Box 6.1: An Overview of Regulation of NBFCs

(1)

Mission

(3) Basic Structure of Regulatory
and Supervisory Framework

To ensure that

Prescription of prudential norms
akin to those applicable to banks,

i.

the financial companies
function on healthy lines,

*

these companies
function in consonance

Submission   of   periodical Returns
for the purpose of off-site surveillance,

Box 6.1: An Overview of Regulation of NBFCs (Concld.)

with the monetary policy
framework, so that their
functioning does not lead to
systemic aberrations,

Supervisory framework comprising
(a) on-site inspection (CAMELS pattern)
(b) off-site Monitoring through returns(c)
market intelligence And (d) Exception
reports by statutory auditors,,

*

the quality of surveillance
and supervision exercised
by the RBI over the NBFCs
keeps pace with the developments
in this sector.

Punitive action like cancellation
of Certificate of Registration
(CoR), prohibition
from acceptance of deposits and
alienation of assets, filing criminal
complaints and winding up petitions
in extreme cases, appointment of the
RBI observers in certain cases, etc.

*

comprehensive regulation and
supervision of Asset liability
and risk management
system for NBFCs,

Co-ordination with State Governments
to curb unauthorised and fraudulent
activities, training programmes
for personnel of NBFCs, State
Governments and Police officials.

(2)

Amendments to the
Reserve Bank of India
(RBI) Act, 1934

(4) Other steps for protection of
depositors’  interest

RBI Act was amended
in January 1997
providing for, inter alia.

Publicity for depositors’ education
And awareness, workshops / seminars
for trade and industry organisations,
depositors’ associations,
chartered accountants, etc.

*

Entry norms for NBFCs
and prohibition of deposit
acceptance (save to the
extent permitted under
the Act) by unincorporated
bodies engaged in financial business,

*

Compulsory registration,
maintenance of liquid
assets and creation of reserve fund,

*

Power of the RBI to issue
directions to an NBFC or to
the NBFCs in general
or to a class of NBFCs.

*

Comprehensive regulation
and Supervision of deposit
taking NBFCs and limited
supervision over those not
accepting public deposits.

Table 6.1: Types of Non-Banking Financial Entities (Regulated by RBI)

Non-Banking Financial Entity

Principal Business

1.

Non-Banking
Financial Company

In terms of the Section 45-l(f)
read with Section 45-i(c) of the
RBI Act, 1934, as amended in 1997,
their principal business is that
of receiving deposits or that of a
financial institution, such as lending,
investment in securities, hire
purchase finance or equipment leasing.

(a)

Equipment leasing
company (EL)

Equipment leasing or
financing of such activity.

(b)

Hire purchase finance
company (HP)

Hire purchase transactions
or financing of such transactions.

(c)

Investment
company (1C)

Acquisition of securities.
These include Primary Dealers
(PDs) who deal in underwriting
and market making for
government securities.

(d)

Loan company (LC)

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

(e)

Residuary non-banking
company(RNBC)

Company which receives
deposits under any scheme or

arrangement by whatever
name called, in one lump-sum
or in instalments by way of contributions
or subscriptions or by sale
of units or certificates or other
instruments, or in any manner.
These companies do not belong
to any of the categories as stated above.

II.

Mutual Benefit Financial
Company(MBFC) i.e.,
Nidhi Company

Any company which is notified
by the Central Government
as a Nidhi Company under
section 620A of the Companies
Act, 1956(1 of 1956)

III.

Mutual Benefit Company(MBC),
i.e., potential Nidhi company

A company which is working
on the lines of a Nidhi company
but has not yet been so declared
by the Central Government,
has minimum net owned fund(NOF)
of Rs.10 lakh, has applied to the RB1
for CoR and also to Department of
Company Affairs(DCA) for being
notified as Nidhi company and has
not contravened directions/
regulations of RBI/DCA.

IV.

