, trading, acquisition of durable consumer

goods, purchase and repair of houses or just for plain consumption. Since their activities

are not controlled by monetary authorities to the same extent as those of commercial

banks, the credit extended by NBFCs may not necessarily be in consonance with national

objectives and priorities. The major function of financial intermediaries is to transfer the

savings of surplus units to deficit units; hence, they can play a useful role in the economy

of the country. To the extent that they help in monetizing the economy and transferring

unproductive financial assets into productive assets, they contribute to the country’s

89

economic development. In fact, the nature and diversity of financial institutions

themselves have become measures of economic development of a country. The Reserve

Bank of India expert committees identified the need of non banking financial companies

in the following areas:

• Development of sectors like transport and infrastructure

• Substantial employment generation

• Help and increase wealth creation

• Broad base economic development

• Irreplaceable supplement to bank credit in rural segments

• Major thrust on semi-urban, rural Areas and first time buyers/users

• To finance economically weaker sections.

• Huge contribution to the state exchequer.

Regulation of NBFCs While NBFCs have been rendering many useful services, several advances, unhealthy

features of their working also have been observed. At present all NBFCs except HFCs

are regulated by the RBI. With enactment of RBI (Amendment) act 1997, all of them

with net owned funds of ì.25Lakhs and above have to register with the RBI now. The

BFS with the help of department of supervision of the RBI began supervising NBFCs

from July 1995. HFCs are regulated by NHB. The major regulatory provisions are:-

(i) The minimum net worth funds of 25 Lakh and the NBFC should achieve

the minimum net worth norm in 3 years or extended 3years more at the

discretion of RBI.

(ii) NBFCs have to maintain 10%and15% of their deposits in liquid assets.

(iii) They have to create reserve fund and transfer not less than 20% of their

net deposits to it every year.

(iv) The RBI directs them on issues of disclosures, prudential norms, credit,

investments etc.

(v) Nomination facility is available to depositors of these companies.

90

(vi) Unincorporated bodies engaged in financial activity cannot accept deposits from the public from April, 1997.

(vii) They have to achieve a minimum capital adequacy norm of 8% by March,

1996.

(viii) They have to obtain a minimum credit rating from any one of 3 credit

rating agencies.

(ix) A ceiling of 15% interest on deposits has been prescribed for MBFCs or

Nidhis.

(x) The interest rate ceiling on deposits as also the ceiling on quantum of

deposits for NBFCs (other than Nidhis) have removed, subject to

compliance with the RBI directions and guidelines.

With a view to protecting the interests of depositors, the regulatory attention was mostly

focused on NBFCs accepting public deposits (NBFS-D) until recently. Over the last few

years however, this regulatory framework has undergone a significant change, with

increasingly more attention now being paid to non-deposit taking NBFCs (NBFCs-ND)

as well. This change was necessitated mainly on account of a significant increase in both

the number and balance sheet size of NBFCs-ND segment which gave rise to systemic

concerns to address this issue. NBFCs-ND with asset size of ì.100 crore and above was

classified as systemically important NBFCs (NBFCs-ND-SI) and are subjected to

‘limited regulations’. The changing regulatory policy also recognized that those

activities of NBFCs which are asset creating must be given special consideration.

Accordingly in December 2006, a reclassification of NBFCs was effected. In terms of

the new classification, companies financing real/physical assets for productive/economic

activity are classified as asset finance companies (AFC), subject to the fulfillment of

certain norms. The prudential norms for AFCs vary from the norms for other NBFCs.

The revised NBFC classification now comprises of AFCs, loan companies (LCs) and

investment companies (ICs) instead of equipment leasing, hire purchase, loan companies

and investment companies earlier.

91

Figure -3.1

Regulatory Focus in Respect of NBFCs in India

Type of NBFC Name of the Regulatory Authority

Equipment Leasing Companies [EL] Reserve Bank of India

Hire Purchase Finance Companies [HP] Reserve Bank of India

Loan Companies Reserve Bank of India

Investment Companies Reserve Bank of India

Residuary Non-Banking Companies Reserve Bank of India

Miscellaneous Non-Banking Companies (Chit Fund)

Reserve Bank of India* and Registrars of Chits of the concerned States

Mutual Benefit Finance Companies (Nidhis and Potential Nidhis)

Department of Company Affairs of GOI

Micro financial companies Department of Company Affairs of GOI

Housing Finance Companies National Housing Bank

Insurance Companies Insurance Regulatory and Development Authority

Stock Broking Companies Securities and Exchange Board of India

Merchant Banking Companies Securities and Exchange Board of India

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai various issues

Protection of Depositors’ Interest: With a view to protecting the interests of the

depositors further, the Reserve Bank initiated steps for creating a charge on the SLR

securities in favour of the depositors. Accordingly, NBFCs accepting/holding public

deposits were advised in January 2007 to create floating charge on the statutory liquid

assets in favour of their depositors, through the mechanism of ‘Trust Deed’. The charge

is required to be registered with the Registrar of Companies and the information in this

regard is required to be furnished to the Trustees and the Reserve Bank. Furthermore,

92

with a view to containing the systemic risk relating to NBFCs-D, measures were initiated

to ensure that only finally sound NBFCs accept deposits. It was, therefore, prescribed in

June 2008 that NBFCs having net owned funds (NOF) of less than ` 200 lakh may freeze

their deposits at the level than held by them. Asset Finance companies(AFC) having

minimum investment grade credit rating and CRAR of 12 per cent may bring down

public deposits to a level that is 1.5 times their NOF, while all other companies may bring

down their public deposits to a lever equal to their NOF by March 31 2009.

Transparency in Operations of the NBFCs: Along with measures for enhancing the

financial strength of NBFCs, initiatives to inculcate fair corporate governance practices

and good treatment of customers were also undertaken. The Reserve Bank issued

guidelines on Fair Practices Code for NBFCs in September 2006; NBFCs were advised to

invariably furnish a copy of the loan agreement along with a copy each of all enclosures

quoted in the loan agreement to all borrowers at the time of sanction/ disbursement of

loans. Deposit – taking NBFCs with deposits of `20 Crore and above and NBFCs-ND-SI

have been advised to frame internal guidelines on corporate governance which should

include, inter alia, constitution audit committee, nomination committee and risk

management committee, among others. Certain disclosure and transparency practices

have also been specified for them. NBFCs have been advised to lay down appropriate

internal principles and procedures for determining interest rates and processing and other

charges, even though interest rates are not regulated by the Reserve Bank. In order to

ensure that only NBFCs which are actually engaged in the business of NBFI hold

Certificate of Registration (COR), it has been decided that all NBFCs should obtain and

submit an annual certificate from their statutory auditors to the effect that they continue

to undertake the business of NBFI to be eligible for holding of COR.

