chapter 4 nbfc sector in india -...

CHAPTER 4

NBFC SECTOR IN INDIA

Sr. No. Topic Page No. 4.1 NBFC Industry Overview 80 4.2 Industry Strategic Analysis 83 4.2.1 Porter's Five Force Model 83 4.2.2 BOT Analysis 88 4.2.3 PEST Analysis 91 4.3 Requlatory Refinements for NBFCs 95 4.4 Prospects of Indian NBFCs 105

4.1 NBFC Industry Overview

Fixed deposits in organizations that earn a fixed rate of return over a period

of time are called Fixed Deposits. Financial institutions and NBFCs also accept

such deposits. Deposits thus mobilized are governed by the Companies Act

under Section 58A. These deposits are unsecured, i.e., if the comp'any

defaults, the investor cannot sell the company to recover his capital, thus

making them a risky investment option.

NBFCs are small organizations, and have modest fixed and manpower costs.

Therefore, they can pass on the benefits to the investor in the form of a

higher rate of interest. However, NBFCs suffer from a credibility crisis. So the

credit rating plays a vital role for an NBFC to operate in the competitive

industry where there are alternative segments meeting the customer

requirements. AAA rating is the safest. According to recent RBI guidelines,

NBFCs and companies cannot offer more than 14% rate of interest on public

deposits, however in these times this was subsequently changed to not

higher than rate of interest for NRE deposits. This is a precise example of

how fast changes are occurring in this industry. These changes can be at

times very detrimental and also at times can offer greatly enhanced business

opportunities. Nevertheless, the only factor common in both these extreme

changes is absence of consistency. That would be the most apt way to define

NBFC industry overview in India.

NBFC fixed deposit provides for faster appreciation in the principal amount

than banking fixed deposits and post-office schemes. However, increase in

interest rate is essentially due to the fact that more uncertainty as compared

to banks and post-office schemes. These deposits are suitable for regular

income with the option to receive monthly, quarterly, half-yearly, and annual

interest income. Moreover, the interest rates offered are higher than banks.

However, these deposits provide limited protection against inflation, with

comparatively higher returns than other assured return options.

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One can borrow against a NBFC Fixed Deposit from banks, but it depends on

the credit rating of the company. Moreover, some NBFCs also offer a loan

facility on the deposits you maintain with them. In addition, these deposits

are unsecured instruments, i.e., there are no assets backing them up.

Therefore, in case the company/NBFC goes under crisis, chances are that one

may not get the principal sum. It depends on the strength of the company

and its ability to pay back your deposit at the time of its maturity. While

investing in an NBFC, always remember to first check out its credit rating.

In a very recent development in consideration of the dire economic and

financial scenario at a global level, RBI is considering options for making

finance cheaper and available to NBFCs including a separate line of credit for

banking finance backed by government securities or AAA-rated commercial

paper (CP).

The central bankers are also reviewing various restrictions on placing banking

funds with NBFCs and may relax prudential ceilings. NBFC representatives

also meet RBI officials over the last few days to avail easier finance since

Commercial Paper (CP) worth Rs. 20,000 crores to Rs. 25,000 crores is

coming up for maturity. The funds are particularly needed for retail finance

because this sector has lately been under strain was the unanimous opinion

of the heads of NBFCs.

CPs are short-term instruments through which companies raise funds from

banks. It is usually rolled over on every maturity date to sustain the flow of

short-term credit to companies. RBI's internal estimates, however, show that

of the total outstanding amount, CPs amounting to Rs. 2,000 crores to Rs.

4,000 crores will immediately need to be rolled over. As a result, RBI is still

debating whether a special refinance window is required for NBFCs in the

current scenario.

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The fund requirements are acute for three to four large NBFCs that have

grown rapidly in recent times and accumulated large exposures in the equity

market, real estate, commodities and retail financing. The problem is acute

not because there is a dearth of liquidity but because banks are unwilling to

lend to NBFCs. They feel that these institutions lend to the real estate sector

and for stock market transactions, both of which are facing a downturn.

At present, a bank's exposure to a single NBFC is currently capped at 10 per

cent of banks' capital funds and 15 per cent for an NBFC engaged in asset

financing companies. Further, banks are not allowed to grant bridge loans

against capital and debenture issues, to avoid asset-liability mismatches.

Shares and debentures are not accepted as collateral for secured loans

granted to NBFCs.

Banks also do not execute guarantees covering inter-company deposits or

loans since it is then interpreted as the banks insuring deposits or loans

accepted by NBFCs.

Therefore, an overview of the current scenario of NBFCs in India raises the

concern about prevailing liquidity crises, what would be the implications of

the same for NBFCs and again highlights the role of RBI in governing the

overall fundamentals of this industry segment.

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4.2 Industry Strategic Analysis

4.2.1 Porter Five Forces Model

The model of Five Competitive Forces was developed by Michael E. Porter

and described in "Competitive Strategy: Techniques for Analyzing Industries

and Competitors" in 1980. Since that time it has become an important tool

for analyzing an organizations industry structure in strategic processes. It is

based on the insight that a corporate strategy should meet the opportunities

and threats in the organizations external environment. Especially,

competitive strategy should base on and understanding of industry structures

and the way they change.