Miscellaneous non-banking
company(MNBC), Managing,
Conducting or supervising as a promoter,
foreman ori.e., Chit Fund Company

Managing, conducting or
supervising as a promoter, foreman or

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

Box 6.2: Regulatory Norms and Directions for NBFCs A. Important Statutory Provisions of

Chapter III B of the RBI Act as applicable to NBFCs

Sr.No.

Subject

Particulars

1.

Certificate of Registration

No company, other than those exempted by the RBI, cancommence or ea the business of non-banking financial institutionwithout obtaining a CoR RBI. The pre-requisite for eligibility forsuch a CoR is that the NBFC f have a minimum NOF of Rs. 25lakh (since raised to Rs. 2 crore on and April 21, 1999 for any new applicant NBFC). The RBI considers grant CoR after satisfying itself about the company’s compliance with the c enumerated in Section 45-1A of the RBI Act

2.

Maintenance of Liquid Assets

NBFCs have to invest in unencumbered approved securities, valued at a not exceeding current market price, an amount which, at the close of business on any day, shall not be less than 5.0 per cent but not exceeding 25.0 per cent specified by RBI, of the deposits outstanding at the close of business on the working day of the second preceding quarter.

3.

Creation of Reserve Fund

Every non-banking financial company shall create a reserve fund and transfer thereto a sum not less than 20.0 per cent of its net profit every year as disi in the profit and loss account and before any dividend is declared. Such fund to be created by every NBFC irrespective of the fact whether it accepts] deposits or not. Further, no appropriation can be made from the fund ft purpose without prior written approval of RBI.

(1)

Deposit Acceptance Related Regulations

1

Ceiling on quantum of public
deposits

Loan and investment companies - 1.5 times of NOF if the company
has NOF of Rs. 25 lakh, minimum investment grade (MIG) credit rating, complies with all the prudential norms and has CRAR of 15 per cent.Equipment leasing and hire purchase finance companies - if company has NOF of Rs. 25 lakh and complies with all the prudential norms.
i. with MIG credit rating and 12 per cent CRAR - 4 times of NOF
ii. without MIG credit rating but CRAR 15 per cent or above -1.5 times of NOF, or Rs. 10 crore, whichever is less.

2

Investment in liquid assets

NBFCs - 15 per cent of outstanding public deposit liabilities as at the close of business on the last working day of the second preceding quarter, of which
i. not less than 10 per cent in approved securities and
ii. not more than 5 per cent in term deposits with scheduled
commercial banks.
Directions for investments by RNBCs were rationalized in June 2004 with a view to reducing the overall systemic risk in the financial sector and safeguarding the interest of the depositors. In this regard the following roadmap was prescribed: a) From the quarter ended June 2005 and onwards, RNBCs were permitted to invest only to the extent of 10% of the Aggregated Liabilities to Depositors (ALDs) as at the second preceding quarter or one time of their Net Owned Funds, whichever is

b)

lower, in the manner which in their opinion of the company
is safe as per approval of its Board of Directors.

From the quarter ended June 2006 onwards, this limit would stand abolished and RNBCs would not be permitted to invest any  mount out of ALDs as per their discretion. However, to avoid strain, in complying with 100% directed investments by  ompanies, the same had been modified to 95% of ALD up to March 31, 2007 and 100% of ALD thereafter. These liquid asset securities are required to be lodged with one of the scheduled commercial banks or Stock Holding Corporation of India Ltd.. or a depository or its participant (registered with SEB1).Effective October 1, 2002, government securities are to be necessarily held by NBFCs either in Constituent’s Subsidiary General Ledger Account with a scheduled commereial bank or in a demat account with a depository participant registered with SEBI.These securities cannot be withdrawn or otherwise dealt with for any purpose other than repayment of public deposits.

