Non Banking Financing Companies Report

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BUSINESS LAW
Group Project
On
Non-Banking Financial Companies
In partial fulfilment of the requirement for the award for
Post Graduate Diploma in Management
2015-2017
Group Members:
Adil Garg
Ankur Agarwal
Anshul Gupta
Ayush Jain
Siddhant Kumar
Varsha Maheshwari

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Acknowledgement
We would like to extend our sincere thanks and heartfelt gratitude to all those
individuals who sacrificed their time and energy to help us successfully
complete this endeavour. Without their valuable guidance, inputs, help,
cooperation & encouragement from time to time we would not have made
sufficient headway in the project.
We are extremely thankful and pay our heartfelt gratitude to Dr. Jagdish
Shettigar for his outstanding teaching on subject of Business Law its need and
the practicality and for his active guidance and support which went into the
completion of this project.
We are also grateful to our friends, relatives and Lastly, we thank Almighty, our
family and friends for their constant encouragement without which this project
would not be possible
We extend our gratitude to Birla Institute of Management Technology for
giving us this wonderful opportunity to learn about the NBFC’s its need,
functionality and the various factors which will effect it and growth factors and
the challlenges faced by it.
Any ommision in this brief acknowledgement does not mean lack of gratitude.
“It is not possible to prepare a project report without the assistance &
encouragement of other people. This one is certainly no exception.”
Thank You

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Contents
Abstract...................................................................................................................................................5
Overview...............................................................................................................................................6
NBFC.......................................................................................................................................................6
NBFC should be registered with RBI .......................................................................................................7
Categories of NBFCs which are regulated by other regulators...............................................................7
NBFC Nature of business.....................................................................................................................7
Regulator.............................................................................................................................................7
Requirements for registration with RBI..................................................................................................8
Procedure for application to the Reserve Bank for Registration............................................................8
Categories of NBFCs registered with RBI ................................................................................................8
I. Asset Finance Company (AFC)..........................................................................................................8
II. Investment Company (IC) ...............................................................................................................8
III. Loan Company (LC): .......................................................................................................................8
IV. Infrastructure Finance Company (IFC............................................................................................9
V. Systemically Important Core Investment Company (CIC-ND-SI):...................................................9
VI. Infrastructure Debt Fund: Non- Banking Financial Company (IDF-NBFC) .....................................9
VII. Micro Finance Institution (NBFC-MFI):.........................................................................................9
VIII. Factors (NBFC-Factors) ..............................................................................................................10
IX. Mortgage Guarantee Companies (MGC) .....................................................................................10
X. NBFC- Non-Operative Financial Holding Company (NOFHC)........................................................10
XI. Residuary Non-Banking Companies (RNBCs)...............................................................................10
50-50 Principal Business Criteria for NBFC ...........................................................................................10
Prudential regulations applicable to NBFCs..........................................................................................11
Owned fund’ and ‘net owned fund’ in relation to NBFCs.....................................................................11
NBFC Entities which can legally accept deposits from public...............................................................11
Other requirements for accepting deposits..................................................................................12
Responsibilities of the NBFCs registered with Reserve Bank, with regard to submission on
compliances and other information .....................................................................................................12
A. Returns to be submitted by deposit taking NBFCs.......................................................................12
B. Returns to be submitted by NBFCs-ND-SI.....................................................................................13
C. Quarterly return on important financial parameters of non deposit taking NBFCs having assets
of more than Rs.50 crore and above but less than Rs 100 crore......................................................13
Housing Finance Company....................................................................................................................13
Procedure for application .....................................................................................................................13

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HFCs can accept public deposits...........................................................................................................13
Ceiling on the maximum amount of public deposit..........................................................................14
NBFC regulated by SEBI.........................................................................................................................14
Trend and Growth in NBFC’s.................................................................................................................14
Growth parameters: .............................................................................................................................16
Increasing size and systemic importance .........................................................................................16
2. Stronger Regulatory Environment leads to higher capital cover and Better Risk
Management.....................................................................................................................................16
3. Move towards Secured Lending ...................................................................................................16
4. Lower Liquidity Risk ......................................................................................................................17
5. Stronger Lending Infrastructure....................................................................................................17
6. Rising number of large players – backed by big corporate houses ..............................................17
7. Diversification and Mortgage Based lending................................................................................17
8. .......................................................................................................................................................18
Key Performance Trends observed in the NBFC Sector........................................................................19
1. Capital Adequacy remains comfortable........................................................................................19
2. Asset quality under pressure due to economic stress..................................................................19
3. Profitability impacted on account of slowdown in growth and asset quality pressure ...............20
4. Resource profile continues to be stable .......................................................................................21
5. Rise in Total Assets........................................................................................................................21
Recent Regulatory Norms....................................................................................................................23
Other Issues and Suggestions ...............................................................................................................24
Suggestions ...........................................................................................................................................26
Conclusion.............................................................................................................................................28
References ............................................................................................................................................29

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Abstract
NBFCs are emerging as an alternative to mainstream banking because of their reach to
interior and smaller parts of India. Besides, they are also emerging as an integral part of
Indian Financial System and have commendable contributions towards Government’s
agenda of financial Inclusion. They have been to some extent successful in filling the gap in
offering to credit to retail customer in underserved and unbanked areas.
NBFCs in India have recorded marked growth in recent years which can be more evident on
point of view that some major businesses houses come into this periphery. After their
existence, they are useful and successful for the evolution of a vibrant, competitive and
dynamic financial system in Indian money market. The success factors of their business has
been by making the most of their ability to contain risk, adapt to changes and tap demand in
markets that are likely to be avoided by the bigger players. Thus the need for uniform
practices and level playing field for NBFCs in India is indispensable.
We have tried to study in this project growth of the NBFC’s in our country. We have shown
some of light of some laws which are prevalent in this sector and also focused on some of
the new guidelines which were given by RBI in November 2014. During this project we came
to know about various aspects of NBFC’s like their problems and what might be their
possible solutions we can think of to make NBFC’s even more better and competitive.
We also suggested some of the suggestive measures with possible solution at the later part
of the report which will help the NBFC’s to grow as sector. With taxation incentives and
suggestive some friendly government initiative this sector will grow at good pace.