Porter has identified five competitive forces that shape every industry and

every market. These forces determine the intenSity of competition and hence

the profitability and attractiveness of an industry. The objective of corporate

strategy should be to modify these competitive forces in a way that improves

the position of the organization. Porter's model supports analysis of the

driving forces in an industry. The intenSity of competition in an industry is a

matter of rooted in its underlining economic structure and goes well beyond

the behavior of the current competitors. The state of competition depends on

five basic competitive forces, which are as below:

Bargaining Powe of Depositor

r

Threat from New Entrants

.LI.

Rivalry amongst~ .<}mpe~or~~ ,

Threat from Substitutes

Bargaining Power of Borrower

Porter five forces competitive model

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Competitive Rivalry between Existing Players

1. Rivalry among NBFCs is high as there are more than 1000 companies in

India and they are competing high as buyers are flexible.

2. Competitors are equal in size & capabilities. No firm is having market

leadership as many of the companies are having capabilities.

3. Rivalry is strong as switching cost is negligible. In NBFC sector there can

be a switchover to another if competitor are providing beneficial services

for instance in the business of hire purchase business person is interested

in interest rate and they will switch over when rivals are providing less

rate scheme.

4. Acquisition & bolstering strategy of rivals is ongoing. Firms that are losing

ground or in financial trouble often react aggressively by acquiring rivals,

introducing new products, boosting advertising, flexible product mix to

capture a hotly contested market share.

5. Rival competition is more due to constraints. The higher the exit barriers,

the stronger the incentive for existing rivals to remain and compete as

best they can, even though they may be earning low profits or even

incurring losses.

6. Competition from external sector is more volatile as related industry

competes with NBFC sector as in areas including hire purchase, lease,

loan, etc.

Herein, competition among rivalry will be Fierce.

Threat of New Entrants

It is easier for other companies to enter this industry and the competition in

an industry will be the higher. In such a Situation, new entrants could change

major determinants of the market environment (e.g. market shares, prices,

customer loyalty) at any time. There is always a latent pressure for reaction

and adjustment for existing players in this industry.

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In context to NBFCs, the entry barriers for new entrant is very high because

of the following reasons, so threat from the new entrance is relatively low in

this sector.

1. In the NBFC sector the initial investments requirement is very high. The

company required Rs. 25 lacs to start operations and also there is most

fixed costs to run operations so these factors are affecting the entry of

the new entrants.

2. Economies of scale in NBFC sector, there is more difficult to achive

economies of scale in very few year because it needs more investment in

this sector so it affect the entry of new entrance

3. In NBFC sector there is requirement of license from for operating the

business. So this also affects the entry of players in the industry.

4. In NBFC sector, most important resource is money and expert man power

which is scare so these factors also affect the entry of new entrance.

5. Switching cost for customers is very low for customers so it becomes easy

to attract customer by providing more benefits then other competitors.

6. Legislation and government action in this sector is very strict. Every NBFC

is required to follow RBI norms and regulations. There is also high degree

of compliance requirement from RBI to start new NBFC.

Herein, threat from new entrant will be Moderate.

Threat of Substitutes

A threat from substitutes exists if there are alternative products with lower

prices of better performance parameters for the same purpose. This category

also relates to complementary products.

1. NBFCs face threat from various investment opportunities available in the

financial market. Mutual Funds investment, Bond market, Stock market,

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Banking sector, Insurance sector are sectors offering substitutes to

investors.

2. Loyalty of customers is another determinant of degree of substitute force,

in NBFC sector customers are not brand loyal for particular company

because customer is seeking their own benefit so they prefer company

which give more benefit to them.

3. In today scenario, most of the investors prefer investing in stock market

because of returns potential.

4. Banking sector is a major competitor in the loans and advances business

segment. Current trend is toward housing finance loan, venture capital

and other NBFCs activities so the current trend is favoring NBFCs for

availing funds.

Herein, threat from substitutes will be Moderate.

Bargaining Power of Borrower

Bargaining power of borrower determines how much borrowers can impose

pressure on margins and volumes. In NBFC sector, the bargaining power of

borrower is very high because of the following reasons:

1. Large numbers of small operators in India available in NBFC sector results

into borrowers having a choice to choose particular company which can

provide more benefit to borrowers, so borrowers have a more bargaining

power.

2. In NBFC sector, the industry requires high fixed costs and starting capital

so borrowers exploit advantage of this and doing more bargaining.

3. In NBFC sector, the product is undifferentiated and can be replaces by the

substitute products so borrowers have more choice for their products

which helps to borrowers to do more bargaining power.

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4. In NBFC sector, switching to an alternative product is relatively simple

and switching cost also very low to borrowerss so borrowers in position to

make more bargaining so borrowerss have more bargaining power.

S. In India borrowers are very price sensitive so borrowers are prefer

companies for services like loan, leasing, etc. so bargaining power of

borrowers is very high in this sector.

