1

Contents

Executive Summary 3
Chapter 1 - Introduction 4
1.2 - Historical background 6
Chapter 2- NBFC 9
2.1- Importance of NBFC 11
2.2 - Role of NBFC 12
2.3 - On Global Crisis 13
Chapter 3 - Factors affecting growth of NBFC 15
Chapter 4 - Norms for NBFC 18
4.1 Entities regulated by RBI 18
4.2 Entities not regulated by RBI 18
4.3 Principal Business Criteria 19
4.4 Residuary Non-Banking Companies 19
4.5 Eligible/ Ineligible for Deposits 20
4.6 Depositor protection Issues 22
4.7 Collective Investment Schemes and Chit funds 23
4.8 NBFC Deposit Criteria 24
Chapter 5 Guidelines for ALM 26
5.1 ALM Information System 28
5.2 ALM Organisation 28
5.3 Liquidity Risk Management 29
Chapter 6 - Commercial Bank v/s NBFC 30
Chapter 7 - Current status of NBFC 33
7.1 Prudential Norms 33
7.2 Financial linkage between Banks and NBFC 34
7.3 Structural linkage between Banks and NBFC 35
Chapter 8- Findings 37
8.1- NBFCs future in India 37
8.2 Conversion of NBFC 38
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Chapter 9- Conclusion 40
References & Webliography 41





























3

Executive Summary

NBFC is emerging as a strong financial intermediary in the retail finance space. Retail NBFC
has grown at a compound annual growth rate (CAGR) of 20 percent between 2011 and 2013.
NBFC continue to gain market share at the expense of bank; NBFCs share in retail finance is
expected to almost match that of banks.

NBFCs higher penetration in smaller towns, products and process innovation, continued focus
on core business, will be the key enablers of its steady growth and competitive position in Retail
finance. On the other hand increased regulatory coverage and movement towards secured asset
classes will strengthen he sector and provide stability.
These factors signal a stronger and more mature retail NBFC sector. This will ensure continued
interest and adequate flow of capital to support and cover asset-side risks.
Additionally new groups are entering NBFC sector in pursuit of growth opportunities offered
by various product segments.

NBFCs especially the domestic players, are well poised to move towards the next phase of
growth and scale up their operations. The challenges they need to address include aligning
their business models with the changing regulations, enhancing and diversifying their
borrowing mix at competitive rates, and ensuring availability of skilled human resource.

The study is aimed to provide a holistic view of the NBFC Industry. There are almost 13000
registered NBFCs in India. The study focuses on the differentiating the types of NBFC. The
regulatory framework of RBI for NBFCs and various requirements to qualify for a deposit
taking NBFC. The study also compared the Commercial v/s NBFC.





4

Chapter 1- INTRODUCTION

We studied about banks, apart from banks the Indian Financial System has a large number of
privately owned, decentralised and small sized financial institutions known as Non-banking
financial companies. In recent times, the non-financial companies (NBFCs) have contributed to
the Indian economic growth by providing deposit facilities and specialized credit to certain
segments of the society such as unorganized sector and small borrowers. In the Indian Financial
System, the NBFCs play a very important role in converting services and provide credit to the
unorganized sector and small borrowers.

NBFCs provide financial services like hire-purchase, leasing, loans, investments, chit-fund
companies etc. NBFCs can be classified into deposit accepting companies and non-deposit
accepting companies. NBFCs are small in size and are owned privately. The NBFCs have grown
rapidly since 1990. They offer attractive rate of return. They are fund based as well as service
oriented companies. Their main companies are banks and financial institutions. According to
RBI Act 1934, it is compulsory to register the NBFCs with the Reserve Bank of India.

The NBFCs in advanced countries have grown significantly and are now coming up in a very
large way in developing countries like Brazil, India, and Malaysia etc. The non-banking
companies when compared with commercial and co-operative banks are a heterogeneous
(varied) group of finance companies. NBFCs are heterogeneous group of finance companies
means all NBFCs provide different types of financial services.

Non-Banking Financial Companies constitute an important segment of the financial system.
NBFCs are the intermediaries engaged in the business of accepting deposits and delivering
credit. They play very crucial role in channelizing the scare financial resources to capital
formation.

NBFCs supplement the role of the banking sector in meeting the increasing financial need of
the corporate sector, delivering credit to the unorganized sector and to small local borrowers.
NBFCs have more flexible structure than banks. As compared to banks, they can take quick
5

decisions, assume greater risks and tailor-make their services and charge according to the needs
of the clients. Their flexible structure helps in broadening the market by providing the saver and
investor a bundle of services on a competitive basis.