To strengthen their financial viability, NBFCs were permitted in December 2006 to

undertake fee based business to augment their income, subject to certain norms. The

diversification business that may be permitted include, marketing and distribution of

mutual fund products as agents of mutual funds and issuing co branded credit cards with

93

scheduled commercial banks, without risk sharing, with prior approval of the Reserve

Bank, for an initial period of two years and a review thereafter.

Foreign Direct Investment (FDI) in NBFC sector: In view of the interest evinced in FDI

participation in the NBFC sector, regulatory measures have also been undertaken in

respect of foreign direct investment (FDI) in the NBFCs sector, FDI under automatic

route is permitted in respect of 18 NBFC activities, subject to prescribed minimum

capitalization norms. While allowing FDI in NBFCs, the Reserve Bank takes into

consideration fit and proper criteria of directors, information about the overseas regulator

of the companies bringing the FDI into India and inter-regulatory views. Bank is

monitoring minimum capitalization norms as regards FDI with a view to ensuring that

NBFC activities are limited to permissible activities.

Monitoring of Frauds in NBFCs: In March 2008 all deposit taking NBFCs (including

RNBCs) were advised that the extant instructions with regard to monitoring of frauds

were revised and as such cases of ‘negligence and cash shortages’ and ‘irregularities in

foreign exchange transactions’ were to be reported as fraud if transactions’ were to be

reported as fraud if the intention to cheat/ defraud was suspected/proved. However, in

cases were fraudulent intention was not suspected/ proved at the time of detection but

involve cash shortages of more than ten thousand rupees and cases where cash shortages

more than five thousand rupees were detected by management/auditor/inspecting officer

and not reported on the occurrence by the persons handling cash, then such cases may

also be treated as fraud and reported accordingly.

Prevention of Money Laundering Act, 2002 – Obligation of NBFCs: It was reiterated in

August 2008 that NBFCs, as a part of transaction monitoring mechanism, are required to

put in place an appropriate software application to throw alerts when the transactions are

inconsistent with risk categorization and updated profile of customers. In the case of

NBFCs, where all the branches are not yet fully computerized, the Principal Officer of

the NBFC should cull out the transaction details from branches which are not

computerized and suitably arrange to feed the data into an electronic file with the help of

the editable electronic utilities of cash transaction report (CTR) and suspicious

94

transaction reports (STR) as have been made available by Financial Intelligence Unit-

India (FIU-IND) on their website. It was further clarified that cash transaction reporting

by branches/offices of NBFCs to their Principal Officer should invariably be submitted

on a monthly basis and the Principal Officer, in turn, should ensure to submit CTR for

every month to FIU-IND within the prescribed time schedule.

Facility of Liquidity Support for NBFCs: On October 15, 2008 the Reserve Bank

announced, purely as temporary measure, that banks may avail of additional liquidity

support exclusively for the purpose of meeting the liquidity requirements of mutual funds

(MFs) to the extent of up to 0.5 per cent of their NDTL. Further, it was decided, on a

purely temporary and ad hoc basis, subject to review, to extend this facility and allow

banks to avail liquidity support under the LAF through relaxation in the maintenance of

SLR to the extent of up to 1.5 per cent of their NDTL. This relaxation in SLR is to be

used exclusively for the purpose of meeting the funding requirements of NBFCs and

MFs. Banks can apportion the total accommodation allowed above between MFs and

NBFCs flexibly as per their business needs.

Policy Initiatives for NBFCs-ND-SI: The number, product variety and size of

NBFCs-ND-SI have witnessed substantial growth in recent years and as a result the

operations of these companies have increasingly assumed systemic implications. As a

response to these developments, the ‘minimal regulatory regime’ that existed for these

companies has been transformed into ‘limited regulatory regime’ by the Reserve Bank.

In line with the growing focus on NBFCs-ND-SI in recent years, certain important policy

initiatives were undertaken in 2007-08.

Supervisory Framework Various entry-level norms for new and existing NBFCs have been laid down. Among the

various measures introduced was compulsory registration of NBFCs engaged in financial

intermediation, prescription of minimum level of Net Owned Funds (NOF), maintenance

of certain percentage of liquid assets, creation of reserve fund and transfer thereto every

year a certain percentage of profits to reserve fund. The regulations also provide for

95

measures like credit rating for deposits, capital adequacy, income recognition, asset

classification, compulsory credit rating provision for bad and doubtful debts, exposure

norms and other measures to keep a check on their financial solvency and financial

reporting. While the regulatory framework has been dovetailed primarily towards NBFCs

accepting/holding public deposits, the supervisory mechanism for NBFCs is based on

three criteria, viz., (a) the size of the NBFC, (b) the type of activity performed, and (c) the

acceptance or otherwise of public deposits. Towards this end, a four-pronged supervisory

setup consisting of on-site examination, off-site surveillance, exception reporting by

NBFCs' statutory auditors and market intelligence system has been instituted.

96

Figure-3.2

Non-Banking Financial Companies - Principal Business

Non-Banking Financial Companies

Principal Business

Non-Banking Financial Company In terms of the Section 45-I(f) of the RBI Act, 1934 as amended in 1997, their principal business is that of a financial institution as defined in Section 45 I(c) or that of receiving deposits under any scheme or lending in any manner.

Equipment leasing company (EL) Equipment leasing or financing of such activity. Hire purchase finance company (HP)

Hire purchase transaction or financing of such transactions.

Investment company (IC) Acquisition of securities and trading in such securities to earn a profit.

Loan company (LC) Providing finance by making loans or advances, or otherwise for any activity other than its own; excludes EL/HP/HFCs.

Mutual benefit financial company (MBFC) i.e. Nidhi Company

Means any company which is notified by the Central Government under Section 620A of the Companies Act 1956 (1 of 1956).

Miscellaneous non-banking company (MNBC) i.e. Chit Fund Company

Managing, conducting or supervising as a promoter, foreman or agent of any transaction or arrangement by which the company enters into an agreement with a specified number of subscribers that every one of them shall subscribe a certain sum in installments over a definite period and that every one of such subscribers shall in turn, as determined by lot or by auction or by tender or in such manner as may be provided for in the agreement, be entitled to the prize amount.

Residuary non-banking company (RNBC)

Company which receives deposits under any scheme or arrangement, by whatever name called, in one lump-sum or in installments by way of contributions or subscriptions or by sale of units or certificates or other instruments, or in any manner. These companies are NBFCs but do not belong to any of the categories as stated above.