6. The borrowers know the total costs of the product and other charges

imposed by NBFCs because RBI regulates it and also companies need to

disclose information. So borrowers are highly aware about the dynamics

and great position to make more bargaining.

Herein, threat from bargaining power of borrowers will be Moderate.

Bargaining Power of Depositors

The term 'depositors' comprises all sources for inputs that are needed in

order to provide goods or services.

The buying industry has low barriers to entry. In such Situations, the buying

industry often faces a high pressure on margins from their depositors. The

relationship to powerful depositors can potentially reduce strategic options

for the organization.

1. In NBFC sector, the investors who invest their money in NBFCs are

considering the depositors for the industry because money is the main

resource for the industry.

2. In context to NBFCs following factor affecting the bargaining power of the

depositors, number of depositors are more for this sector so bargaining

power is a bit low but at same time depositors have many option to invest

their money in many other alternative which may increase their

bargaining power.

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3. The depositors customers are fragmented as the investors who provide

money to NBFC sector are fragmented in many area so they are not well

informed so their bargaining power is very low.

4. NBFC sector has high entry barriers to entred in sector so there is less

player in the market and depositor are more so bargaining power of

depositor is very much lees in this sector.

Herein, threat from bargaining power of depositors will be Moderate.

4.2.2 BOT ANALYSIS

Barriers of NBFCs

1. Many NBFCs raise deposits from investors similar to a bank but with

greater risk of non performance and default.

2. NBFCs have lower trust quotient as compared to a regular Banks

3. DFIs and NBFCs do not have larger number of retail branches as banks

do. This limits their access to low cost savings deposits and makes them

rely on agents to attract the relatively more expensive retail and

corporate deposits.

4. Credit ration is mandatory with Volatility-Lending is their main business,

which makes the NBFCs highly volatile.

S. Carry a higher risk, since they face constant threat of being downgraded

in credit ratings. Also they are unsecured, so you stand to lose your

entire amount unless you invest in NBFCs with the highest credit rating.

6. Too narrow a product line relative to rivals is a concern as NBFCs cannot

accept depOSits for less than 12 months or more than 60 months and

cannot give gifts or incentives.

7. NBFCs have to bear high cost of fund and stiff competition with Financial

Services as well as with banking sector.

S. NBFCs have small balance sheet size resulting in high cost of funds and

low asset profit and inability to raise funds due to RBI restriction.

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Opportunities for NBFC

1. NBFCs are able to earn higher returns due to their ability to manage

higher risk assets, for instance auto financing is high yielding but faces

limited competition from banks.

2. Liquidity Factor is of high importance as Investors can withdraw money

before maturity. They can also take a loan against deposit. NBFCs readily

give such loans. So this flexibility will ensure that future customers will be

tempted towards NBFCs.

3. NBFCs have been helping to bridge the credit gaps in several sectors

which traditional institutions such as banks are unable to fulfill.

4. Good returns the returns from NBFCs can be higher than those of the

manufacturing companies. Selected NBFCs with a high credit rating were

offering interest rates in the range of 12% to 14% on one-year deposits.

5. NBFCs are characterized by their ability to provide niche financial services

and due to their relative organizational flexibility they can often provide

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

6. The Reserve Bank of India (RBI) released final guidelines for non-banking

financial companies (NBFCs) to enter the insurance business.

7. NBFCs have the ability to grow rapidly because of sharply rising demand

in automobile sector. To an extent both industries have become

complementary in this segment where their growth is directly co-related

in terms of lending and sales.

8. With GDP growth forecast of 6-7% over the next few years, the Indian

economy will continue to provide several growth opportunities. The

increased thrust on the infrastructure sectors, including power, reads,

ports, telecom another urban infrastructure projects will continue to

provide excellent investment opportunities in the future.

9. In addition, the service sector, which is growing at rapid pace and

contributes substantially to GDP, will provide many new opportunities or

the financial service industry in India with deposits available at lesser

costs over the next few years.

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10. The budget initiative from the Government focusing on infrastructure as

well as housing with Rs. 40,000 crores on new projects, is expected to

provide growth for current year and augurs well for transportation,

Commercial Vehicle and Earth Moving equipment industries.

11. Consumer finance and home loan finance show considerable promise, in

addition to vehicle finance. The retail finance business will continue to

grow, strongly aided by robust growth of economy and expanding base of

potential consumers with timely Government support by offering relief in

form of duties and subsidies.

Threat for NBFCs

NBFC sector continues to face competitive pressures from the banking sector

and financial institutions due to their increased penetration in the consumer

financing market, with comparatively low cost of funds at their disposal.

1. Market risk refers to uncertainty of future earnings resulting from

changes in the values of financial instruments. This could arise from

changes in liquidity conditions, interest rates and foreign exchange rates.

2. Interest rate risk arises when there is a mismatch in the interest rate

profile of asset and liabilities, adversely impacting net interest income.

3. Currency risk is the result of fiuctuating currency rates, which may

adversely impact the company's financial performance.

4. NBFCs deposits are unsecured and uninsured for the present. Regulations

pertaining to NBFCs are constantly changed. This creates an atmosphere

of uncertainty.