3

Period of Deposits

No demand deposits
NBFCs – 12 to 60 months
RNBCs – 12 to 84 months
MNBCs (chit Funds) – 6 to 36 months

4

Ceiling of deposit rate

NBFCs, MNBCs and Nidhis - 11.0 per cent per annum (effective March 4,2003)

RNBCs - Minimum interest of 4.0 per cent on daily deposits and6.0 per cent on other than daily deposits.Interest may be paid or compounded at periods not shorter than monthly rests.

5

Advertisement methodology for acceptance of deposits/public deposits

Every company which accepts deposits by advertisement has to comply with the advertisement rules prescribed in this regard, the deposit acceptance form should contain certain prescribed information ,issue receipt for deposits and maintain a deposit register. etc.

6

Submission of returns

All NBFCs holding or accepting public deposits have to submit periodical returns to RBI at Quarterly, half yearly and annual intervals.

(2)

Prudential Norms applicable to only those NBFCs which are accepting/holding public deposits

1

Capital to Risk Assets Ratio
(CRAR)

The NBFCs holding/accepting public deposits are required to
maintain CRAR as under:
i. Equipment leasing companies/hire purchase finance
companies (with MIG credit rating) 12 percent
ii. Equipment leasing companies/hire purchase finance
companies (without MIG credit rating) 15 percent
iii. Loan/investment companies 15 percent
iv. RNBCs 12 per cent
CRAR comprises – tier I and tier II capitalTo be maintained on a
daily basis and not merely on the reporting dates.Tier I Capital –
core capital or NOF but includes compulsorily convertible
preference shares (CCPS) as a special case for CRAR purposes.Tier
II Capital – all quasi-capital like preference shares (other than
CCPS) subordinated debt, convertible debentures, etc.Tier III

Capital not to exceed tier I capitalGeneral provisions and loss reserves not to exceed 1.25 per cent of the risk – weighted assets.Subordinated debt issued with original tenor of 60 months or more.

2

Restrictive norms

Acceptance of public deposits not allowed if the prudential norms
are not complied with fully.

Any NBFC defaulting in repayment of the matured deposits
prohibited from creating any further assets until the defaults are
rectified

Investments in real estate, except for own use, restricted to 10
per cent of the owned fund.Investments in unquoted shares
restricted as under:EL/HP Companies 10 percent of owned
fund

Loan/investment companies 20 per cent of owned
fund

No further investments in real estate or unquoted shares in case
of excess position held till its regularisation.

Sufficient adjustment period allowed - further extension on merits
of each case.

3

Credit/investment concentration
norms

Single borrower exposure limits credit - 15 percent of owned
fund

Investments - 15 percent of owned
fund

Single group of borrower exposure 25 percent of owned
limits credit - fund

Composite (credit and investments) exposure limits
Single borrower 25 percent of owned fund

Single group of borrowers 40 percent of owned
fund

I Exposure norms also applicable to own group companies and
subsidiaries.

ii. Includes all forms of credit and credit related and certain
other receivables as also off balance sheet exposures.

iii. Debentures/bonds to be treated as credit for the purpose of
prudential norms but as investments for the purpose of
balance sheet and compliance with investment obligations.

4

Reporting System: Half yearly
Return

Half-yearly returns to be submitted as at the end of March and
September every year,

i. Time allowed for submission - 3 months from the due date,

ii. The return to be certified by the statutory auditors of the

company. However, it need not wait for audit and the figures furnished therein could be the unaudited figures but must be certified by auditors

(3)

Prudential Norms applicable to all NBFCs irrespective of whether they accept/hold public deposits or not

1

Income Recognition Norms

The recognition of income on the NPA is allowed on cash basis only.The unrealised income recognised earlier is required to be reversed.

2

NPA norms

Recognition of income on accrual basis before the asset becomes
NPA as under:Loans and Advances: Upto 6 months and 30 days
past due period (past due period done away with effect from March
31, 2003) Lease and Hire Purchase Finance: 12 months

3

Restrictive Norms

Loans against own shares not allowed

4

Policy on demand/call loans

Companies to frame a policy for demand and call loans relating
To cut-off date for recalling the loans, the rate of interest,
periodicity of such interest, periodical reviews of such performance,
etc.