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Overview
The share of NBFC has steadily grown from 10.7% of banking assets in 2009 to 14.8 per cent in
March 2015. There are 11,769 NBFCs with an asset size of ₹16,10,729 crores at end September
2015. There are 202 entities with assets of ₹500 crore or more, with a total asset size of ₹14,126
billion, according to RBI data.
NBFCs due to their focus on niche segment, expertise in the specific asset classes, deeper
penetration in the rural and unbanked markets.
However, on the other side, they
 depend to a large extent on bank borrowings,
 leading to high cost of borrowings and
 face competition from banks which have lower cost of funds.
The growing asset size of the NBFC sector has increased the need for risk management in the sector
due to growing interconnectedness of NBFCs with other financial sector intermediaries. The Reserve
Bank of India (RBI) has been in the recent past trying to strengthen the risk management framework
in the sector, simplify the regulations and plug regulatory gaps so as to prevent regulatory arbitrage
between banks and NBFCs. The Reserve Bank of India released the ‘Revised Regulatory Framework
for NBFCs’ on November 10, 2014 which broadly focuses on strengthening the structural profile of
NBFC sector, wherein focus is more on safeguarding of the depositors’ money and regulating NBFCs
which have increased their asset-size over time and gained systemic importance. Due to subdued
economic growth, last two years, have been challenging period for the NBFCs with moderation in
rate of asset growth, rising delinquencies resulting in higher provisioning thereby impacting
profitability. However, comfortable capitalisation levels and conservative liquidity management,
continues to provide comfort to the credit profile of NBFCs in spite of impact on profitability
NBFC
Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956
engaged in the business of loans and advances, acquisition of
shares/stocks/bonds/debentures/securities issued by Government or local authority or other
marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but
does not include any institution whose principal business is that of agriculture activity, industrial
activity, purchase or sale of any goods (other than securities) or providing any services and
sale/purchase/construction of immovable property. A non-banking institution which is a company
and has principal business of receiving deposits under any scheme or arrangement in one lump sum
or in instalments by way of contributions or in any other manner, is also a non-banking financial
company

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NBFC should be registered with RBI
In terms of Section 45-IA of the RBI Act, 1934, no Non-Banking Financial company can commence or
carry on business of a non-banking financial institution without
i. it should be a company registered under Section 3 of the companies Act, 1956
ii. It should have a minimum net owned fund of Rs 200 lakh
However, in terms of the powers given to the Bank, to obviate dual regulation, certain
Categories of NBFCs which are regulated by other regulators are exempted
from the requirement of registration with RBI viz.
NBFC Nature of business Regulator
Venture Capital Fund/Merchant Banking
companies/Stock broking companies
SEBI
Insurance Company IRDA
Housing Finance Companies National Housing Bank

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Requirements for registration with RBI
A company incorporated under the Companies Act, 1956 and desirous of commencing business of
non-banking financial institution as defined under Section 45 I(a) of the RBI Act, 1934 should comply
with the following:
i. it should be a company registered under Section 3 of the companies Act, 1956
ii. It should have a minimum net owned fund of Rs 200 lakh. (The minimum net owned fund (NOF)
required for specialized NBFCs like NBFC-MFIs, NBFC-Factors, CICs is indicated separately in the FAQs
on specialized NBFCs)
Procedure for application to the Reserve Bank for Registration
1. The applicant company is required to apply online and submit a physical copy of the
application along with the necessary documents to the Regional Office of the Reserve Bank
of India. The application can be submitted online by accessing RBI’s secured website
https://cosmos.rbi.org.in
2. The company would then get a Company Application Reference Number for the CoR
application filed on-line
3. Thereafter, the company has to submit the hard copy of the application form (indicating the
online Company Application Reference Number, along with the supporting documents, to
the concerned Regional Office
Categories of NBFCs registered with RBI
I. Asset Finance Company (AFC): An AFC is a company which is a financial institution
carrying on as its principal business the financing of physical assets supporting productive/economic
activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material
handling equipment, moving on own power and general purpose industrial machines. Principal
business for this purpose is defined as aggregate of financing real/physical assets supporting
economic activity and income arising therefrom is not less than 60% of its total assets and total
income respectively.
II. Investment Company (IC): IC means any company which is a financial institution carrying
on as its principal business the acquisition of securities,
III. Loan Company (LC): LC means any company which is a financial institution carrying on as
its principal business the providing of finance whether by making loans or advances or otherwise for
any activity other than its own but does not include an Asset Finance Company.