S. There is currently very little opportunity for the Company to raise cheaper

funds on a large scale to compete in the market. Company is facing

competition from FIs, Banks and MNCs having wide network and large

scale low interest funds.

6. The spreads in lending business have also narrowed conSiderably,

bringing risk-adjusted margins to generally unviable levels.


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4.2.3 PEST ANALYSIS

A scan of the external macro-environment in which the firm operates can be

expressed in terms of Political, Economic, Social and Technological factors.

The acronym PEST (or sometimes rearranged as "STEP") is used to describe

a framework for the analysis of these macro environmental factors, which

affect the industry.

Political Legal Factors

RBI Regulations

Till 1997 there was an unorganized NBFC sector. As the NBFC emerged as

one of the major competitor of banks, the RBI made rules and regulation to

organize the sector. RBI made regulations that NBFCs have to register

themselves and made it mandatory for NBFC wanting to raise funds through

public deposits. RBI is constantly monitoring NBFCs and framing regulations

from time to time to regulate the sector.

Taxation Regulations

NBFC sector is liable to pay income tax per the section 269T under income

tax regulation. As NBFCs fall under service tax norms, mostly hire purchase

and lease financing companies are liable to pay service taxes.

Companies Act Regulations

The Companies Regulation Bill aims to consolidate the law relating to NBFCs

with a view to ensure depositor protection. This indicates that NBFCs will now

be classified as financial companies under RBI guidance and regulations.

Investigative powers have been vested with District magistrates and

Superintendents of Police.

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Consumer Protection

Company Law Boards will be authorized to adjudicate claims of depositors. In

case of defaults in repayments by NBfCs of either the principal amount or

interest or both on deposits, the depositor can approach concerned regional

bench of Company Law Boards. Alternatively, consumer can approach

disputes redressal forum at district, state or national level.

For Ceiling

The ceiling of FDI in NBFC industry is 50%. This is also affects growth of the

sector because foreign direct investment adds viable leverage in the cost of

net owned funds and hence plays an important role in growth of NBFC.

Economic Factors

Following are the economical factors which affect the NBFC industry:

Gross Domestic Product CGDP)

Economic condition of any country and economy can be measured by GDP.

From the consumption side, GDP is equal to the sum of private consumption,

government consumption, investment and net exports. In 2006-2007 the

GDP was about 8% which was close to double than previous years.

Inflation

Recent inflation rate has been 3.6% but over the recent past months it has

ranged from 12% to 5% and has been highly volatile in the entire history.

This affects NBFCs in the long run as rise in inflation rate will affect the

disposable income and thus it will affect the savings and cost to raise funds,

Agriculture and NBFC

If we consider various types of component of NBFC such as Hire purchase,

Lease finance and Loan than we can say that they are directly related with

NBFC, as in hire purchase most of tractors are mainly sold in installment

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basis. More than 50% farmers use loans and to purchase agricultural devices

they also use lease finance for agricultural development.

Industrv and NBFC

Mainly manufacturing industries and mining sector are acquiring the

equipment and machineries on lease basis or hire purchase. So the growth in

industry will impact the NBFC sector significantly. Industry has contributed

around 6.5% of GOP in the previous years.

Interest Rate

As per the RBI regulation, the NBFC cannot offer more than 11% on public

deposit if than there is any change in for banking industry's interest rates it

will directly affect the NBFCs the collection of deposit from public.

Social Factors

Following are the social factors which affect non banking financial services

industry.

1. Due of industrialization more rural people are attracted towards the urban

areas, which has resulted into the emergence of a large middle class.

2. India is coming out of its typical mentality that the debt is bad. More and

more people of people of middle class and upper middle class are buying

computer, television, vehicles and also home on installment this is

positive sign of NBFCs .

3. NBFCs are providing loan to those whose application is denied by bank or

any other financial institution so it is providing venture capital for new

businesses. This is again helpful in generating further opportunities for

gainful employment and in turn creating an additional customer segment.

4. Development of rural areas is also on the wheel as rural class population

has gone up from 25% to 32% which indicate that there is vast

opportunity in rural area.

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- Technical Factors

Following are the technical factors, which affect the non-banking financial

services industry.

Internet

Through internet an NBFC can provide its information of customers. Further,

it can also shorten the process as customers planning to avail loans can get

detail about the interest rate, EM I, tax benefits, etc.

Telecommunication Services

Customer can use help lines for information about existing loans and many

NBFCs have replaced physical discussion by telephonic discussions. This

again benefits the way the business is conducted and facilitating customers.

Interconnected Branches

NBFCs which are well managed and which are widely spread all over the

country are connected with one another through information technology.

MIS Application

Information technology can be a great advantage to automate all the

functions of NBFCs it is useful in maintaining, gathering data and refine

organizational systems which enhance decisions and ensure data availability

easily whenever required by them.

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4.3 Regulatory Refinements for NBFCs

The RBI has been a fatherly figure in the development and nurturing of

NBFCs in India. It has constantly monitored the progress at each and every

stage and has made NBFCs an integral part of the financial system in India.