5

Accounting Standards

All the Accounting Standards and Guidance Notes issued by
Institute of Chartered Accountants of India (ICAl) are applicable
To all NBFCs in so far as They are not inconsistent with the
guidelines of RBI.

6

Accounting for investments

All NBFCs to have a well defined investment policy.

Investments classified into two categories - (1) long term and (ii)
current investments.

Long term investments to be valued as per Accounting Standard,
issued by ICAI.

Current investments to be classified into - (a) quoted and (b)
unquoted.

Current quoted investments to be valued at lower of cost or market
value.

Block valuation permitted - Notional gains or losses within the
block permitted to be netted - but not inter-block, net notional
gains to be ignored but notional losses to be provided for.

Valuation norms for current unquoted investments are as under:

i. Equity shares (at lower of cost or break up value or fair value)

ii. Re I/- for the entire block of holding if the balance sheet of

the investee company is not available for the last two years

iii. Preference shares at lower of cost or face value

iv. Government securities at carrying cost

v. Mutual Fund units at net asset value (NAV) for each scheme

and

vi. Commercial paper (CP) at its carrying cost

7

Asset Classification

All forms of credit (including receivables) to be classified into four
categories -

i. Standard asset

ii. Sub-standard asset

iii.Doubtful asset

iv.Loss asset

8

Provisioning for Non-Performing
Assets – Loans and Advances

Standard assets - No provisionSub-
standard assets- 10 per cent of outstanding balance

Doubtful assets - on unsecured portion 100 per cent and on
secured portion 20, 30 and 50 per cent depending on the age of
the doubtful assets

Loss asset - 100 per cent of the outstanding

9

Provisioning for Non-Performing
Assets – Equipment Lease and
Hire Purchase accounts

i.

Unsecured portion to be fully provided for

ii.

Further provisions on net book value (NBV) of EL/HP assets

iii.

Accelerated additional provisions against NPAsNPA for 12
months or more but less than 24 months 10 per cent of
NBVNPA for 24 months or more but less than 36 months 40
per cent of NBVNPA for 36 months or more but less than 48
months 70 per cent of NBVNPA for 48 months or more 100
per cent of NBVValue of any other security considered only
against additional provisions.Rescheduling in any manner will
not upgrade the asset upto 12 months of satisfactory
performance under the new terms.Repossessed assets to be
treated in the same category of NPA or own assets - option
lies with the company.

10

Risk – Weights and Credit Conversion factors

i.

Risk - weights to be applied to all assets except intangible assets.

Ii

Risk - weights to be applied after netting off the provisions
held against relative assets.

iii.

Risk - weights are 0, 20 and 100.

iv.

Assets deducted from owned fund like exposure to subsidiaries
or companies in the same group or intangibles to be assigned
0 per cent risk - weight.

v.

Exposures to all-India financial institutions (AIFIs) at 20 per
cent risk -weight and all other assets to attract 100 per cent
risk - weights.

vi.

Off-balance sheet items to be factored at 50 or 100 and then
converted for risk - weight.

11

Disclosure requirements

1.

Every NBFC is required to separately disclose in its balance
sheet the provisions made as outlined above without netting
them from the income or against the value of assets.

2.

The provisions shall be distinctly indicated under separate
heads of accounts as under:

i. provisions for bad and doubtful assets; and

ii. provisions for depreciation in investments.

3.

Such provisions shall not be appropriated from the general
provisions and loss reserves held, if any, by the NBFC.

4.

Such provisions for each year shall be debited to the profit
and loss account. The excess of provisions, if any, held under
the heads general provisions and loss reserves may be written
back without making adjustment against them.

5.

Nidhis and Chit Fund companies exempted.