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IV. Infrastructure Finance Company (IFC): IFC is a non-banking finance company
a) which deploys at least 75 per cent of its total assets in infrastructure loans,
b) has a minimum Net Owned Funds of Rs. 300 crores,
c) has a minimum credit rating of ‘A ‘or equivalent
d) and a CRAR of 15%.
V. Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is
an NBFC carrying on the business of acquisition of shares and securities which satisfies the following
conditions: -
a) it holds not less than 90% of its Total Assets in the form of investment in equity shares,
preference shares, debt or loans in group companies;
b) its investments in the equity shares (including instruments compulsorily convertible into
equity shares within a period not exceeding 10 years from the date of issue) in group
companies constitutes not less than 60% of its Total Assets;
c) it does not trade in its investments in shares, debt or loans in group companies except
through block sale for the purpose of dilution or disinvestment;
d) it does not carry on any other financial activity referred to in Section 45I(c) and 45I(f) of the
RBI act, 1934 except investment in bank deposits, money market instruments, government
securities, loans to and investments in debt issuances of group companies or guarantees
issued on behalf of group companies.
e) Its asset size is Rs 100 crore or above and
f) It accepts public funds
VI. Infrastructure Debt Fund: Non- Banking Financial Company (IDF-NBFC) :
IDF-NBFC is a company registered as NBFC to facilitate the flow of long term debt into infrastructure
projects. IDF-NBFC raise resources through issue of Rupee or Dollar denominated bonds of minimum
5 year maturity. Only Infrastructure Finance Companies (IFC) can sponsor IDF-NBFCs.
VII. Micro Finance Institution (NBFC-MFI): NBFC-MFI is a non-deposit taking NBFC
having not less than 85% of its assets in the nature of qualifying assets which satisfy the following
criteria:
a) loan disbursed by an NBFC-MFI to a borrower with a rural household annual income
not exceeding Rs. 1,00,000 or urban and semi-urban household income not
exceeding Rs. 1,60,000;
b) loan amount does not exceed Rs. 50,000 in the first cycle and Rs. 1,00,000 in
subsequent cycles;
c) total indebtedness of the borrower does not exceed Rs. 1,00,000;
d) tenure of the loan not to be less than 24 months for loan amount in excess of Rs.
15,000 with prepayment without penalty;
e) loan to be extended without collateral;
f) aggregate amount of loans, given for income generation, is not less than 50 per cent
of the total loans given by the MFIs;

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g) loan is repayable on weekly, fortnightly or monthly instalments at the choice of the
borrower
VIII. Factors (NBFC-Factors): NBFC-Factor is a non-deposit taking NBFC engaged in the
principal business of factoring. The financial assets in the factoring business should constitute at
least 50 percent of its total assets and its income derived from factoring business should not be less
than 50 percent of its gross income.
IX. Mortgage Guarantee Companies (MGC) - MGC are financial institutions for which at
least 90% of the business turnover is mortgage guarantee business or at least 90% of the gross
income is from mortgage guarantee business and net owned fund is Rs.100 crore.
X. NBFC- Non-Operative Financial Holding Company (NOFHC) is financial
institution through which promoter / promoter groups will be permitted to set up a new bank .It’s a
wholly-owned Non-Operative Financial Holding Company (NOFHC) which will hold the bank as well
as all other financial services companies regulated by RBI or other financial sector regulators, to the
extent permissible under the applicable regulatory prescriptions
XI. Residuary Non-Banking Companies (RNBCs)
Residuary Non-Banking Company is a class of NBFC which is a company and has as its principal
business the receiving of deposits, under any scheme or arrangement or in any other manner and
not being Investment, Asset Financing, Loan Company.
Such companies were required to invest 100 per cent of their deposit liability into highly liquid and
secure instruments
At present, only RNBCs in existence (Peerless) has been directed by the Reserve Bank to stop
collecting deposits, repay the deposits to the depositor and wind up their RNBC business as their
business model is inherently unviable.
50-50 Principal Business Criteria for NBFC
Below conditions are required to be fulfilled to eligible for NBFC
A. Financial assets should constitute more than 50% of a NBFC’s total assets &
B. Income from financial assets constitute more than 50 per cent of the gross income
RBI has defined it so as to ensure that only companies predominantly engaged in financial activity
get registered with it and are regulated and supervised by it. Hence if there are companies engaged
in agricultural operations, industrial activity, purchase and sale of goods, providing services or
purchase, sale or construction of immovable property as their principal business and are doing some
financial business in a small way, they will not be regulated by the Reserve Bank. Interestingly, this
test is popularly known as 50-50 test and is applied to determine whether or not a company is into
financial business.

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Prudential regulations applicable to NBFCs
 Banking Financial (Deposit Accepting or Holding)
 Companies Prudential Norms (Reserve Bank) Directions, 2007,
 Non-Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding)
 Companies Prudential Norms (Reserve Bank) Directions, 2015 and
 Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding)
 Companies Prudential Norms (Reserve Bank) Directions, 2015.
Applicable regulations vary based on the deposit acceptance or systemic importance of the NBFC.
The directions inter alia, prescribe guidelines on income recognition, asset classification and
provisioning requirements applicable to NBFCs, exposure norms, disclosures in the balance sheet,
requirement of capital adequacy, restrictions on investments in land and building and unquoted
shares, loan to value (LTV) ratio for NBFCs predominantly engaged in business of lending against
gold jewellery, besides others. Deposit accepting NBFCs have also to comply with the statutory
liquidity requirements. Details of the prudential regulations applicable to NBFCs holding deposits
and those not holding deposits is available in the section ‘Regulation – Non-Banking – Notifications -
Master Circulars’ in the RBI website.
Owned fund’ and ‘net owned fund’ in relation to NBFCs
‘Owned Fund’ = Equity Shareholders funds + Convertible Preference shares
(Aggregate of the paid-up equity capital, preference shares which are compulsorily convertible into
equity, free reserves, balance in share premium account and capital reserves representing surplus
arising out of sale proceeds of asset, excluding reserves created by revaluation of asset, after
deducting therefrom accumulated balance of loss, deferred revenue expenditure and other
intangible assets).
'Net Owned Fund' = Owned Fund - amount of investments of such company in shares of its
subsidiaries, companies in the same group and all other NBFCs and the book value of debentures,
bonds, outstanding loans and advances including hire purchase and lease finance made to and
deposits with subsidiaries and companies in the same group, to the extent it exceeds 10% of the
owned fund.
NBFC Entities which can legally accept deposits from public
Non-bank finance companies, which have been issued Certificate of Registration by RBI with a
specific licence to accept deposits, are entitled to accept public deposit. In other words, not all
NBFCs registered with the Reserve Bank are entitled to accept deposits but only those that hold a