It is often argued that NBFCs are overly regulated and to an extent these act

as entry barriers for NBFCs in various segments where they have more

competence and competitive advantage over the traditional lending

institutions. On the other hand the investor protection regulations have been

welcomed by the investors but at the same time have raised doubt over the

competency of NBFCs in raising funds in a confident manner.

In the past few years, RBI has cancelled the certificate of registration issued

to various NBFCs for e.g. Maanasa Auto Finance Private Limited and M.G.

Kalyan Leafin & Investments Limited, both Hyderabad based NBFCs, for

carrying the activities of an NBFC due to non compliance reasons. This shows

ample evidence of RBI's interest in regulating and ensuring accountability

from this sector.

The various changes that have been affected by RBI in these current times

spread over the past years have been summarized below.

SummarY of RBI Master Notification amended October 2004

Minimum Credit Rating requirements where no NBFC having net owned funds

of Rs. Twenty Five Lacs and above shall accept public deposit unless it has

obtained minimum investment grade or other specified credit rating for fixed

depOSits from anyone of the approved credit rating agencies at least once a

year and a copy of the rating is sent to the RBI. This clause shall not apply to

an Equipment Leasing or Hire Purchase Finance Company. In the event of

upgrading or downgrading of credit rating of any NBFC to any level from the

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level previously held by NBFC, it shall within fifteen working days of its being

so rated inform, in writing, of such upgrading/downgrading to the RBI.

Restrictions on acceptance of public deposits by non-banking financial

companies was advocated where no NBFC shall accept or renew any public

deposit whether accepted before or after January 1998 unless such deposit is

repayable after a period of twelve months but not later than sixty months

from the date of acceptance or renewal thereof.

Further the ceiling on commission, incentive or any other benefit by whatever

name called was amended where in excess of 2% of the deposit so collected

and expenses by way of reimbursement on the basis of relative

vouchers/bills, in excess of 0.5% of deposit collected would not be allowable.

From January 2000 onwards, it was decided that it is the obligation of NBFC

to intimate the details of maturity of the deposit to the depOSitor at least two

months before the date of maturity of the deposit.

Where a NBFC permits an existing depositor to renew the deposit before

maturity for availing of the benefit of higher rate of interest, such company

shall pay the depOSitor the increase in the rate of interest provided that the

deposit is renewed in accordance with the other provisions of these directions

and for a period longer than the remaining period of the original contract and

the interest on the expired period of the deposit is reduced by 1% from the

rate which the company would have ordinarily paid, had the deposit been

accepted for the period for which such deposit had run; any interest paid

earlier in excess of such reduced rate is recovered/adjusted.

NBFC can allow interest on an overdue public deposit or a portion of the said

overdue deposit from the date of maturity of the deposit subject to the

conditions that the total amount of overdue deposit or the part thereof is

renewed in accordance with other relevant provisions, from the date of its

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maturity till some future date and the interest allowed shall be at the

appropriate rate operative on the date of maturity of such overdue deposit

No NBFC shall grant any loan against a public deposit or make premature

repayment of a public deposit within a period of three months from the date

of its acceptance. In the case of a deposit accepted prior to the aforesaid

date, such NBFC may, if so permitted by the terms and conditions of

acceptance of such deposit, repay it prematurely at the request of the

depositor, after the expiry of three months from the date of deposit or grant

a loan up to 75% of the amount of public deposit to a depositor after the

expiry of three months from the date of deposit at a rate of interest two

percentage pOints above the interest rate payable on the deposit.

Every non-banking financial company shall furnish to every depositor or his

agent or group of joint depositors, a receipt for every amount received by the

company by way of deposit. If such receipts pertain to installments

subsequent to the first installment of a recurring deposit it may contain only

name of the depositor and date and amount of deposit.

Every NBFC shall keep one or more registers in respect of all deposits in

which shall be entered separately in the case of each depOSitor in respect of

the deposit accounts opened by that branch of the company and a

consolidated register for all the branches taken together at the registered

office of the company and shall be preserved in good order for a period of not

less than eight calendar years following the financial year in which the latest

entry is made of the repayment or renewal of any deposit of which

particulars are contained in the register.

No non-banking financial company shall open its branch or appoint agents to

collect deposits except those having the certificate of registration issued by

RBI. Permitted NBFCs can open its branch or appoint agents if it's NOF is up

to Rs. 50 crores its credit rating is AA or above.

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No NBFC shall close its branch/office without publishing such intention in any

one national level newspaper and in one vernacular newspaper in circulation

in the relevant place and without advising RBI before ninety days of the

proposed closure.

NBFC receiving any amount in the ordinary course of its business as security

deposit from any of its employees for due performance of his duties shall

keep such amount in an account with a scheduled commercial bank or in a

post office in the joint names of the employee and the company.

Every NBFC accepting/holding public deposit shall deliver to the RBI an

audited balance sheet as on the last date of each financial year and an

audited profit and loss account in respect of that year as passed by the

company in general meeting together with a copy of the report of the Board

of Directors laid before the company and a certificate from its auditor, to the

effect that the full amount of liabilities to the depositors of the company,

including interest payable thereon, are properly reflected in the balance

sheet, and that the company is in a position to meet the amount of such

liabilities to the depositors.

