NBFC & Mutual Funds


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NBFC (As per GoI norms) & Cover Story ~ Mutual Funds

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NBFC & Mutual Funds

  1. 1. Non Banking Finance Companies (As per Government of India specifications) Rahul Guhathakurta & Zardar Badami Indian Institute of Planning & Management Ahmedabad Cover Story Mutual Funds
  2. 2. As per Sec. 45 I (f) of RBI Act, 1934 A financial institution is an NBFC… … which has a principle business of receiving deposits under any scheme or an arrangement or lending in any manner, Approved by Central Government and Notified by Official Gazette What is an NBFC?
  3. 3. <ul><li>In April 1999, RBI further announced that identification of a company as an NBFC will depend on: </li></ul><ul><li>On the assets </li></ul><ul><li>The income pattern of the company </li></ul><ul><li>From the last audited balance sheet, RBI will decide on the principal business of the company </li></ul>Identification Parameters for an NBFC given by RBI Factors Determining an NBFC Financial Assets of the Company Total Assets of the Company (Netted off against Tangible Assets ) 50% > Income from Financial Assets Gross Income 50% > … then the company will be treated as an NBFC
  4. 4. Chronology of the NBFC’s Regulatory Provisions Chapter III-B, III-C & V of Reserve Bank of India Act, 1934 The Miscellaneous Non-Banking Companies (RBI) Directions, 1977 Residuary Non-Banking Companies (RBI) Directions, 1987 Housing Finance Companies (NHB) Directions, 1989 Non Banking Financial Companies (RBI) Directions, 1998 Reserve Bank of India (Amendment) Act, March 1997
  5. 5. Initial Regulatory Environment as per RBI Act,1934 Entry barriers were low There were no capital adequacy Norms. No prudential norms Little restrictions on Interest rates Offered to the depositors Regulatory Factors
  6. 6. Call for an amendment in the Act & other Provisions <ul><li>Reasons: </li></ul><ul><li>1. The regulations that existed seemed to be inadequate to protect the depositor’s interest. </li></ul><ul><li>2. Incidents of depositors loosing there money due to mismanagement or due to fraud were cropping up. </li></ul>Consequently, three new sets of directions were issued by the RBI for governing the operations of NBFC's Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions 1998 Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998 Non-Banking Financial Companies Auditor’s Report (Reserve Bank) Directions, 1998
  7. 7. Further Classification of the NBFCs (aftermath of Directions issued in January 1998) Regulations for Deposits NBFCs Accepting Public Regulations for NBFCs Not Accepting Public Deposits Regulations for Core Investment Companies
  8. 8. Regulations for NBFCs Accepting Public Deposits Income Recognition Asset Classification Accounting Standards Provision for Bad & Doubtful debts Capital Adequacy Credit/Investment Concentration Prudential Norms The companies accepting public deposits are required to comply with all the Prudential Norms mentioned below… Note: The provision norms are on par with those of Commercial Banks
  9. 9. Eligibility Criteria for Accepting Public Deposit <ul><li>An NBFC having Net Owned Funds of Rs. 200.00 lakhs and above only can accept Public Deposits </li></ul><ul><li>It has to obtain Minimum Stipulated Credit Rating from any one of the approved Credit Rating Agencies at least once in a year. </li></ul><ul><li>Copy of the Credit Rating should be sent to the RBI along with the Return on Prudential Norms. </li></ul><ul><li>The NBFC should have acquired a credit rating of not less than AAA rating or its equivalent in the previous year </li></ul>
  10. 10. Eligibility Criteria for Accepting Public Deposit <ul><li>If the Credit Rating is either down graded or upgraded, the NBFC is required to report this fact to the RBI within 15 days from the date when it receives such information. </li></ul><ul><li>It is to be noted that the deposits taken by the NBFCs are repayable on demand and the Minimum period for which Public Deposits can be accepted is not less than 12 months with a maximum period of 84 months. </li></ul><ul><li>There is a ceiling provided for the quantum of deposits accepted by NBFCs. </li></ul>
  11. 11. Eligibility Criteria for Accepting Public Deposits <ul><li>The CRAR has been fixed 12% and above. </li></ul><ul><li>(Rated NBFCs) and 15% & above </li></ul><ul><li>(Un-Rated NBFCs) </li></ul><ul><li>The Credit norms has been fixed at 15% </li></ul><ul><li>and The Investment Concentration norms </li></ul><ul><li>has been fixed at 25% </li></ul><ul><li>The Total Loan and Investments </li></ul><ul><li>have a ceiling of 25% & 40% of the </li></ul><ul><li>owned funds, respectively. </li></ul>… depending on whether the exposure is To a single party or to an Industry group. … depending on whether the exposure is to a Single borrower or a Group of borrowers.