Non Banking Finance Companies (NBFCs) are a constituent of the institutional structure of the
organized financial system in India. The Financial System of any country consists of financial
Markets, financial intermediation and financial instruments or financial products. All these
Items facilitate transfer of funds and are not always mutually exclusive. Inter-relationships
Between these are parts of the system e.g. Financial Institutions operate in financial markets and
are, therefore, a part of such markets.

NBFCs at present providing financial services partly fee based and partly fund based. Their fee
based services include portfolio management, issue management, loan syndication, merger and
acquisition, credit rating etc. their asset based activities include venture capital financing,
housing finance, equipment leasing, hire purchase financing factoring etc. In short they are now
providing variety of services. NBFCs differ widely in their ownership: Some are subsidiaries of
large Manufacturers (e.g., T.V. Motors T.V. Finances and Services Ltd). Many others are owned
by banks such as ICICI Banks, ICICI Securities Ltd, SBI Capital Market Ltd, Muthoot Bankers
Muthoot Financial Services Ltd a key player in Kerala financial services. Other financial
institutions are IFCIs IFCI Financial Services Ltd or IFCI Custodial Services Ltd (Devdas,
2005).
Non-banking Financial Institutions carry out financing activities but their resources are not
directly obtained from the savers as debt. Instead, these Institutions mobilize the public savings
for rendering other financial services including investment. All such Institutions are financial
intermediaries and when they lend, they are known as Non-Banking Financial Intermediaries
(NBFIs) or Investment Institutions.
The term Finance is often understood as being equivalent to money. However, final exactly
is not money; it is the source of providing funds for a particular activity. The word system, in
the term financial system, implies a set of complex and closely connected or inter-linked
Institutions, agents, practices, markets, transactions, claims, and liabilities in the Economy. The
financial system is concerned about money, credit and finance. The three terms are intimately
6

related yet are somewhat different from each other:

Money refers to the current medium of exchange or means of payment.
Credit or loans is a sum of money to be returned, normally with interest; it refers to a
debt
Finance is monetary resources comprising debt and ownership funds of the state,
company or person.

1.1 HISTORICAL BACKGROUND

The Reserve Bank of India Act, 1934 was amended on 1st December, 1964 by the Reserve Bank
Amendment Act, 1963 to include provisions relating to non-banking institutions receiving
deposits and financial institutions. It was observed that the existing legislative and regulatory
framework required further refinement and improvement because of the rising number of
defaulting NBFCs and the need for an efficient and quick system for Redressal of grievances of
individual depositors. Given the need for continued existence and growth of NBFCs, the need to
develop a framework of prudential legislations and a supervisory system was felt especially
to encourage the growth of healthy NBFCs and weed out the inefficient ones. With a view to
review the existing framework and address these shortcomings, various committees were formed
and reports were submitted by them. Some of the committees and its recommendations are given
hereunder:

1. James Raj Committee (1974)

The James Raj Committee was constituted by the Reserve Bank of India in 1974. After studying
the various money circulation schemes which were floated in the country during that time and
taking into consideration the impact of such schemes on the economy, the Committee after
extensive research and analysis had suggested for a ban on Prize chit and other schemes which
were causing a great loss to the economy. Based on these suggestions, the Prize Chits and Money
Circulation Schemes (Banning) Act, 1978 was enacted
7

2. Dr.A.C.Shah Committee (1992):

The Working Group on Financial Companies constituted in April 1992 i.e. the Shah Committee
set out the agenda for reforms in the NBFC sector. This committee made wide ranging
recommendations covering, inter-alia entry point norms, compulsory registration of large sized
NBFCs, prescription of prudential norms for NBFCs on the lines of banks, stipulation of credit
rating for acceptance of public deposits and more statutory powers to Reserve Bank for better
regulation of NBFCs.

3. Khan Committee (1995)

This Group was set up with the objective of designing a comprehensive and effective supervisory
framework for the non-banking companies segment of the financial system. The important
recommendations of this committee are as follows:

i. Introduction of a supervisory rating system for the registered NBFCs. The ratings
assigned to NBFCs would primarily be the tool for triggering on-site inspections at
various intervals.

ii. Supervisory attention and focus of the Reserve Bank to be directed in a comprehensive
manner only to those NBFCs having net owned funds of Rs.100 laths and above.

iii. Supervision over unregistered NBFCs to be exercised through the off-site surveillance
mechanism and their on-site inspection to be conducted selectively as deemed necessary
depending on circumstances.

iv. Need to devise a suitable system for co-coordinating the on-site inspection of the NBFCs
by the Reserve Bank in tandem with other regulatory authorities so that they were
subjected to one-shot examination by different regulatory authorities.