The directions that apply to every Residuary Non-Banking Company (RNBC)

that is to say a non-banking institution, being a company, which receives any

deposit 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 other manner and

which, according to the definitions contained in the NBFCs acceptance of

Public Deposits. Accordingly, no RNBC shall receive any deposit repayable on

demand or on notice or after a period of less than 12 months or more than

84 months from the date of receipt of such deposit or renew any deposit.

Further, any amounts towards processing or maintenance charges or any

such charges shall not be charges for meeting its revenue expenditure.

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In addition, an RNBC cannot accept or renew deposits without complying

with all the requirements of NBFC Prudential Norms and the interest rate

shall not be less than the amount calculated at the rate of 8% per annum.

From July 2000, the amount payable by way of interest, premium, bonus or

other advantage, by whatever name called, by a RNBC in respect of deposits

received from that date, shall not be less than 6% per annum.

From May 1987, no RNBC shall forfeit any amount deposited by a depOSitor,

or any interest, premium bonus or other advantage accrued thereon.

Every RNBC shall furnish to every depOSitor or his agent, a receipt for every

amount which has been or which may be received by the company by way of

deposit before or after the commencement of these Directions.

Every residuary non-banking company shall keep one or more registers in

which shall be entered separately in the case of each depositor with

particulars. Further, every RNBC shall maintain separate books of account

and registers with respect to deposit received/to be received or by sale of

units or certificates or other instruments after the commencement of these

directions.

Most of these amendments were pertaining to disclosure norms of NBFCs and

RNBCs as they were not defined in the definition of NBFCs resulting into a

gap exploited by many forcing the policy designers to incorporate these

concerns.

List of Notifications induded in the Master Notification of October 2004

1. Notification No.68 dated April 10, 1993

2. Notification No. 69 dated April 19, 1993

3. Notification No.75 dated April 19, 1994

An Analytical Study 0/ Non-Banking Financial Companies Vaibhav Bharwad Page 99

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4. Notification No. 82 dated March 22, 1996

5. Notification No.85 dated July 7, 1996

6. Notification No.88 dated July 24, 1996

7. Notification No.95 dated January 1, 1997

8. Notification NO.l02 dated March 31, 1997

9. Notification No.105 dated March 31, 1997

10. Notification No.l06 dated April 30, 1997

11. Notification No. 113 dated November 11,1997

12. Notification No. 136 dated January 13, 2000

13. Notification No. 143 dated June 30, 2000


15. Notification No. 156 dated January 1, 2002

16. Notification No. 161 dated October 1, 2002



19. Notification No. 171 dated July 31, 2003

20. Notification No. 176 dated September 19,2003


22. Notification No. 180 dated September 25, 2004

Post these major grass root changes in the fundamental way in which

business was conducted by NBFCs, the RBI has continued to strengthen the

sector with enhanced regulations that predominantly protect the interest of

the investors and also operationally lead the NBFCs to be more efficient and

compete on a fair ground in terms of regulations. The major changes that

have occurred in the recent years have been summarized below.

February 2005

NBFCs were advised to follow certain customer identification procedure for

opening of accounts and monitoring transactions of a suspicious nature for

the purpose of reporting it to appropriate authority. These guidelines have

been revisited in the context of the Recommendations made by the Financial


Action Task Force (FATF) on Anti Money Laundering (AML) standards and on

Combating Financing of Terrorism (CFT). These standards have become the

international benchmark for framing Anti Money Laundering and combating

financing of terrorism policies by the regulatory authorities. Compliance with

these standards by the banks/financial institutions/NBFCs in the country has

become necessary for international financial relationships. The objective of

these guidelines is to prevent banks from being used, intentionally or

unintentionally, by criminal elements for money laundering activities.

June 2005

All NBFCs including RNBCs were informed about for widening scope of

infrastructure lending and increase in the risk weight for exposure to public

financial institutions (PFIs). Specific segments included construction relating

to projects involving agro-processing and supply of inputs to agriculture,

construction for preservation and storage of processed agro products,

perishable goods such as fruits, vegetables and flowers including testing

facilities for quality and construction of educational institutions and hospitals.

August 2005

The developments in prudential standards for the banking system pertaining

to the period for which a non-performing asset remains a substandard asset

or period after which a sub-standard asset would become doubtful assets

were also issued for financing of infrastructure projects by NBFCs.

Accordingly, an asset would be classified as sub-standard asset, if it remains

non-performing for a period not exceeding 18 months, instead of the present

norm of 24 months. Also, an asset would be classified as doubtful if it

remains non- performing for a period exceeding 18 months instead of

present norm of 24 months. The NBFCs can restructure or reschedule or

renegotiate the terms of infrastructure loan agreement as per broad policy

framework laid down by their Board of Directors. If the amount of interest

due, is converted into equity or any other instrument, and income is


recognized in consequence, full provision should be made for the amount of

income so recognized to offset the effect of such income recognition.

November 2005

In a mid-term review of the Annual Policy pertaining to Banking Finance to

NBFCs, banks are precluded from granting finance against existing assets

whether by way of term loans for purchase of such assets or by way of

finance to leasing companies for purchase and release of such assets.