  12. 12. RBI Guidelines for Un-rated NBFCs <ul><li>All EL/HP Finance companies that do not have: </li></ul><ul><li>The minimum investment grade credit rating </li></ul><ul><li>& mobilizing public deposits up to 1.5 times of their NOF or Rs. 10 Crore </li></ul><ul><li>… whichever is lower, should not have a CAR less than 15%. </li></ul>
  13. 13. NBFC’s comprise following Business Organizations Equipment Leasing Activities Loan Granting Activities Housing Finance Insurance Business Mutual Fund Finance Investment Activities Hire Purchase Finance NBFC’s Comprise Following Business Organizations
  14. 14. Classification based on purpose of acceptance of deposits by NBFC Directions 1998 Equipment Leasing (EL) Hire Purchase (HP) Investment Companies (IC) Loan Companies (LC) Source: Re Classification of NBFCs December 6 2006 ~ RBI / 2006-07/200 DNBS.PD. CC No. 85 / 03.02.089 /2006-07 Re-classification of NBFCs on December 6 , 2006 Asset Finance Companies (AFC) Investment Companies (IC) Loan Companies (LC)
  15. 15. Regulations for NBFCs not Accepting Public Deposits <ul><li>As these companies do not accept Public Deposits, all regulations related to interest rates, period and ceilings on quantum of borrowing do not applied. </li></ul><ul><li>However, to ensure the disclosure of a true and fair picture of their financial health, these companies are subjected to Prudential Norms. </li></ul>… excepting the CAR and Credit Concentration Norms
  16. 16. Regulations for Core Investment Companies <ul><li>These companies are exempted from all the provisions of the directions except the statutory provisions for registration and creation of reserve fund. </li></ul>
  17. 17. Mother-of-All-Rules <ul><li>“ According to RBI guidelines issued on April 1, 1999, All NBFCs are required to maintain liquid assets of 15% of public deposits held on the last working day of the secondary preceding quarter .” </li></ul>
  18. 18. Books and Records maintained by NBFCs Books & Records Maintained by an NBFC Cash Book & Bank Book Depositor’s Ledger Due Date & Renewal Register Interest Register Loan Ledger Investment Ledger General Ledger
  19. 19. General Recommendations General Recommend. Integrate domestic financial market by making NBFCs - channel partners to larger banks Reduction in interest cost and hence benefits the ultimate consumer Enhancing the credit delivery mechanisms Reversing the inverse relationship between the size of borrowing and the cost of borrowing Strengthening the professionalism of the NBFC sector through education and training
  20. 20. MUTUAL FUNDS An NBFC Cover Story
  21. 21. Introduction : Mutual Funds Mutual Funds A “ Pooling Concept” Portfolio of Stocks Portfolio of Bonds Portfolio of Other Investment Instruments All Mutual Funds aim at achieving one or more of the following: <ul><li>Providing steady flow of income </li></ul><ul><li>Providing high capital appreciation </li></ul><ul><li>Providing capital appreciation with income </li></ul><ul><li>Providing income or capital appreciation with tax benefits </li></ul>
  22. 22. Types of Mutual Funds <ul><li>An Open-Ended Fund </li></ul><ul><li>Unlimited Capitalization </li></ul><ul><li>No predetermined date of redemption </li></ul><ul><li>Sale & purchase of units at current net asset value (NAV) </li></ul><ul><li>No restrictions on entry & exit </li></ul><ul><li>Purchase of units directly from funds </li></ul><ul><li>Sale of units directly to the funds </li></ul><ul><li>A Close-Ended Fund </li></ul><ul><li>Constant Capitalization </li></ul><ul><li>Pre-determined date of redemption </li></ul><ul><li>Pre-determined date for closing subscription </li></ul><ul><li>Frequent lock-in-period </li></ul><ul><li>Purchase & sale of units at the traded prices at the stock exchanges </li></ul>“ In India, additionally, the close-ended funds can be purchased from & sold back to the funds”