Non-banking non-financial company (NBNFC)

Means an industrial concern as defined in the Industrial Development Bank of India Act, 1964, or a company whose principal activity is agricultural operations or trading in goods and services or construction/sale of real estate and which is not classified as financial or miscellaneous or residuary non- banking company.

Housing finance company (HFC) The financing of the acquisition or construction of houses including the acquisition or development of plots of land. These companies are supervised by the National Housing Bank.

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai, 2006-07.

97

Unincorporated Bodies: After the RBI (Amendment) Act, 1997, they cannot receive

deposits except from relatives as specified in Section 45-S of RBI Act, if such bodies are

engaged, wholly or partly in any of the activities specified in clause (c) of Section 45-I of

the Act, ibid or principal business is that of receiving deposits or lending. Miscellaneous

non-banking companies covered by the Miscellaneous Non-Banking Companies (Reserve

Bank) Directions, 1973 are of two types they are, (a) Those conducting prize chits,

benefit/ savings schemes, lucky draws, etc; (b) Those conducting conventional or

customary chit funds where under the foremen companies enter into agreements with a

specified number of subscribers that every one of them shall subscribe a certain sum in

installments over a definite period and that every one of such subscriber shall in his turn,

as determined by lot or by auction or by tender or in such other manner as may be

provided for in the agreements, be entitled to the prize amount. This prize amount is

arrived at by deduction from out of the total amount subscribed at each installment by all

subscribers, (i) the commission charged by the company service charges as a promoter or

a foreman or an agent and (ii) discount, i.e, any sum which a subscriber agrees to forego,

from out of the total subscriptions of each installment in consideration of the balance

being paid to therm.

Companies conducting the conventional types of chits or those conducting any other form

of chits/kuris or executing any other business similar to this type of business are

comparatively of a recent origin. And of late there has been a mushroom growth of such

companies which are doing brisk business in several parts of the country, especially in

big cities like Ahmedabad, Bangalore, Bombay, Calcutta and Delhi. They have also

established branches in various States. These companies float schemes for collecting

money from the public. The ‘modus operandi” of such schemes is that the company acts

as the foreman or promoter and collects subscriptions in one lump sum or by monthly

installments spread over a specified period from the subscribers to the schemes.

Periodically, the numbers allotted to members holding the tickets or units are put to a

draw and the member holding the lucky ticket gets the prize either in cash or in the form

of an article of utility, such as a motor car, scooter, etc. Once a person gets the prize, he is

98

very often not required to pay further installments and his name is deleted from further

draws. The schemes usually provide for the return of subscriptions paid by the members

with or without an additional sum by way of bonus or premium at the end of the

stipulated period in case they do not get any prize. The principal items of income of these

companies are interest earned on loans given to the subscribers against the security of the

subscriptions paid or on an unsecured basis as also loans to other parties, service charges

and membership fees collected from the subscribers at the time of admission to the

membership of the schemes. The major heads of expenditure are prizes given in

accordance with the rules and regulations of the schemes, advertisements and publicity

expenses and remuneration and other perquisites to the directors.

Miscellaneous Non-Banking Companies (MNBCs) MNBCs are mainly engaged in the Chit Fund business. The term 'deposit' as defined

under Section 45 I (bb) of the Reserve Bank of India Act, 1934 does not include

subscription to Chit Funds. The Chit Fund companies have been exempted from all the

core provisions of Chapter IIIB of the RBI Act including registration. In terms of

Miscellaneous Non-Banking Companies (RBI) Directions, the companies can accept

deposits up to 25 per cent and 15 per cent of the NOF from public and shareholders,

respectively, for a period of 6 months to 36 months, but cannot accept deposits repayable

on demand/notice.

A study group on Miscellaneous Non-Banking companies (RBI) during 1997 headed by

Dr. Bhabatosh Dutta reviewed the role of various non banking financial institutions it

observed that the chit funds were not efficient as saving or lending institutions and they

encouraged consumption spending and in some cases hoarding of scarce commodities. As

elimination of chit funds would leave credit gap they should be regulated by appropriate

legislation to ensure safeguarding the interests of the members. In 1974 a study group

headed by Dr.J.S.Raj observed that prize chits or benefit schemes do not serve any social

purpose, on the contrary they are prejudicial to public interest also adversely affecting the

efficiency of fiscal and monetary policy. The study group therefore recommended the

total ban of the conduct of Prize Chits. In 1978 the Prize Chits and Money Circulation

99

Schemes (Banning) Act 1978 was enacted. As a follow up of the recommendations of

the Raj Committee a set of directions were issued by the Reserve Bank called the

Miscellaneous non banking(Reserve Bank) Directions, 1977 regulating the working of

the conventional chits.

The Miscellaneous Non-Banking Companies (Reserve Bank ) Directions, 1977 came into

force with effect from the 1st July, 1977. These directions shall apply to every financial

institution which is a company and which carries on in any place in the State of Jammu

and Kashmir, any of the following types of business and to every financial institution

which is a company and which carries on, in any place in India, any of the mentioned

types of business referred to collecting whether as a promoter, foreman, agent or in any

other capacity, monies in one lump sum or in installments by way of contribution, or

subscription or by sale of units, certificates or other instruments or in any other manner or

as membership fees or admission fees or service charges to or in respect of any savings,

mutual benefit, thrift, or any other scheme or arrangement by whatever name called, and

utilizing the monies so collected or any part thereof or the income accruing from

investment or other use of such monies for all or any of the following purposes:

a. Giving or awarding periodically or otherwise to a specified number of subscribers

as determined by lot, draw or in any other manner, prizes or gifts in cash or in

kind, whether or not the recipient of the prize or gift is under a liability to make

any further payment in respect of such scheme or arrangement.

b. Refunding to the subscribers or such of them as have not won any prize or gift,

the whole or part of the subscriptions, contributions, or other monies collected,

with or without any bonus, premium, interest or other advantage, howsoever

called, on the termination of the scheme or arrangement or, on or after the expiry

of the period stipulated therein.

Managing, conducting or supervising as a promoter, foreman or agent of any transaction

or arrangement by which the company, enters into an agreement with a specified number

of subscribers that every one of them shall subscribe a certain sum in installments over a

100

definite period and that every one of such subscribers shall, in his turn as determined by

lot or by auction or by tender or in such other manner as may be provided for in the

arrangement be entitled to the prize amount. Conducting any other form of chit or kuri

which is different from the type of business referred above.