However, in view of the expertise gained by NBFCs in financing second hand

assets and to encourage credit dispensation, it is proposed that banks may

extend finance to NBFCs against second hand assets financed by them,

provided suitable loan policies duly approved by the boards.

Februarv 2006

This was regarding entry of NBFCs into Insurance Business, here, permitted

NBFCs registered with the Reserve Bank to set up insurance joint ventures

for undertaking insurance business with risk participation and also to

undertake insurance business as agents of insurance companies on fee basis.

However, before entering into insurance buSiness, NBFCs are required to

obtain prior approval of the Insurance Regulatory and Development Authority

(IRDA) and RBI. Further, NBFCs should not adopt any restrictive practice of

forcing its customers to go in only for a particular insurance company in

respect of assets financed by the NBFC. The customers should be allowed to

exercise their own discretion. The premium should be paid by the insured

directly to the insurance company without routing through the NBFC.

May 2006

The Government today revised foreign equity investment in NBFCs granting

permission to holding NBFCs to set up 100% downstream subsidiaries with a

minimum capital of US$ 5 million (Rs. 22 crores). The holding NBFC with

minimum capital of US$ 50 million (Rs. 220 crores), will however have to

disinvest its equity to minimum extent of 25% through a public offering,

An Analytical Study of Non-Bonking Financial Companies Vaibhav Bharwad Pagel0Z

within a period of three years. This has been done after reviewing the policy

in this regard based upon experience in the working of NBFCs, the difficulties

being faced in setting up operation of these companies due to hurdles in

locating credible Indian partners in a short time. The existing guidelines

provide 100% foreign equity in NBFCs where a company has to act only as a

holding company and specific activities to be undertaken by step down

subsidiaries.

March 2007

The Amendment to RBI Regulations for NBFCs for safe custody of liquid asset

securities in an exclusive demat account was incorporated in view certain

developments and changes in market conditions. These were relating to

NBFCs including RNBCs required to maintain liquid assets in the form of

Government securities/guaranteed bonds and lodge such securities in a

Constituents' SubSidiary General ledger (CSGl) Account with a scheduled

commercial bank (SCB) / Stock Holding Corporation of India ltd., (SHCIl) or

in a demat account with a depository through a depository participant (DP)

registered with Securities & Exchange Board of India (SEBI) or with a branch

of SCB to the extent such securities are yet to be dematerialised.

August 2007

RBI has permitted NBFCs to enter into ready forward contracts in gilts

(including reverse ready forward contracts). The NBFCs should scrupulously

adhere to the restrictions and requirements for entering into such deals and

meticulously comply with the related instructions. It may be noted that

NBFCs can transact in Government securities held in excess of the prescribed

statutory liquid assets requirement.

September 2007

The provisions relating to premature repayment of public depOSits or deposits

mention that a NBFC or MNBC is not permitted to repay any public deposit or

depOSits as the case may be, within a period of three months from the date


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of acceptance of the same. Similarly, a RN~C is not permitted to repay any

deposit within a period of twelve months from the date of its acceptance .

However, after the above period, the deposits can be pre-paid subject to

certain conditions. Such repayments may vitiate the ALM discipline of

companies and in case of a company whose assets may be insufficient to

meet all its outside liabilities, such repayments may result in preferential

treatment to those depositors who exit early.

Copied below is an example of how well RBI is focused on NBFCs for investor

protection and development of this sector.

RBI guidelines for safe Investments In NBFCs·

• The NBFC'" should be registered with RetMtl'V1!t Bank of India .as a deposit taking company. Registration of an NBFC with RBI merety .authorises it to conduct the business of NBFC. It i. not a guarantee tor repayment of deposita by NBFCIJ. NBFCa cannot use the name 0' Reserve Bank of India in any manner.

• The NBFC· cannot - oller mare than ,,'" Intereol on publlc depoBlts - offer any gifts I incentives - accept deposita for less than 12 months or more than 60 month, They must Issue a ptaper receipt lor clepaelts.

• It ahould have at least in"estment grade ae<fit rating. - tr not, it should be engaged In equipment ' ••• ing or hire purchase

nnance activities or It should be a residuary non-banking company.

• Unincorporated bodies. such as, individuals, proprietorship and pannership flnns. It they are engaged In the business of loants and advanc ... leasfng and hire purchase, cannot accept deposits from public.

• In case an NBFC faUs to repay the deposit or the interest, the depositor can complain to; (I) Consumer D1spute Redreu.al forum at district level: or (ii) Company Law Board at Chennai I Defhi I Kolkatal Mumbai; or (III) Nearest RBI office.

NBFC' deposits Bre neither insured nor guaranteed.

Issued In public intorest by:

'il<dl:q R-ita ~ KESEKVB BANK OF INDIA For a complete list of NBFCs, visit: www.nbfcllst.rbi,org,ln

• N8FC:p 1rtc!1,i~ '-'.u;lng, M. pUrehit:J8, !'XIns.nd Inws1men1 oompanl"s, O~QlllfI rrwblU,.!on SlCh.",.. of compa.nieo!l enQIloe<f In ~ aC1i\Mles.. euch a9 plantation, nldhlB, commodltiee uading, manufacturing.. houllllnQ. ek., 00 nor:oom. undaf eho ~H.lrvl ..... of the RK6r ..... Bank ollndi-a..