  23. 23. Functional Entities involved in Mutual Funds Operation Trust or Trustee Company Asset Management Company (AMC) Custodian Registrars/ Transfer Agents Distributors <ul><li>They form mutual funds under the existing Trust or </li></ul><ul><li>Companies Acts. </li></ul><ul><li>Trust managed by the Trustees & Trustee Companies </li></ul><ul><li>are managed by the board of Directors. </li></ul>Undertakes the administration & investment activities Of the fund He/She is an independent entity who is Responsible for safekeeping the fund’s assets i.e., stocks, bonds and cash <ul><li>They handle sales and redemption related </li></ul><ul><li>activities of the fund. </li></ul><ul><li>They also maintain records of the shareholders and </li></ul><ul><li>send the payment cheques to the investors </li></ul><ul><li>They are the fund distributors/underwriters to </li></ul><ul><li>handle the sales of units. </li></ul><ul><li>The underwriters act as an wholesale selling units to the </li></ul><ul><li>brokers who in turn , sell to the retail investors </li></ul>
  24. 24. Fundamental Structure of Global Mutual Funds
  25. 25. Sponsor Company Establishes MF as a Trust Registers MF with SEBI Holds unit-holder’s fund in MF Ensures compliance to SEBI Enters into agreement with AMC Floats MF Funds Manages fund as per SEBI Guidelines &AMC agreements Provides necessary custodian services Provide Banking Services Mutual Fund Asset Management Company Custodian Bankers Registrar & Transfer Agents Managed by Board of Trustees Provide Registrar services and Act as an Transfer Agents Structure of Indian Mutual Funds
  26. 26. Categories of Mutual Funds Money Market Funds Lilliput Funds Index Funds Sector Funds Balanced Funds Bond Funds Income Funds Growth and Income Funds Asset Allocation Funds Growth Funds Aggressive Growth Fund Overseas Funds Guaranteed Funds Fund of Funds Venture Capital Funds
  27. 27. Basis for Classification <ul><li>Risk </li></ul><ul><ul><li>Sectoral funds are most risky; money market funds are least risky </li></ul></ul><ul><li>Tenor </li></ul><ul><ul><li>Equity funds require a long investment horizon; liquid funds are for the short term liquidity needs </li></ul></ul><ul><li>Investment objective </li></ul><ul><ul><li>Equity funds suit growth objectives; debt funds suit income objectives </li></ul></ul>
  28. 28. Risk and Return Liquid funds ST debt funds Gilt funds Debt Funds Index funds Equity funds Sectoral funds Balanced funds Risk Return
  29. 29. Mutual Fund Taxation <ul><li>Mutual fund is exempt from paying taxes (Section 10 (23D)) </li></ul><ul><li>Income for investors </li></ul><ul><ul><li>Dividend </li></ul></ul><ul><ul><li>Capital gain </li></ul></ul><ul><li>Present position </li></ul><ul><ul><li>Dividend exempt from tax. </li></ul></ul><ul><ul><li>Fund pays dividend distribution tax at 10%. </li></ul></ul><ul><ul><li>Open end funds with >50% in equity, fully exempt. No tax is paid by the fund or the investor. </li></ul></ul>
  30. 30. Taxation:Finance Act 2002-03 <ul><li>Dividend fully taxable in the hands of investors </li></ul><ul><ul><li>TDS @10% for dividends above Rs.1000 </li></ul></ul><ul><ul><li>Deductions under Section 80L along with other interest and dividend income, up to Rs. 9000. </li></ul></ul><ul><li>Section 88 benefit reduced </li></ul><ul><ul><li>GTI less than 1.5 lakhs :20% </li></ul></ul><ul><ul><li>GTI >1.5 lakhs < 5 lakhs:15% </li></ul></ul><ul><ul><li>GTI > 5 lakhs, no rebate. </li></ul></ul>
  31. 31. Asset Allocation and Model Portfolios <ul><li>Deciding the allocation of funds amongst equity, debt and money market. </li></ul><ul><li>Incorporating product, investor profile and preferences in the portfolio. </li></ul><ul><li>Equity, debt and money market products are called asset classes. Allocating resources to each of these is called asset allocation. </li></ul>
  32. 32. Graham’s Model Portfolio <ul><li>Based on the 50:50 rule. </li></ul><ul><li>Basic managed portfolio. </li></ul><ul><li>Basic indexed portfolio. </li></ul><ul><li>Simple managed portfolio. </li></ul><ul><li>Complex managed portfolio. </li></ul><ul><li>Readymade portfolio. </li></ul>