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v. Some of the non-banking non-financial companies like industrial/manufacturing units
were also undertaking financial activities including acceptance of deposits, investment
operations, leasing etc to a great extent. The committee stressed the need for identifying
an appropriate authority to regulate the activities of these companies, including plantation
and animal husbandry companies not falling under the regulatory control of Either
Department of Company Affairs or the Reserve Bank, as far as their mobilization of
public deposit was concerned.

vi. Introduction of a system whereby the names of the NBFCs which had not complied with
the regulatory framework / directions of the Bank or had failed to submit the prescribed
returns consecutively for two years could be published in regional newspapers.

4. Narasimhan Committee (1991)

This committee was formed to examine all aspects relating to the structure, organization &
functioning of the financial system.

These were the committees which founded non- banking financial companies.










9

Chapter 2 - NON-BANKING FINANCIAL COMPANY (NBFC)

MEANING

Non-Banking Financial Companies (NBFCs) play a vital role in the context of Indian Economy.
They are indispensable part in the Indian financial system because they supplement the activities
of banks in terms of deposit mobilization and lending. They play a very important role by
providing finance to activities which are not served by the organized banking sector. So, most
the committees, appointed to investigate into the activities, have recognized their role and have
recognized the need for a well-established and healthy non-banking financial sector.

Non-Banking Financial Company (NBFC) is a company registered under the Companies Act,
1956 and is engaged in the business of loans and advances, acquisition of
shares/stock/bonds/debentures/securities issued by Government or local authority or other
securities of like marketable nature, leasing, hire-purchase, insurance business, chit business but
does not include any institution whose principal business is that of agriculture activity,
industrial activity, sale/purchase/construction of immovable property.

Non-banking institution which is a company and which has its principal business of receiving
deposits under any scheme of arrangement or any other manner, or lending in any manner
is also a non- banking financial company.






DEFINITIONS OF NBFC
10


Non-Banking Financial Company has been defined as:
A Non-Banking Financial Company (NBFC) is a company
a) registered under the Companies Act, 1956,
b) its principal business is lending, investments in various types of
shares/stocks/bonds/debentures/securities, leasing, hire-purchase, insurance business, chit
business, and
c) its principal business is receiving deposits under any scheme or arrangement in one lump sum
or in installments.
However, a Non-Banking Financial Company does not include any institution whose principal
business is agricultural activity, industrial activity, trading activity or sale/purchase/construction
of immovable property. (Section 45 I (c) of the RBI Act, 1934) . One key aspect to be kept in
view is that the financial activity of loans/advances as stated in 45 I ( c) , should be for activity
other than its own. In the absence of this provision, all companies would have been NBFCs.
NBFCS provide a range of services such as hire purchase finance, equipment lease finance,
loans, and investments. NBFCS have raised large amount of resources through deposits from
public, shareholders, directors, and other companies and borrowing by issue of non-convertible
debentures, and so on.
Non-banking Financial Institutions carry out financing activities but their resources are not
directly obtained from the savers as debt. Instead, these Institutions mobilize the public savings
for rendering other financial services including investment. All such Institutions are financial
intermediaries and when they lend, they are known as Non-Banking Financial Intermediaries
(NBFIs) or Investment Institutions:
UNIT TRUST OF INDIA.
LIFE INSURANCE CORPORATION (LIC).
GENERAL INSURANCE CORPORATION (GIC).
2.1 IMPORTANCE OF NBFCs
11


According to RBI Non-Banking Finance Companies (NBFCs) is a constituent of the institutional
structure of the organized financial system in India. NBFCs perform a significant and important
role in our financial system. They facilitate the process of channelising of public savings and
provide better return to the depositors. We are aware that due to liberalization and globalisation,
banking industry and financial sector has gone through many reforms. In the present economic
environment it is very difficult to cater need of society by Banks alone so role of Non Banking
Finance Companies and Micro Finance Companies become indispensable. The activities of non-
banking financial companies

(NBFCs) in India have undergone qualitative changes over the years through functional
specialisation. The role of NBFCs as effective financial intermediaries has been well recognised
as they have inherent ability to take quicker decisions, assume greater risks, and customise their
services and charges more according to the needs of the clients. While these features, as
compared to the banks, have contributed to the proliferation of NBFCs, their flexible structures
allow them to unbundle services provided by banks and market the components on a competitive
basis. The distinction between banks and non-banks has been gradually getting blurred since
both the segments of the financial system engage themselves in many similar types of activities.
At present, NBFCs in India have become prominent in a wide range of activities like hire-
purchase finance, equipment lease finance, loans, investments, etc. By employing innovative
marketing strategies and devising tailor-made products, NBFCs have also been able to build up
a clientele base among the depositors, mop up public savings and command large resources as
reflected in the growth of their deposits from public, shareholders, directors and their companies,
and borrowings by issue of non-convertible debentures, etc.