Acceptance of deposit by miscellaneous non-banking companies On and from the 1st July, no miscellaneous non-banking company shall, receive any

deposit repayable on demand, or on notice, or repayable after a period less than six

months and more than thirty-six months from the date of receipt of such deposit or renew

any deposit received by it whether before or after the aforesaid date unless such deposit,

or renewal is repayable not earlier than six months and not later than thirty-six months

from the date of such renewal. Provided that where a miscellaneous non-banking

company has before the 1st July, 1977, accepted deposits repayable after a period of more

than thirty-six moths, such deposits shall, unless renewed in accordance with these

directions, be repaid in accordance with the terms of such deposits. Further provided that

nothing contained in this clause shall apply to monies raised by the issue of debentures or

bonds.

General provision regarding repayment of deposits

(i) No miscellaneous non-banking company shall repay any deposit within a period

of three months from the date of its

. (ii) Where a miscellaneous non- banking company repays a deposit after the period

indicated in sub-clause (i) above but before its maturity, it shall pay interest as a)

Three months but before expiry of six months – no interest; b) Six months but

before the date of maturity - one percentage point less than the contracted rate.

Provided that the event of death of a depositor, the deposit may be repaid

prematurely to the surviving depositor/s, in the case of joint holding with survivor

clause, or legal heirs with interest at the contracted rate up to the date of

repayment.

101

(iii)A miscellaneous non-banking company may grant a loan up to seventy per cent of

the amount of deposit to a depositor after the expiry of three months from the date

of deposit at the rate of interest two per cent points above the interest payable on

the deposit.

Other directions include, i)Every miscellaneous non-banking company should furnish

copies of balance sheet and accounts together with director’s report to the Reserve Bank;

ii) Every miscellaneous non-banking company should submit to the Reserve Bank a

return, furnishing the information specified the 1st schedule hereto, with reference to its

position as on the dates specified in the said schedule; iii) Balance sheet, returns, etc. to

be submitted to the Department of Financial Companies; iv)Every miscellaneous non-

banking company shall comply with the provisions of the non-banking financial

companies and miscellaneous non-banking companies (advertisement) rules, 1977, and

shall also specify in every advertisement to be issued there under, the following:

(a) The actual rate of return by way of interest, premium, bonus or other

advantage to the depositor.

(b) The mode of pa payment to the depositors.

(c) The maturity period of deposit

(d) The interest payable on a specified deposit.

(e) The rate of interest which will be payable to the depositor in case the

depositor withdraws the deposit prematurely, the terms and conditions

subject to which a deposit will be renewed, and

(f) Any other special features relating to the terms and conditions subject to

which the deposits are accepted/renewed.

102

Acceptance of Deposits by chit fund companies

The Reserve Bank of India, having considered it necessary in the public interest,

amended the Miscellaneous Non-Banking Companies (Reserve Bank) Directions, 1977,

in exercise of the powers conferred by sections 45j, 45k and 45l of the Reserve Bank of

India Act, 1934, (2 of 1934) and all the powers enabling it in this behalf, with immediate

effect vide their letter No. :RBI/2009-10/133,RNBS (PD) CC.NO.159 /03.03.01/2009-

10, prohibit MNBCs from accepting deposits from public except from shareholders,

which is subject to the conditions specified in the directions issued by the Reserve Bank.

Any deposit accepted and held by the MNBCs other than from its shareholders as on date

shall be repaid on maturity and shall not be eligible for renewal.

The Reserve Bank only regulates the deposits accepted by these companies, but it does

not regulate their Chit Fund business, which is administered by the respective State

Governments through the offices of Registrars of Chits. The Chit Funds Act, 1982 was

enacted as a Central Act for ensuring uniformity in the provisions applicable to Chit Fund

institutions throughout the country, and all State Governments are required to frame rules

for extending the provisions of this Act to their respective jurisdictions. At present, 16

States and 6 Union Territories have adopted the Central Act and the Reserve Bank is

pursuing with the State Governments of Andhra Pradesh, Arunachal Pradesh, Gujarat,

Haryana, Kerala, Maharashtra, Mizoram and Nagaland for early formulation of rules

under the Central Act.

103

Table-3.1

Number of Non-Banking Financial Companies Registered with the Reserve Bank (During 1999 to 2012)

(Figures are in NOs)End –June Number of

Registered NBFCs Annual

Growth RateNBFCs Accepting Public

Deposits Annual Growth

Rate 1999 7855 - 623(8.0) -

2000 8451 7.59 679(8.0) 8.99

2001 13815 63.47 776(5.6) 14.29

2002 14077 1.9 784(5.5) 1.03

2003 13849 -1.62 710(5.1) -9.44

2004 13764 -0.61 604(4.3) -14.93

2005 13261 -3.65 507(3.8) -16.06

2006 13014 -1.86 428(3.2) -15.58

2007 12968 -0.35 401(3.1) -6.31

2008 12809 -1.23 364(2.8) -9.23

2009 12740 -0.54 336(2.6) -7.69

2010 12630 -0.86 308(2.4) -8.33

2011 12409 -0.02 297(2.2) -0.04

2012 12385 -0.001 271(2.1) -0.09

Note: Figures in brackets indicate percentage to the total number of NBFCs.

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

104

Table-3.2 Major Components of Liabilities of NBFCs-D by Classification of NBFCs

(During 2003-04 to 2011-12) (Amount in ì. Crore) Classification 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12Liabilities Asset Finance -- -- -- 24,718

(50.9) 50,998 (68.4)

56,496 (73.2)

60,902 (64.6)

74,008 (70.2)

85,600 (73.2)

Equipment Leasing 7,996 (21.2)

3,744 (11.4)

4727 (13.1)

325 (0.7)

162 (0.2)

--

--

--

--

Hire Purchase 22,163 (58.8)

19,929 (60.8)

20,500 (56.9)

17,376 (35.8)

178 (0.2) -- -- -- --

Investment 2,208 (5.9)

2,422 (7.4)

1,890 (5.2)

1,633 (3.4)

402 (0.5)

2 (0.0) -- -- --

Loan 4,109 (10.9)

5,485 (16.7)

6,964 (19.3)

4,499 (9.3)

22,819 (30.6)

20,631 (26.7)

33,310 (35.4)

31,424 (29.8)

31,300 (26.8)

MNBC -- -- -- 2(0.0) 3(0.0) -- -- -- -- Others(include MNBC)

1,233 (3.3)

1,173 (3.6)

1,922 (5.3) -- -- -- -- -- --

Total 37,709 32,754 36,003 48,554 74,562 77,128 94,212 1,05,432 1,16,900 Deposits Asset Finance -- -- -- 186

(8.9) 1,161 (56.9)

1,553 (78.8)

2,268 (83.2)

3,628 (80.4)

4500 (76.9)