  33. 33. Bogle’s Strategic Asset Allocation <ul><li>Combine age, risk profile and preferences in asset allocation </li></ul><ul><ul><li>Older investors in distribution phase </li></ul></ul><ul><ul><ul><li>50% equity;50% debt </li></ul></ul></ul><ul><ul><li>Younger investors in distribution phase </li></ul></ul><ul><ul><ul><li>60% equity; 40% debt </li></ul></ul></ul><ul><ul><li>Older investors in accumulation phase </li></ul></ul><ul><ul><ul><li>70% equity; 30% debt </li></ul></ul></ul><ul><ul><li>Younger investors in accumulation phase </li></ul></ul><ul><ul><ul><li>80% equity; 20% debt </li></ul></ul></ul>
  34. 34. Fixed and Flexible Asset Allocation <ul><li>Fixed ratio between asset classes </li></ul><ul><ul><li>Portfolio has to be periodically re-balanced </li></ul></ul><ul><ul><li>Disciplined approach </li></ul></ul><ul><ul><li>Enables investor to book profits in a rising market and invest more in a falling market. </li></ul></ul><ul><li>Flexible allocation </li></ul><ul><ul><li>No re-balancing; asset class proportions can vary when prices change. </li></ul></ul><ul><ul><li>If equity returns are higher than debt returns, equity allocation will go up at a faster rate. </li></ul></ul>
  35. 35. Developing a Model Portfolio <ul><li>Develop long term goals </li></ul><ul><ul><li>Investment avenues, time horizon, return and risk </li></ul></ul><ul><li>Determine asset allocation </li></ul><ul><ul><li>Allocation to broad asset classes </li></ul></ul><ul><li>Determine sector distribution </li></ul><ul><ul><li>Allocation of sectors of the mutual fund industry </li></ul></ul><ul><li>Select specific fund schemes for investment </li></ul><ul><ul><li>Compare products and choose actual funds to invest in </li></ul></ul>
  36. 36. Jacob’s Model Portfolios <ul><li>Accumulation phase </li></ul><ul><ul><li>Diversified equity: 65 - 80% </li></ul></ul><ul><ul><li>Income and gilt funds: 15 - 30% </li></ul></ul><ul><ul><li>Liquid funds: 5% </li></ul></ul><ul><li>Distribution phase </li></ul><ul><ul><li>Diversified equity: 15 - 30% </li></ul></ul><ul><ul><li>Income and gilt funds: 65 - 80% </li></ul></ul><ul><ul><li>Liquid funds: 5% </li></ul></ul>
  37. 37. Regulatory Framework <ul><li>SEBI (Mutual Fund) Regulations, 1996 </li></ul><ul><li>RBI as regulator </li></ul><ul><ul><li>Guarantees of sponsors in bank-sponsored mutual funds </li></ul></ul><ul><ul><li>Regulator of G-Secs and money markets </li></ul></ul><ul><li>Stock exchange </li></ul><ul><ul><li>listed mutual funds </li></ul></ul>
  38. 38. Regulatory Framework cont’d… <ul><li>Companies Act </li></ul><ul><ul><li>AMCs and Trustee Company </li></ul></ul><ul><ul><li>DCA as regulator </li></ul></ul><ul><ul><li>RoC for Compliance </li></ul></ul><ul><ul><li>CLB for prosecution and penalties </li></ul></ul><ul><li>Office of the public trustee </li></ul><ul><ul><li>Registration </li></ul></ul><ul><ul><li>Complaints against trustees </li></ul></ul>
  39. 39. Funds Rating in India Ratings of mutual funds has not yet been institutionalized in India, however some attempts are being made. The following agencies involved in rating process are as follows: CRISIL : Credit Rating and Investment Services Ltd [Est. – 1987] Duff & Phelps Credit Rating India Ltd [Est. 1996] – (Now Fitch IBCA) CARE: Credit Analysis and Research Ltd [Est. – 1993] ICRA : Investment Information and Credit Rating Agency of India [Est. – 1991] Credence (Mumbai) Value Research (New Delhi) Indian Mutual Fund Research Agencies
  40. 40. Bibliography <ul><li>RBI Guideline from http://www.rbi.gov.in </li></ul><ul><li>Critical role for non-banking finance sector R. Vaidyanathan , Professor of Finance and Control, Indian Institute of Management Bangalore, [email_address] </li></ul><ul><li>Investigation into NBFCs By P Sarath Kumar, FCA </li></ul><ul><li>Mutual Funds in India – Marketing Strategies and Investment Practices By H.Sadhak: Second Edition / Response Books ~ Sage Publications NEW DELHI </li></ul><ul><li>Securities and Exchange Board of India (Mutual Funds) Regulations 1996 guidelines </li></ul><ul><li>Investment Analysis and Portfolio Management – Second Edition by Prasanna Chandra CFM-TMH Professional Series in Finance </li></ul><ul><li>The Ground rules of Mutual Fund Investing by MutualFunds India Research Team </li></ul>
  41. 41. <ul><li>THANK YOU </li></ul>© 2007 Rahul Guhathakurta ~ Zardar Badami / IIPM Ahmedabad