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deposit accepting Certificate of Registration can accept deposits. They can accept deposits, only to
the extent permissible.
 Housing Finance Companies, which are again specifically authorized to collect deposits and
companies authorized by Ministry of Corporate Affairs under the Companies Acceptance of
Deposits Rules framed by Central Government under the Companies Act can also accept
deposits also up to a certain limit.
 Cooperative Credit Societies can accept deposits from their members but not from the
general public. The Reserve Bank regulates the deposit acceptance only of banks,
cooperative banks and NBFCs.
It is not legally permissible for other entities to accept public deposits. Unincorporated bodies like
individuals, partnership firms, and other association of individuals are prohibited from carrying on
the business of acceptance of deposits as their principal business. Such unincorporated bodies are
prohibited from even accepting deposits if they are carrying on financial business
Other requirements for accepting deposits
NBFCs are required to get an investment grade rating March 31, 2016
Limit on deposits
Those NBFCs to which the Bank had given a specific authorisation and have an investment grade
rating are allowed to accept/ hold public deposits to a limit of 1.5 times of its Net Owned Funds
Interest rate on deposits The maximum rate of interest an NBFC can offer is 12.5%
Tenure of deposits The NBFCs are allowed to accept/renew public deposits for a minimum period
of 12 months and maximum period of 60 months. They cannot accept deposits repayable on
demand.
Responsibilities of the NBFCs registered with Reserve Bank, with
regard to submission on compliances and other information
A. Returns to be submitted by deposit taking NBFCs
 NBS-1 Quarterly Returns on deposits in First Schedule.
 NBS-2 Quarterly return on Prudential Norms is required to be submitted by NBFC accepting
public deposits.
 NBS-3 Quarterly return on Liquid Assets by deposit taking NBFC.
 NBS-4 Annual return of critical parameters by a rejected company holding public deposits.
(NBS-5 stands withdrawn as submission of NBS 1 has been made quarterly.)
 NBS-6 Monthly return on exposure to capital market by deposit taking NBFC with total
assets of Rs 100 crore and above.
 Half-yearly ALM return by NBFC holding public deposits of more than Rs.20 crore or asset
size of more than Rs. 100 crore
 Audited Balance sheet and Auditor’s Report by NBFC accepting public deposits.
 Branch Info Return.

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B. Returns to be submitted by NBFCs-ND-SI
 NBS-7 A Quarterly statement of capital funds, risk weighted assets, risk asset ratio etc., for
NBFC-ND-SI.
 Monthly Return on Important Financial Parameters of NBFCs-ND-SI.
 ALM returns:
 Statement of short term dynamic liquidity in format ALM [NBS-ALM1] -
Monthly,
 Statement of structural liquidity in format ALM [NBS-ALM2] Half yearly,
 Statement of Interest Rate Sensitivity in format ALM -[NBS-ALM3], Half
yearly
 Branch Info return
C. Quarterly return on important financial parameters of non-deposit
taking NBFCs having assets of more than Rs.50 crores and above but less
than Rs 100 crore
Basic information like name of the company, address, NOF, profit / loss during the last three years
has to be submitted quarterly by non-deposit taking NBFCs with asset size between Rs 50 crore and
Rs 100 crore.
There are other generic reports to be submitted by all NBFCs as elaborated in Master Circular on
Returns to be submitted by NBFCs as available on www.rbi.org.in → Notifications → Master Circulars
→ Non-banking and Circular DNBS (IT) CC.No.02/24.01.191/2015-16 dated July 9, 2015 as available
on www.rbi.org.in → Notifications
Housing Finance Company
For commencing the housing finance business, an HFC is required to have the following in addition
to the requirements under the Companies Act, 1956:
 Certificate of registration from NHB
 Minimum net owned fund of Rs. 1000 lakhs
Procedure for application
The applicant company is required to submit a physical copy of the application (in duplicate) along
with the necessary documents to the Head Office of the National Housing Bank. The application can
be viewed and downloaded from NHB’s website
http://www.nhb.org.in/Regulation/applicaioncr.php. Application should be made in the prescribed
form only.
HFCs can accept public deposits
a) Companies carrying on business of housing finance before June 12, 2000 can accept deposits
provided they have NOF of over rupees 25 lacs and have applied for certificate of
registration with NHB before December 12, 2000 and either have been granted the

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certificate of registration valid for acceptance of deposits by NHB or their application is still
pending for issue of certificate of registration with NHB.
b) Companies commencing the business of housing finance after June 12, 2000 can accept
public deposits only after:
i. obtaining certificate of registration from NHB valid for acceptance of
deposits; and
ii. having minimum net owned funds (NOF) of [rupees two crores or more] *.
Ceiling on the maximum amount of public deposit
HFCs having credit rating from approved credit
rating agencies not below ‘A’&
can accept deposit not exceeding five times of
its net owned fund
The HFCs having no credit rating can accept deposit upto 2 times of its net
owned fund or rupees ten crores whichever is
lower
such HFC complies with all prudential norms and also has capital adequacy ratio of not less than
fifteen percent as per the last audited balance sheet.
NBFC regulated by SEBI
SEBI is responsible to regulate
 Venture Capital Fund
 Merchant Banking companies
 Stock broking companies
 Mutual Funds
We are not going in detail of these
Trend and Growth in NBFC’s
The Non-Banking Financial Companies has been gaining systemic importance in the recent
years in the financial world and the share of NBFC has been steadily grown from 10.7% of
banking assets in 2009 to 14.3% of banking assets in 2014 further we can see that the
market capitalization of all the combined NBFC have overtaken the combined banking
sector in recent two years.