Equipment Leasing 511 (10.1)

344 (8.0)

343 (8.7)

43 (2.1)

10 (0.5)

--

--

--

--

Hire Purchase 3,539 (70.3)

2,963 (68.6)

2,423 (61.7)

1,683 (81)

169 (8.3)

--

--

--

--

Investment 125 (2.5)

106 (2.5)

94 (2.4)

45 (2.2)

19 (0.9)

--

--

--

--

Loan 177 (3.5)

178 (4.1)

205 (5.2)

117 (5.6)

682 (33.4)

418 (21.2)

458 (16.8)

434 (10.6)

1,300 (23.1)

MNBC -- -- -- 2(0.1) 1(0.1) -- -- -- -- Others(include MNBC)

683 (13.6)

727 (16.8)

861 (21.9)

--

--

--

--

--

--

Total 5,035 4,317 3,926 2,077 2,042 1,971 2,727 4,062 5800 Borrowings Asset Finance -- -- -- 19,091

(58.8) 34,093 (67.4)

40,689 (72.8)

54,202 (78.5)

40,689 (72.8)

54,202 (78.5)

Equipment Leasing 6,472 (26.4)

2,811 (13.5)

3,112 (13.5)

128 (0.4)

76 (0.2)

--

--

--

--

Hire Purchase 13,650 (55.8)

12,141 (58.2)

13,385 (58.1)

10,683 (32.9)

38 (0.1)

--

--

--

--

Investment 1,613 (6.6)

1,718 (8.2)

1,092 (4.7)

133 (0.4)

358 (0.7)

- 0

- 0

- 0

- 0

Loan 2,600 (10.6)

3,775 (18.1)

4,656 (20.2)

2,417 (7.4)

16,012 (31.7)

15,208 (27.2)

14,867 (21.5)

15,208 (27.2)

14,867 (21.5)

MNBC -- -- -- -- -- -- -- -- -- Others(include MNBC)

145 (0.6)

407 (2.0)

799 (3.5)

--

--

--

--

Total 24,480 (100)

20,852 (100)

23,044 (100)

32,452 (100)

50,557 (100)

55,897 (100)

69,070 (100)

55,897 (100)

69,070 (100)

--: Nil/Negligible Note: Figures in parentheses are percentage share in respective total. Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

105

Profile of NBFCs RBI’s supervision of NBFCs since the amendment to the RBI Act in 1997 has shown that

these companies are in a wide range in size - from the small with just the minimum

prescribed NOF of ì.25 lakh and assets built with this, to the large with deposits/assets of

over ì. 500 crore (RNBCs have deposits of very large size comparable to small sized

banks and stand as a distinct set of NBFCs. A size wise break up of these is furnished at

Table 3.1. It clearly evident that, the total number of NBFCs registered with the Reserve

bank, consisting of NBFCs-D (deposit-taking NBFCs), RNBCs, Mutual Benefit

Companies (MBCs), Miscellaneous Non Banking Companies (MNBCs) and Nidhi

companies, declined from 14,077 at end-June 2002 to 12,385 at end-June 2012.The

number of NBFC-D also declined from 784 at end-June 2002 to 271 at end-June 2012,

mainly due to exit of many NBFCs from deposit taking activity. The annual growth rates

are consistently negative from the year 2003, for both number of NBFCs registered and

number of NBFCs accepting deposits. Despite the decline in the number of NBFCs, their

total assets as well as net owned funds registered an increase during 2010-11, while

public deposits recorded a decline.

Operations of NBFCs (excluding RNBCs) The liabilities, Deposits and Borrowings of major components of NBFCs-D are furnished

in the Table-3.2. It is observed that, Asset Finance Companies (AFCs) held largest share

in the Liabilities, Deposits and Borrowings consistently from the year 2006-2012,

followed by loan companies, hire purchase companies and equipment leasing companies.

It is mainly on account of the reclassification of NBFCs, which was initiated in

December 2006.

106

Table-3.3

Profile of public deposits of different categories of NBFCs

(During 1998 to 2011) (Amount in ì. Crore)Year Classification of NBFCs Asset

Finance Equipment Leasing

Hire Purchase

Investment Loan RNBCs Others including MNBC

Total

1998 -- 1,962.09

(8.2) 3,937.75

(16.5) 6,628.92

(27.8) --

10,248.72 (43.0)

1,042.97 (4.5)

23,820.45 (100.0)

1999 -- 1,172.91

(5.7) 3,339.78

(16.3) 4,455.80

(21.8) --

10,644.27 (47.8)

816.17 (4.0)

20,428.93 (100.0)

2000 -- 1,021.20

(5.2) 4,083.54

(21.2) 2517.46 (13.0)

-- 11,003.77

(56.9) 715.75 (3.7)

19,341.72 (100.0)

2001 -- 1,450.21

(8.0) 3,659.19

(20.2) 785.82 (4.3)

-- 11,625.24

(64.3) 564.18 (3.1)

18,084.64 (100.0)

2002 -- 668 (3.5)

3,709 (19.7)

1,029 (5.5)

-- 12,889 (68.5)

528 (2.8)

18,822 (100.0)

2003 -- 511

(10.1) 3,539 (70.3)

125 (2.5)

177 (3.5)

-- 683

(13.6) 5,035

(100.0)

2004 -- 344 (8.0)

2,963 (68.6)

106 (2.5)

178 (4.1)

-- 727

(16.8) 4,318

(100.0)

2005 -- 343 (8.7)

2,423 (61.7)

94 (2.4)

205 (5.2)

-- 317

(11.9) 3,926

(100.0)

2006 -- 153 (5.7)

2,039 (76.5)

81 (3.0)

77 (2.9)

-- 317

(11.9) 2,667

(100.0)

2007 1,161 (56.9)

10 (0.5)

169 (8.26)

19 (0.9)

683 (33.44)

-- -- 2,042

(100.0)

2008 1,161 (56.9)

10 (0.5)

169 (8.26)

19 (0.9)

682 (33.4)

1 (0.04)

-- 2,042

(100.0)

2009 2,287 (83.3)

-- -- --

458 (16.7)

-- -- 2,745

(100.0)

2010 3600 (90.0)

-- -- --

400 (10.0)

-- -- 4,000

(100.0)

2011 4500

(77.58) -- --

--

1300 (22.42)

-- -- 5,800

(100.0) Note: Figures in Parenthesis indicate percentage to respective tables. Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

107

Table-3.4

Range of Deposits held by Non-Banking Financial Companies

(During 2003-04 to 2011-12) (Amount in ì. Crore) Number of NBCs/ Amount of deposits

Deposit Range 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Less than ì. 0.5 Crore