An Analytical Study af Nan-Banking Financial Companies Vaibhav Bharwad Page 104

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4. 4 Prospects of Indian NBFCs

NBFCs have registered significant growth in recent years both in terms of

number and volume of business transactions. Foreign equity investments in

NBFCs are permitted in 17 categories of NBFC activities so far approved for

foreign equity investments such as merchant banking, stock broking, venture

capital, housing finance, forex broking, leasing and finance, financial

consultancy, etc. With guidelines for foreign investment in NBFC sector been

amended so as to provide for a minimum capitalization norm of US$ 0.5

million, for the activities which are not fund based and only advisory or

consultancy in nature, irrespective of the foreign equity participation level.

This provision would be applicable to Investment Advisory Services, Financial

Consultancy, Credit Reference Agencies, Credit Rating Agencies, Forex

Borking and Money Changing Business.

The RBI is looking at further strengthening the NBFCs to help the sector grow

in terms of its asset base. RBI has provided NBFCs with an option to move

out of public deposits acceptance activity voluntarily if the regulatory costs

outweighed their benefits. If NBFCs chose to get out of public deposits, the

RBI would help them in their efforts, including imparting training and

technology support.

Recently, the NBFC industry council met the Finance Ministry with the

objective framing regulations from a three-year perspective for NBFC sector.

The council urged the RBI that NBFCs should be viewed as complementing

the banking sector and not competitive as NBFCs played a significant role in

financing road transport and infrastructure and could also reach the

grassroots level through micro finance.

Additional concerns by the council were that NBFCs should have a level field

with housing finance companies in matters such as funding from banks and

access to refinancing institutions such as SIDBI and NABARD. Further, the

An Analytical Study of Non-Banking Financial Companies Va/bhav Bharwad Page 105

•

representatives of NBFCs urged that provisions of Debt Recovery Tribunal Act

available to banks and housing finance companies could be extended to

NBFCs to protect their assets.

However, at the same time the regulations impose too many barriers on

NBFCs that it seems the RBI wants NBFCs to phase out their accepting of

fixed deposits. In the complete absence of a vibrant corporate debt market

or a municipal debt market, this will throw the hapless savers to the mercy of

banks and asset management companies. This will only force more and more

to seek out government savings schemes, leading to increased borrowing

costs for the government as well as explosion in the size of government debt.

The Indian NBFC sector is again set to gain momentum. Very recently,

Australia based South East Asia Bank has sought permission from the Foreign

Investment Promotion Board to establish a wholly owned NBFC in India. The

company, in its application filed with FIPB, has stated that it will be primarily

engaged in project financing and will also take up related financial services.

Top global financial firms which have acquired a foothold in the Indian NBFCs

segment are now pursuing an aggressive strategy to expand their reach

within the country. Fullerton India, a subsidiary of Temasek which is

Singapore government's investment arm, is emerging as one of the most

aggressive players in the financial sector. Other recent entrants in the NBFC

segment include biggies such as AIG Capital while other global players,

namely, Citi Financial and StanChart's Prime Financialm BNP Paribas and

Societe Generale have also entered the business by acquiring stakes in

Indian firms. Besides, the new players have to contend with local firms,

Future Group and Indiabulls which have also forayed into this business

during the past few years.

In the backdrop of general slowdown in the real estate market and some of

the industrial activities coupled with steep decline in the value of some of the


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unquoted shares, the NPAs of NBFCs have registered an upward movement.

At the same time, the managerially sound NBFCs are being encouraged to

continue their genuine business operations. Banking credit to the NBFCs for

their advances against commercial vehicles has recently been brought under

the ambit of priority sector advances.

Hopefully, the draining of liquidity in the system will come to the rescue of

savers and allow the emergence of a number of lucrative investment options.

NBFCs are now not a major avenue for investment and resources. About 800

NBFCs held close to Rs. 5,000 crores of deposits at the end of March 2007.

Also, fixed deposits are also not the primary source of finance for NBFCs, in

well managed NBFCs they form only about 20% of the total funds mobilized

by the organization.

The prospects for NBFCs are, however, looking up. They could emerge as a

major avenue for investment that offers better returns to investors. The

opportunity could now be lost if these norms are not relaxed a bit by the

regulators. At one time, banks had about Rs. 50,000 crores in the system

that could not be deployed effectively. The excess liquidity forced banks to

peg the rates on term deposits at low levels. The corporate sector also found

it easy to borrow from banks at exceptionally attractive terms. Even firms

such as ICICI, IDBI and several NBFCs relied less on retail funds as cheaper

sources of finance through term deposits, banks and mutual funds became

available. But with the crunch in liquidity, the regulations are the single most

important variable in how the sector designs its future.

An Analytical Study of Non-Banking Financial Companies Valbhav Bharwad Page 107

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