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The growing asset size of the NBFC sector has increased the need for risk management and
its assessment in the sector due to growing interconnectedness of NBFCs with other
financial sector intermediaries. The Reserve Bank of India (RBI) has been in the recent past
trying to strengthen the risk management framework in the sector, simplify the regulations
and plug regulatory gaps and also bringing NBFC on par with bank’s rules and regulation so
as to prevent regulatory arbitrage between banks and NBFCs however it is still insufficient
as due to large amount of NBFC’s and still some loopholes present in the guidelines.
However, some of the strict measures were taken recently by RBI as we can see that
recently RBI cancelled license of 56 NBFC’s on 5 December 2015.
The Reserve Bank of India released the ‘Revised Regulatory Framework for NBFCs’ on
November 10, 2014 which broadly focuses on strengthening the structural profile of NBFC
sector, wherein focus is more on safeguarding of the depositors’ money and regulating
NBFCs which have increased their asset-size over time and gained systemic importance and
less time given for bad loan declaration.
Due to average economic growth, have been challenging period for the NBFCs with
moderation in rate of asset growth as it only risen about 9 percent in 2013- 2014 but
recently in 2015 it has risen more than 18 percent, earlier it was due to rising delinquencies
resulting in higher provisioning thereby impacting profitability but it improved due high
growth rate in India. However, comfortable capitalization levels and conservative liquidity
management, and also new regulation and guidelines given by RBI continue to provide
comfort to the credit profile of NBFCs in spite of impact on profitability. In the coming
scenario we can find that NBFC will play important role in developing India to a great extent.
The World Bank, IMF and other agencies predicted that India to be having biggest growth
for major economy in next decade we can assume that NBFC’s have substantial opportunity
for growth as such they have to keep bad loans in check to attain a sustainable growth in
this period.

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Growth parameters:
Increasing size and systemic importance
NBFC sector has been gaining systemic importance. The same can be seen with the rise in
share of NBFC assets as a percentage of bank assets which is reflected in the equity share of
NBFC’s as it was first time in history more than pure banks. The share of NBFC assets have
steadily grown from 10.7% of banking assets in 2009-10 to 14.3% in 2014-15 of bank assets.
As such we can see that they have substantial growth during this period.
Source: RBI Reports
2. Stronger Regulatory Environment leads to higher capital cover and
Better Risk Management
With increase in systemic importance, Reserve Bank of India has been tightening the
regulations to manage the risk in the sector and has been prescribing higher capital and
provisioning requirement. RBI also has been emphasizing on higher disclosures by large size
NBFCs as well as deposit taking NBFCs to safeguard public money and avert any systemic
shocks and also maintaining the certain amount of asset size. In addition, the RBI has taken
prompt preventive actions in addressing specific issues to manage systemic risk which we
can see it in new guidelines framed in 10 November, 2014.
3. Move towards Secured Lending
During the credit crisis of 2008-2009, NBFCs saw a surge in Non-Performing Assets (NPAs) in
the unsecured lending products like short term personal loans. As a result, NBFCs which had
high exposure to unsecured loans faced severe losses on account of higher provisioning.

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Post 2009, most NBFCs have reduced the proportion of unsecured lending in their portfolio.
As such they moved towards secured lending products.
4. Lower Liquidity Risk
Another lesson learnt by NBFCs from the credit crisis of 2008-2009 was conservative
liquidity management. Over the years, NBFCs have shifted towards maintaining conservative
Asset Liability Maturity (ALM) profile by increasing the proportion of long term funding and
generally maintaining liquidity buffers in terms of liquid investments and committed lines
from banks.
5. Stronger Lending Infrastructure
In the last 5 years, the sector has grown stronger in terms of lending infrastructure. NBFCs
have seen increase in scale of operations which has necessitated up-gradation in technology
and IT systems. The establishment of Credit Bureaus and rating agencies like CRISIL and
CARE has helped improvement in credit culture which has helped the NBFCs in the retail
financing business. Over the period, the credit bureaus have built sizeable database which
will help in strengthening the lending infrastructure in the long run. High growth in scale of
business requires better management capability as a result most NBFCs have now put in
professional management teams to manage business and credit operations.
6. Rising number of large players – backed by big corporate houses
Over the last few years, the sector has seen rise in the number of large players which are
backed by corporate houses / private equity investors who wish to participate in the credit
growth of the country but faced stringent regulations and high entry barriers in Indian
banking sector. Many of the large corporate houses and banks have also diversified into
lending and lending related businesses focusing into niche segments. However, with a rise in
number of players, the competition in sector has intensified and impact of stiff competition
in the long needs to be observed. We can see that Bajaj, Reliance, etc. came into NBFC as
we can see that these big players help to grow in this sector.
7. Diversification and Mortgage Based lending
During last couple of years most of the large sized NBFCs have diversified in various product
segments in order to mitigate product concentration risk. In the recent past, mortgage
finance has emerged as one of the better performing asset class resulting in most of the
large NBFCs diversifying in mortgage finance including housing loans and loan against

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property. Also many NBFCs have set up their housing finance companies in order to focus on
this asset class.
8.

Until a decade ago, NBFCs were little players with a small resource base. The market
capitalization of leading NBFC is now comparable with or larger than many mid-sized banks,
their combined market capitalisation of the top 10 NBFCs (Rs 1.27 lakh crore) is now twice
that of mid- and small-sized government banks (Rs 63,500 crore) as on Aug 3, 2015
 If stock markets are an indicator, it is a matter of time before NBFCs will become larger than
most Tier-II and –III state-owned banks.). This gives these NBFCs larger fundraising capacity
than government-owned banks
 Rating agencies largely attribute it to the resource constraints faced by government-owned
banks. The internal accruals for government-owned banks have fallen sharply due to losses
from bad loans and general fall in profitability. This has constrained their lending ability
 It has opened up a large market for NBFCs as they operate in customer’s segments which are
not served by PSUs banks such as small & medium enterprises and self-employed. These
segments offer higher yields allowing NBFCs to earn superior profit margins which they can
leverage to grow even faster.