491 (56.44)

428 (55.3)

368 (52.57)

264 (57.02)

213 (60.86)

185 (64.24)

141 (61.84)

134 (61.75)

117 (59.69)

65 (1.3)

53 (1.2)

43 (1.1)

37 (1.4)

28 (1.4)

23 (1.1)

17 (0.6)

19 (0.47)

14 (0.24)

More than ì. 0.5 crore and up to ì.2 crore

233 (26.78)

210 (27.13)

197 (28.14)

120 (25.92)

85 (24.29)

57 (19.79)

45 (19.74)

38 (17.51)

34 (17.35)

225 (4.5)

206 (4.8)

195 (5.0)

116 (4.3)

82 (4.0)

55 (2.8)

47 (1.8)

44 (1.08)

38 (0.65)

More than ì. 2 crore and up to ì.10 crore

90 (10.34)

82 (10.59)

84 (12.0)

48 (10.37)

38 (10.86)

30 (10.42)

26 (11.4)

28 (12.9)

27 (13.78)

360 (7.1)

352 (8.2)

375 (9.6)

201 (7.5)

186 (9.1)

133 (6.7)

122 (4.5)

129 (3.18)

113 (1.93)

More than ì. 10 crore and up to ì.20 crore

21 (2.41)

18 (2.33)

18 (2.57)

14 (3.02)

4 (1.14)

6 (2.08)

5 (2.19)

7 (3.23)

7 (3.57)

284 (5.6)

242 (5.6)

265 (6.7)

196 (7.3)

61 (3.0)

76 (4.0)

69 (2.5)

108 (2.66)

109 (1.87)

More than ì. 20 crore and up to ì.50crore

12 (1.38)

17 (2.2)

18 (2.57)

6 (1.3)

2 (0.57)

4 (1.39)

3 (1.32)

2 (0.92)

4 (2.04)

364 (7.2)

569 (13.2)

601 (15.3)

199 (7.5)

56 (2.7)

142 (7.2)

107 (4.0)

81 (1.99)

120 (2.05)

ì.50 crore and above

23 (2.64)

19 (2.45)

15 (2.14)

11 (2.38)

8 (2.29)

6 (2.08)

8 (3.51)

8 (3.69)

7 (3.57)

3,737 (74.3)

2,895 (67.0)

2,447 (62.3)

1,917 (71.9)

1,629 (79.8)

1,543 (78.2)

2,364 (86.6)

3,681 (90.62)

5,447 (93.25)

Total 870 (100.0)

774 (100.0)

700 (100.0)

463 (100.0)

350 (100.0)

288 (100.0)

228 (100.0)

217 (100.0)

196 (100.0)

5,035 (100.0)

4,317 (100.0)

3,926 (100.0)

2,667 (100.0)

2,042 (100.0)

1,971 (100.0)

2,727 (100.0)

4,062 (100.0)

5,841 (100.0)

Note: Figures in parentheses are percentages to total deposit. --: Nil/Negligible Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

108

Profile of public deposits of different categories of NBFCs

The profile of public deposits of various Categories of NBFCs from the year 1998 to

2011 is presented in the Table-3.3. it is evident from the table that, public deposits held

by all groups of NBFCs taken together, declined moderately during the year 2003-04, and

2004-05, except loan companies and other companies increased during 2003-04, and

2004-05.This trend is indicative of the shift in preference of NBFCs from public deposits

to bank loans/debentures. Continuing the trend of the previous year, public deposits held

by all groups of NBFCs taken together, declined moderately during 2008-09. This trend

is indicative of the shift in preference of NBFCs from public deposits to bank

loans/debentures. The decline in public deposits was mainly evident in the case of loan

companies and equipment leasing companies due to reclassification of some of these

companies as asset finance companies. And they have shown a gradual increase in the

years 2009-2012.

Range of Deposits held by Non-Banking Financial Companies From the Table-3.4 it is observed that, there is a sharp increase in the share of NBFCs-D

located at the upper-end having deposit size of ì. 50 crore and above accounting for about

90.6% of total deposits at end-March 2011.However there were only 8 MBFCs-D

belonging to this category constituting about 3.7% of the total No. of NBFCs-D. Thus,

only relatively bigger NBFCs-D was able to raise resources through deposits.

109

Table-3.5 Financial Performance of NBFCs-D

(During 1999 to 2011) (Amount in ì. Crore) Classification of

NBFCs As at end March

1999 2000 2003 2004 2005 2006 2007 2008 2009 2010 2011 A. Income(i+ii) 6809 6770 5084 4332 4582 4578 5721 11879 13656 13615 15200 (i) Fund Based

6551

6299

4709 (92.6)

4005 (92.5)

4208 (91.8)

4433 (96.8)

5590 (97.7)

11572 (97.4)

13489 (98.8)

13388 (98.3)

15100 (99.2)

(ii) Fee-Based

258 471 375 (7.4)

327 (7.5)

374 (8.2)

145 (3.2)

131 (2.3)

307 (2.6)

167 (1.2)

227 (1.7)

100 (0.8)

B. Expenditure (i + ii + iii)

6416

6363

4491

3621

3657

4134

4831

8789

11166

11038

10900

(i) Financial

4355

3687

2.757 (61.4)

2099 (58.0)

2168 (59.3)

2174 (52.6)

2765 (57.2)

5663 (64.4)

6742 (60.4)

6546 (59.3)

6800 (62.3)

Of which interest payment

--

--

--

783 (21.4)

-- (-)

508 (10.5)

211 (2.4)

289 (2.6)

730 (6.6)

900 (8.2)

(ii) operating

1077

1614

1734 (38.6)

1522 (42.0)

1489 (40.7)

1960 (47.4)

1261 (26.1)

2392 (27.2)

2587 (23.2)

2666 (24.2)

3000 (27.1)

(iii) Others

984

1062

-- -- -- -- 804 (16.6)

734 (8.3)

1837 (16.4)

1825 (16.5)

1100 (10.5)

C. Tax Provisions 273 270 254 180 353 291 385 1017 1085 1096 1400

D. Operating Profit (PBT)

-- -- 593 711 924 443 890 3090 2490 2577 4300

E. Net Profit (PAT) 120 137 339 531 572 152 504 2073 1405 1482 2900

F. Total Assets 35968 40007 37709 32754 36003 35561 48554 77128 93709 94212 105400

G. Fin Ratios (as % to Total Assets)

i) Income 18.9 16.9 13.5 13.2 12.7 12.9 11.8 15.4 14.6 14.5 14.4 ii) Fund Based Income

18.2

15.7

12.5

12.2

11.7

12.5

11.5

15.0

14.4

14.2

14.3

iii) Fee Based Income

0.7

1.2

1.0

1.0

1.0

0.4

0.3

0.4

0.2

0.0

0.0

iv) Expenditure 17.8 15.9 11.9 11.0 10.2 11.6 9.9 11.4 11.9 11.7 10.4 v) Financial Expenditure

12.1

9.2

7.3

6.4

6.0

6.1

5.7

7.3

7.2

0.1

0.1

vi) Operating Exp 3.0 4.0 2.9 3.1 4.1 5.5 2.6 3.1 2.8 2.8 2.8 vii) 2.7 2.7 -- -- -- -- -- -- -- -- -- viii)Tax provision 0.8 0.7 0.7 0.5 1.0 0.8 0.8 1.3 1.2 1.2 1.3 ix) Net Profit 0.3 0.3 0.9 1.6 1.6 0.4 1.0 2.7 1.5 1.6 2.7 H. Cost to Income Ration

-- -- -- -- 79.8 90.3 84.4 74.0 81.8 81.1 72.0

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

110

Table 3.6

Non Performing Asset Ratios of NBFCs-D

(During 2001 to 2012) (Figure in Percentage)

End-March Gross NPAs to Gross Advances Net NPAs to Net Advances

(1) (2) (3)

2001 11.5 5.6

2002 10.6 3.9

2003 8.8 2.7

2004 8.2 2.4

2005 5.7 2.5

2006 3.6 0.5

2007 2.2 0.2

2008 2.1 #

2009 2.0 #

2010 1.3 #

2011 0.7 #

2012 2.1 0.5

# P: Provisional. # Provision exceeds NPA

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various

issues.

111

Table-3.7

Capital Adequacy Ratio of NBFCs-D

(During 2003 to 2011) (Figures are in number) Category Year Ending March AFC EL HP LC/IC Total

1) Up to 15 per cent

2003 -- 11 25 16 52 2004 -- 6 16 9 31 2005 -- 4 55 7 66 2006 -- 6 13 3 22 2007 21 4 17 5 47 2008 22 4 15 10 51 2009 2 -- -- 3 5 2010 2 -- -- 3 5 2011 2 -- -- 1 3

2) More than 15 and up to 20 per cent

2003 -- 4 32 9 45 2004 -- 2 15 2 19 2005 -- 3 19 4 26 2006 -- -- 10 -- 10 2007 3 1 7 1 12 2008 5 0 0 3 8 2009 5 -- -- 2 7 2010 5 -- -- 3 8 2011 8 -- -- 3 11

3) More than 20 and upto 30 per cent

2003 -- 9 54 11 74 2004 -- 6 38 7 51 2005 -- 6 32 3 41 2006 -- 5 30 3 38 2007 2 2 23 6 33 2008 25 0 1 3 29 2009 19 -- -- 8 27 2010 19 -- -- 3 22 2011 16 -- -- 2 18

4) Above 30 per cent

2003 -- 32 334 121 487 2004 -- 28 300 55 383 2005 -- 28 219 33 280 2006 -- 22 211 19 252 2007 44 22 217 22 305 2008 117 10 66 46 239 2009 140 -- -- 37 177 2010 142 -- -- 27 169 2011 131 -- -- 27 158

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

112

Financial Performance of NBFCs

The financial performance of NBFCs suffered a setback during 2005-06. While income

earned by NBFCs declined marginally, expenditure increased sharply. As a result,

operating profit and net profit declined sharply. It is evident from the Table-3.5, financial

performance of NBFCs in terms of income and net profit improved during 2008-09. Both

fund based income and fee based income registered robust growth. The financial

performance of NBFC-D witnessed improvement as reflected in the increase in their

operating profits during 2010-11. This increase in profit was mainly on account of growth

in income (fund based) while expenditure declined marginally. The operating profit along

with an increase in tax provision resulted in almost doubling of net profit during 2010-11.

Non Performing Assets: Table 3.6 shows that, Gross NPAs (as a percentage of gross advances) as well as net

NPAs (as per cent of net advances) of reporting NBFCs, as a group, registered a steady

decline between end-March 2001 and end-March 2004 and further to 0.7 per cent in 2011

and stood at 2.1 per cent in 2012. While gross NPAs continued to decline during the year

ended March 2005, net NPAs increased significantly. Gross NPAs (as a per cent of gross

advances) as well as net NPAs (as per cent of net advances) of reporting NBFCs

registered a sharp decline during the year ended March 2012. In continuation of the trend

witnessed during the last few years, gross NPAs (as per cent of gross advances) as well as

net NPAs (as per cent of net advances) of reporting NBFCs declined further during the

year ended March 2012. The gross NPAs (as per cent of gross advances) of equipment

leasing and investment companies increased during 2006-07, while those of loan

companies and hire purchase companies declined. Net NPAs (as per cent of net advances)

also showed a decline in the case of equipment leasing and loan companies. The gross

NPAs of equipment leasing and hire purchase companies increased during 2007-08, due

to reclassification of NBFCs, while those of asset finance companies and loan companies

declined. Net NPAs (as per cent of net advances) increased marginally in case of asset

finance companies, hire purchase companies and investment companies, while those of

equipment leasing companies, and loan companies improved further. Gross NPAs (as

113

percentage of gross advances) of asset finance companies, equipment leasing companies

and investment companies and hire purchase companies declined during 2008-09. Net

NPAs (as percentages of net advances) increased marginally in case of asset finance

companies and hire purchase companies, while those of equipment leasing and

investment companies’ decreased. NPAs of loan companies remained negative during

2008-11.

Capital Adequacy Ratio Capital to risk – weighted assets ratio (CRAR) norms were made applicable to NBFCs in

1998, in terms of which every deposit-taking NBFC is required to maintain a minimum

capital consisting of Tier-1 and Tier-II capital of not less than 12 per cent (15 per cent in

case of unrated deposit-taking loan/investment companies) of its aggregate risk –

weighted assets and of risk-adjusted value of off-balance sheet items. Total of Tier-II

capital, at any point of time, is required not to exceed 100 per cent of Tier-I capital.

It is noteworthy that the NBFC sector is witnessed a consolidation process in the last

few years, wherein the weaker NBFCs are gradually exiting, paving the way for a

stronger NBFC sector. It is clear from the Table-3.7 that, all NBFCs with minimum

CRAR 12% to above 30% at the end March 2011, declined gradually.