19
Key Performance Trends observed in the NBFC Sector
1. Capital Adequacy remains comfortable
At present the Capital Adequacy Ratio (CAR) for the NBFC sector is comfortable both on
Total CAR as well as Tier I CAR basis. The Total CAR for the sector was around 20% with Tier I
CAR of around 15.5% as on March 31, 2014 which was comfortably higher than the
minimum regulatory requirement of 15% for Total CAR and 7.5% for Tier I CAR except for
gold loan NBFCs which is required higher minimum Tier I CAR of 12%.
Trend in Capital Adequacy of NBFCs
Source: CARE Reports
Overall capital adequacy ratio has remained stable over last couple of years with entry of
new large players with strong capital back-up in the Indian market. However, due to
issuance of Tier II capital primarily in the form of subordinated debt followed by preference
capital and perpetual debt, the share of Tier II capital has increased over a period. However,
at the current level of Tier I CAR, the sector seems comfortable with respect to revised
guidelines of 10% of Tier I CAR by March, 2018.
2. Asset quality under pressure due to economic stress
NBFCs have witnessed a stress in asset quality during the last two-three years due to weak
operating environment and economic downturn. Sectors which are directly linked to
economic activities like commercial vehicle, construction equipment and infrastructure
financing have witnessed sharp deterioration in asset quality. Gold loan NBFCs have also

20
witnessed asset quality concerns on account of regulatory uncertainties, correction in gold
prices and funding constraints.
Trend in Asset Quality of NBFCs
Source: RBI Reports
Deposit accepting NBFCs have seen higher deterioration in asset quality as compared to
non- deposit accepting NBFCs as major deposit accepting NBFCs are operating in
commercial vehicle financing. However, deposit accepting NBFCs have better provision
coverage of around 60%. During current financial year i.e. FY15 (refers to period April 01,
2014 to March 31, 2015), delinquencies for NBFCs remained at elevated levels due to no
pick-up in industrial activity. However, the industrial activity is expected to see recovery
during later part of the year.
3. Profitability impacted on account of slowdown in growth and asset
quality pressure
During FY13, overall profitability remained stable as compared to FY12 levels. The Return on
Total Assets (ROTA) for FY13 was at 2.57% as compared to 2.58% for FY12.
Trend in Capital Adequacy

21
Source: CARE Reports
During FY14, due to hardening of interest rates and rising delinquencies, the NBFC sector
has seen pressure on net interest margins and increase in credit cost. Increase in NPAs has
dual effect – (1) not earning of interest and (2) reversal of interest income which was
booked in earlier period. Due to which the profitability has taken a hit which is visible from
ROTA declined from 2.57% for FY13 to 2.06% for FY14.
4. Resource profile continues to be stable
Borrowings through capital market including NCDs, subordinated debt, preference shares,
perpetual debt continued to be the major source of funding for NBFCs as it accounted for
34% of total borrowings in FY14 followed by banks funding which accounted for 31% of their
total borrowings. Overall borrowing mix in FY14 has remained in-line with FY13.
Dependency on short term borrowings like commercial paper is less at around 7% which
helps them to manage their asset liability mismatches.
Revised guidelines on securitization and priority sector lending made NBFCs to re-look at
their business model. Direct loans given to NBFCs are now not classifying as priority sector
lending except for NBFC-MFIs. Lending via securitization route through direct assignment
without credit enhancement or through Pass Through Certificates (PTCs) can be classified as
priority sector lending criteria.
Change in above guidelines has made NBFCs to explore channel business tie-ups and direct
assignment i.e. securitization without credit enhancement with banks to save their capital
cost and overcome fund raising constraints.
5. Rise in Total Assets
As we can see that in below graph we can interpret that the total asset have been risen
more than 18 percent in 2015 as comparison to average growth which we can attribute it to
the rise and coming of big players in this sector as such more big corporates houses will
come into this sector thus increasing total assets as they want to come into banking system.

22
Total Assets of all NBFC’s (figures in crores rupees)
Source: RBI annual reports
0.00
200000.00
400000.00
600000.00
800000.00
1000000.00
1200000.00
1400000.00
1600000.00
1800000.00
Mar-2012
May-2012
Jul-2012
Sep-2012
Nov-2012
Jan-2013
Mar-2013
May-2013
Jul-2013
Sep-2013
Nov-2013
Jan-2014
Mar-2014
May-2014
Jul-2014
Sep-2014
Nov-2014
Jan-2015
Mar-2015
Total Assets

23
Recent Regulatory Norms
1. The new stipulations mandate that net owned funds (paid-up equity and reserves) of NBFCs
should be Rs 1 crore by March 2016 and Rs 2 crore by March 2017. It is also mandatory that
50% of the assets owned by them should be financial assets and 50% of the income from
should come from financial assets.
Impact-Many NBFCs will lose their registrations. But it will not have any impact as they are
mostly in the nature of core investment companies and asset financing companies. Even
these companies number only around 300. With regulations getting stricter, many NBFCs
will lose their licences but it will have no impact on the sector.
2. Funding is a major hurdle for the sector with most NBFCs. There is an securitisation route and
equity funding.
Impact - NBFCs are over-dependent on banks for funds.
Looking forward- Refinance window is necessary for the robust development of the sector.
3. Reduction of classification of loan as bad loan from 180 to 90 days for NBFCs
Impact- Stringent non-performing loan (NPL) recognition norms could significantly increase
gross NPLs for asset financing NBFCs
Way-out - There should be continues follow up with defaulting borrowers so that the
interest and/or instalment is not overdue for a period of over 90 days and the account is not
classified as NPA. There should be follow up with borrowers already classified as NPA to
make all the overdue so the account can again be classified as Performing assets (Standard
assets).
4. The risk weights for the sector are also higher than banks. The risk weights irrespective of the
asset class is at 100% for the NBFCs but for funding stocks and real estate it is 150%.
Impact - sector is squeezed out of funds
Way-out - RBI needs to reduce the risk weights so that the sector is not squeezed out of
funds.
5. The RBI came up with the revised regulatory framework for NBFCs, Under the revised
framework, the definition of systemic importance has changed increasing the threshold to
Rs500 crore from Rs100 crore.
Under the new framework, there are two types of NBFC-NDs –
(i) NBFC-NDs with asset size of Rs500 crore or more, i.e., Systemically Important NBFC-ND
(NBFC-ND-SI) – These NBFCs shall be governed by the Systemically Important Non-Banking
Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank)
Directions, 2015
(ii) NBFC-NDs with asset size of less than Rs500 crore, i.e., Non Systemically Important NBFC-
ND (NBFC-ND-Non SI) – These NBFCs shall be governed by the Non-Systemically Important
Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms
(Reserve Bank) Directions, 2015
Impact - which have brought about a plethora of change in the NBFC universe. Under the
erstwhile regulations, non-deposit taking NBFCs (NBFC-ND) having asset size of Rs100 crore
or more were considered as systemically important and were subject to stringent regulations
such as concentration norms, capital adequacy requirement etc.