114

Table-3.8

Net Owned Funds / Public Deposits (During 2003 to 2011) (Amount in ì crore)

Classification 2003 2004 2005 2006 2007 2008 2009 2010 2011 Asset Finance -- -- -- -- 2,673

(38.62) 6,939 (68.01)

9,863 (74.4)

8,697 10,818

186 (0.1)

1,161 (0.2)

2,268 (0.2)

2287 (0.3)

3628 (0.3)

Equipment Leasing

154 (3.72)

96 (2.34)

430 (8.54)

553 (10.09)

-15 (-0.22)

-50 (-0.49)

--

511 (3.3)

344 (3.6)

343 (0.8)

153 (0.3)

43 (-2.9)

10 (-0.2)

Hire Purchase 2,979 (71.94)

2,235 (54.57)

2,521 (50.06)

3,896 (71.08)

3,004 (43.4)

-76 (-0.74)

--

3,539 (1.2)

2,963 (1.3)

2,423 (1.0)

2,039 (0.5)

1,683 (0.6)

169 (-2.2)

Investment 553 (13.35)

607 (14.82)

662 (13.15)

766 (13.98)

822 (11.88)

83 (0.81)

--

125 (0.2)

106 (0.2)

94 (0.1)

81 (0.1)

45 (0.1)

19 (0.2)

Loan 367 (8.86)

893 (21.8)

1,052 (20.89)

128 (2.34)

437 (6.31)

3,306 (32.4)

3,394 (25.6)

4806 4170

177 (0.5)

178 (0.2)

205 (0.2)

77 (0.6)

117 (0.3)

682 (0.2)

458 (0.2)

545 (0.1)

434 (0.1)

MNBC

-- -- -- -- 0

1 (0.01)

--

2 (6.6)

1

Others 88 (2.13)

265 (6.47)

371 (7.37)

138 (2.52)

-- -- --

683 (7.8)

727 (2.7)

861 (2.3)

317 (2.3)

Total 4,141 (100.0)

4,096 (100.0)

5,036 (100.0)

5,481 (100.0)

6,921 (100.0)

10,203 (100.0)

13,257 (100.0)

13503

14987

5,035 (100.0)

4,317 (100.0)

3,923 (100.0)

2,667 (100.0)

2,077 (100.0)

2,042 (100.0)

2,727 (100.0)

2831 4062

Note: Figures in Parenthesis indicate percentage to respective totals. Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

115

Table-3.9

Total Public Deposits Held by NBFCs and RNBCs (During 1998 to 2011) (Amount in ì crore)

NBFC RNBC Per company public deposits

Year(End-March)

No of Reporting Companies

Public Deposits

No of ReportingCompanies

Public Deposits

Total Public

Deposits

Total Reporting companies

NBFC RNBC

1998 1420 (99.37)

13572 (56.97)

9 (0.63)

10249 (43.03)

23821 (100.0)

1429 (100.0)

9.6 1138.8

1999 1536 (99.29)

9785 (47.9)

11 (0.71)

10644 (52.1)

20429 (100.0)

1547 (100.0)

6.4 967.6

2000 996 (99.1)

8338 (43.11)

9 (0.9)

11004 (56.89)

19342 (100.0)

1005 (100.0)

8.4 1222.7

2001 974 (99.29)

6459 (35.71)

7 (0.71)

11625 (6428)

18085 (100.0)

981 (100.0)

6.6 1660.7

2002 905 (99.45)

5933 (31.52)

5 (0.55)

12889 (68.48)

18822 (100.0)

910 (100.0)

6.6 2577.8

2003 870 (99.43)

5035 (25.05)

5 (0.57)

15065 (74.95)

20100 (100.0)

875 (100.0)

5.8 3013

2004 774 (99.61)

4317 (21.98)

3 (0.39)

15327 (78.02)

19644 (100.0)

777 (100.0)

5.6 5109

2005 700 (99.57)

3926 (19.13)

3 (0.43)

16600 (80.87)

20526 (100.0)

703 (100.0)

5.6 5533.3

2006 432 (99.31)

2447 (10.82)

3 (0.69)

20175 (89.18)

22622 (100.0)

435 (100.0)

5.7 6725

2007 371 (99.2)

2075 (84)

3 (0.8)

22622 (91.6)

24697 (100.0)

374 (100.0)

5.6 7540.7

2008 288 (99.31)

1971 (9.14)

2 (0.69)

19596 (90.86)

21567 (100.0)

290 (100.0)

6.8 9798

2009 228 (99.13)

2727 (15.81)

2 (0.87)

14520 (84.19)

17247 (100.0)

230 (100.0)

12 7260

2010 217 (98.6)

4062 (28.0)

3 (1.4)

10500 (72.0)

14562 (100.0)

220 (100.0)

19 3500

2011 196 (98.0)

5841 (48.0)

3 (2.0)

6300 (52.0)

12141 (100.0)

199 (100.0)

30 2100

Note: Figures in brackets are percentage in total deposits and total reporting companies respectively.

Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

116

Net Owned Funds Vis-à-vis Public Deposits of NBFCs-D

Net owned fund (NOF) of NBFCs is the aggregate of paid –up capital and free reserves,

netted by (i) the amount of accumulated balance of loss, (ii) deferred revenue expenditure

and other intangible assets, if any, and adjusted by investments in shares and loans and

advances to (a0 subsidiaries, (b) companies in the same group and (c) other NBFCs (in

excess of 10 per cent of owned fund). Information of NOFs can complement the

information on CRAR.

Table 3.8 presented the picture of Net owned funds to Public deposits ratios of NBFCs.

The ratio of public deposits to NOF in respect of almost all NBFC groups except loan

companies, after increasing marginally during the year ended March 2004, declined

during the year ended March 2005-2008. The ratio of public deposits to NOF in the case

of loan companies and hire purchase declined during the year ended March 2009, while

that of other category companies witnessed a marginal increase. The ratio of hire

purchase companies continued to be negative because of negative NOF. The ratio of

public deposits to NOF for all categories of NBFCs taken together was unchanged at 0.2

per cent at end March 2009. The ratio of Public deposits to net owned funds (NOF) of

NBFCs taken together has increased marginally 0.3% at end March 2011. There was an

increase in NOF and Public deposits of NBFC-D during 2010-11. This increase was

mainly concentrated in the NOF size category of ì. 500 and above.

Total Public Deposits Held by NBFCs and RNBCs Table 3.9 presents the information regarding total public deposits held by NBFCs and

RNBCs from the year 1998 to 2011. The number of NBFCs gradually decreased from

the year 1998 and the deposits held by NBFCs also gradually decreased till the year 2008.

The years 2009, 2010 and 2012 have noticed a growth in the public deposits held by

NBFCs. The number of RNBCs has not been considerably increased and the public

deposits held by RNBCs have noticed a sharp increase.