24
6. NBFCs-ND need to ensure a leverage ratio of 7 (i.e. total outside liabilities do not exceed 7
times their owned funds).
The revised regulatory framework has introduced a new concept of the Leverage Ratio as
part of the limited prudential norms, which will be applicable to all NBFCs-ND that are
subject to limited prudential norms. Such NBFCs-ND need to ensure a leverage ratio of 7 (i.e.
total outside liabilities do not exceed 7 times their owned funds). This additional
requirement would link the asset growth of such NBFCs to the capital they hold.
NBFC should increase its net owned funds so that more amount can be borrowed as the
total outside liabilities cannot exceed 7 times the net owned funds.
7. Increase in minimum Tier I Capital to 10% for NBFCs-ND-SI.
Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of
view. It is composed of core capital, which consists primarily of common stock and disclosed
reserves (or retained earnings), but may also include non-redeemable non-cumulative
preferred stock.
For the NBFCs-ND-SI, the minimum Tier I Capital has been increased to 10%. This is to be
achieved in a phased manner i.e. 8.5% by the end of March 2016 and 10% by the end of
March 2017. So Tier 1 capital has to be increased.
8. Provision on standard assets increased from 0.25% to 0.40%
Impact – Will strengthen the balance sheet of NBFCs by increasing the loss absorption
capacity of NBFCs in long run
Will have higher impact on profitability in short
run
Other Issues and Suggestions
High cost of raising funds & inaccessibility to cheap sources
Banks get their deposits from general public @ 4 to 6 % in saving deposit, 0% in current
account and 8.5% to 9.5% in Fixed Deposits.
NBFCs borrow @ 8 to 9% on corporate debt.
Way-out - A bank can easily lend @ 10.25% for home loan but for NBFC it is very difficult.
Anyone will choose lower rates than higher. With more banking licenses coming NBFCs
competitiveness will reduce as new banks will lower the cost of borrowing even more
leaving very little rooms for NBFCs through reduced margins. NBFCs should
i) Increase their net owned funds and comply with all the requirement so that they
can get bank license and get cheaper funds from public.
ii) Keep their cost to the minimum till such time so that they compete with banks
offering loans at lesser rates. So their borrowing cost and administration cost
should be minimum so that they can compete with them.

25
Limit on deposit acceptance
New limit to 1.5 times of Owned Funds from 4 times of Owned Funds for Deposit taking
AFCs and mandatory investment grade credit rating for accepting public deposits
NBFCs cannot accept deposits from public.
Way Out- NBFCs can take loans from corporates and banks subject to limits prescribed by
Reserve Bank of India. NBFCs can even convert themselves into bank but for that it should
have a net worth of Rs. 500 crores and for that NBFCs should raise its capital, reserves and
surplus so that it is in a position to apply for banking license. Minimum dividend should be
paid to increase the reserves and surplus and more investment should be brought in the
form of capital to increase the net worth.
Note:
NBFCs include Deposit taking NBFCs (NBFCs-D), Mutual
Benefit Financial Companies (MBFCs) (Notified Nidhis),
Mutual Benefit Companies (MBCs) (Potential Nidhis)
etc. till 2004-05 and only NBFCs-D thereafter.
Source: Reserve Bank of India. (ON298) (ON392)
Requirement of Minimum net worth for conversion into bank
500 crore net worth is required for conversion from NBFC to bank.
Solution- NBFCs should raise its capital, reserves and surplus to Rs. 500 Crore so that it is in
position to apply for banking license. Minimum dividend should be paid to increase the
reserves and surplus and more investments should be brought in the form of capital to
increase the net worth.

26
Entry Barrier-Minimum net owned funds of Rs. 2 crore is required for registration.
Under the extant law, all NBFCs registered after April 21, 1999 are required to have
minimum net owned funds (NOF) of Rs.2 crores. However, a large number of NBFCs which
were registered prior to that date were permitted to continue to maintain minimum NOF of
Rs.25 lakhs. It is apparent that NBFCs with a minimum capital below Rs.2 crores are likely to
be carrying out very limited business activities, if any. Considering that a higher NOF would
be required for the adoption of advanced technology and to ensure a sufficient capital base
for the diverse activities conducted by NBFCs, the minimum NOF of Rs.2 crore is now being
made mandatory for all NBFCs, whether registered prior to or post April 21, 1999. All NBFCs
are required to attain a minimum NOF level of Rs.1 crore by the end of March 2016 and Rs.2
crores by the end of March 2017.
So the net owned funds should not be below Rs. 2 crores but if it is due to losses then more
capital should be brought in so that the minimum net owned funds should be brought be
above Rs. 2 crores.
Suggestions
Simplification of Structure complexities
Consolidation of NBFCs into 2 categories – (i) Core Investment Companies, and (ii) other NBFCs •
Availability of benefits such as tax benefits, bank limits or priority sector status to continue based on
pro-rata asset basis
Differential risk weights for capital adequacy ratio
The risk weights to be applied by banks for capital adequacy purposes also take into account the
credit rating of the borrower. This provision is not available for NBFCs even though banks and NBFCs
operate in the same macroeconomic environment. Even in respect of secured lending / investments
where the quality of security is similar to that of banks, no differentiation in risk weights is allowed
for NBFCs. To add to their difficulties, the draft NBFC guidelines proposed higher risk weights for
exposure to capital markets and the commercial real estate sector.
Access to refinancing schemes
Currently, NBFCs are not eligible for access to refinancing schemes from the National Bank for
Agriculture and Rural Development (NABARD), National Housing Bank (NHB), Small Industries
Development Bank of India (SIDBI) etc. This is because the refinancing schemes of these bodies are
available to only certain types of institution. For example, a Housing Finance Company would be
eligible for refinancing by the NHB; however, an NBFC providing housing loans to retail consumers
does not have access to such schemes
Extension of tax benefits to NBFCs similar to that currently available to banks

27
• Section 43D of the I.T. Act recognises the principle of taxing income on NPA on receipt basis. In
accordance with the directions issued by the RBI, similar to the other financial institutions, NBFCs
also follow prudential norms and are required to defer income in respect of their non-performing
accounts. In the absence of specific coverage of this section for NBFCs, the current tax framework
requires NBFCs to recognise income on such NPAs on an accrual basis, resulting in levy of tax on
income which may not be realised at all. This severely impacts the liquidity of NBFCs in terms of cash
flow pay-outs, impacts their profitability and also has a consequent impact on their cost of
operations.
• As per section 36(1) (vii a) of the I.T. Act, provisions for bad and doubtful debts made by banks are
tax deductible subject to certain prescribed limits. Alternatively, such banks have been given an
option to claim a deduction in respect of any provision made for assets classified as doubtful assets
or loss assets up to an extent. NBFCs are similar to banks in almost respect of financing and are
subject to same directions of RBI as regards income recognition and provisioning norms. Accordingly,
as per its directions, NBFCs need to necessarily make provisions for NPAs. It is appropriate, in all
fairness, that the provision for NPAs made by NBFCs registered with RBI also be allowed as a tax
deduction
• As per section 194A of the I.T. Act, TDS @10% is required to be deducted on the interest portion
of the instalment paid to NBFCs whereas banking companies and public financial institution are
exempted from the purview of this tax withholding requirement. This creates severe cash flow
constraints since NBFCs operate on a thin spread/ margin on interest which at times is even lesser
than the TDS on the gross interest.
• As per section 72A of the I.T. Act, at the time of amalgamation of banking companies, the
accumulated losses are allowed to be carried forward and claimed by the amalgamated entity.
However, similar benefit is not specifically available to NBFCs resulting in lapse of accumulated
losses upon amalgamation.

28
Conclusion
The extension of the corporate governance compliance procedures to NBFC-ND is certainly
a step in the right direction as this will help ensure that the management of NBFCs is of “fit
and proper” character and help build investor/ customer confidence. However, the RBI will
still need to provide clarity on a number of aspects for the effective implementation and
compliance with the regulations.
Furthermore, adequate guidance is still wait on the details of the application process,
application format, supporting documentation required, etc. that have been specifically
prescribed with respect to fresh NBFC applications, to ensure simplicity and transparency in
the process, resulting in awareness both amongst the applicants and the RBI officials
reviewing the application, thereby ensuring the efficient disposal of applications.
The recognition of NBFCs as integral to the financial services ecosystem is reflected in the
recent policy measures. In addition, activity based regulation is likely to rationalize the cost
of compliance and create better fit between the regulations and the regulated entities.
Restrictions on debentures funding, securitisation and loss of Priority Sector status to on-
lending through NBFCs will continue to constrain the funding ability of the NBFCs. While the
tepid growth environment of the last few years and regulatory push has forced banks’
attention towards direct and indirect lending to priority sector borrowers, this is very likely
to reverse once the need for project finance and large scale funding for growth kicks in.
Banks have a different cost structure and are geared to service a certain nature of clientele.
NBFCs, by virtue of their business focus are well positioned to build profitable businesses in
the priority sector borrower segment.
As differentiated licensing of different types of banks creates greater vitality in the small
finance segment that will benefit consumers through increased penetration and wider suite
of products and services, the opportunity for NBFCs will continue to grow. Considering the
funding constraints, conversion to universal or small banks will provide viable option for
NBFCs looking to scale up their operations and expand their reach in terms of market access
and customer base. However, this looks difficult for most of the larger players as the
migration of a large book without regulatory forbearance seems extremely difficult.
Even after differential licensing becomes a more accepted reality, NBFCs will continue to
present an attractive business model to asset focussed organizations, or organizations that
can tap into viable funding sources, domestic or foreign. Therefore, in the context of a
growing economy, a stable regulatory environment will provide opportunities to NBFCs to
continue to grow in the financial ecosystem and create meaningful financial inclusion and
employment opportunities in the remote corners of the country.

29
References
 http://www.tradingeconomics.com/india/NBFC
 http://www.researchgate.net/post/inflation
 http://www.livemint.com/Opinion/VpODtln8lv3dEF9C8bYdUP/Governm
ent-spending-Numbers-dont-lie.html
 http://smallbusiness.chron.com
 http://www.heritage.org/research/reports/2013/03/the-impact-of-
NBFC-on-economic-growth
 http://www.tradingeconomics.com/search.aspx?q=government%20spe
nding%20india
 http://planningcommission.nic.in/data/datatable/
 http://pib.nic.in/budget2015/Previousyear.aspx?id=2
 www.rbi.org.in
 www.indiastat.com
 www.careratings.com

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