According to KPMG survey the Indian Non-Banking Finance Company (NBFC) sector has
often been relegated to the shadows, in most discussions on the Indian Financial Services (FS)
industry. Banks, insurance companies and capital market players take centre stage and
invariably, NBFCs attract public attention only during times of crisis. Little attention has been
paid to the silent but effective manner in which NBFCs have spread their operations across the
country. NBFCs have provided financial solutions to sections of society who hitherto were at
12

the mercy of unorganized players for credit and savings products, which were delivered on
economically and socially usurious terms. In recent times, NBFCs are once again in the spotlight for
their perceived strengths and capabilities rather than their problems. While this re-rating ought to
bring cheer to a much maligned sector, a degree of caution needs to be instilled within potential
investors in NBFCs, who need to clearly understand the true drivers of value for finance companies.
This understanding is imperative to enable a better judgment of the intrinsic worth of NBFCs. This
article proceeds to illustrate the key factors responsible for the strong re-rating of the NBFC sector,
as well as discuss the validity of each of these factors, as actual drivers of value. Today, the NBFC
sector is as financially sound as it has ever been. To an extent, this can be attributed to the very
problems affecting the sector which have resulted in the purging of several players, leaving the fittest
few to dominate the landscape. Taking the Reserve Bank of Indias (RBI) definition of NBFC as a
proxy for non-dormant players, a mere 24 NBFCs held 92.7 percent of the total assets of all NBFCs
in 2005-2006. The balance assets, amounting to less than 8 percent of the total, were fragmented
across 439 NBFCs. In addition to this consolidation, at present, NBFCs in general are well-
capitalized with strong parent support. A majority of active NBFCs reported capital adequacy ratios
exceeding 12 percent.


2.2 ROLE OF NBFCs

According to EPW Research Foundation (EPWRF) the Indian economy is going through a
period of rapid `financial liberalisation'. Today, the `intermediation' is being conducted by a
wide range of financial institution through a plethora of customer friendly financial products.
The segment consisting of Non-Banking Financial Companies (NBFCs), such as equipment
leasing/hire purchase finance, loan and investment companies, etc. have made great strides in
recent years and are meeting the diverse financial needs of the economy. In this process, they
have influenced the direction of savings and investment. The resultant capital formation is
important for our economic growth and development. Thus, from both the macroeconomic
perspective and the structure of the Indian financial system, the role of NBFCs has become
increasingly important. The crucial role of Non-Banking Finance Institutions (NBFIs) in
broadening access to financial services, and enhancing competition and diversification of the
financial sector has been well recognized. The main advantages of these companies lie in their
13

ability to lower transactions costs of their operations, their quick decision-making ability,
customer orientation and prompt provision of services. While NBFIs are sometimes seen as akin
to banks in terms of the products and services offered, this is strictly not accurate, as more often,
NBFIs play a range of roles that complement banks. Further, Status Note on NBFCs
NBFIs can add to economic strength to the extent they enhance the resilience of the financial
system to economic shocks. A well developed and properly regulated NBFI sector is thus an
important component of broad, balanced, efficient financial system that spreads risks and
provides a sound base for economic growth and prosperity.

2.3 ON GLOBAL CRISIS

According to CARE: NBFC sector faced significant stresses on asset quality, liquidity and
funding costs due to the global economic slowdown & its impact on the domestic economy.
While all the NBFCs were affected, the impact varied according to the structural features of each
NBFC. Asset-liability maturity (ALM) profiles, type of assets financed and origination /
collection models followed were the primary differentiators within NBFCs. The support
provided by the Reserve Bank of India (RBI) highlighted the explicit acceptance of the systemic
importance of the sector. FY10 was marked by re-aligning of the liability profiles, tightening of
lending norms coupled with closing down of many of the unsecured loan segments. On a
structural basis, the sector is now more robust due to the lessons learned by NBFCs from this
crisis. Profitability is expected to be lower than historical levels due to conservative ALM
management, higher provisioning and avoidance of high yielding unsecured loan segments.
However profits are at the same time expected to be much more stable & less susceptible.





2.4 Factors contributing to the Growth of NBFCs:
14

According to A.C. Shah Committee, a number of factors have contributed to the growth of
NBFCs. Comprehensive regulation of the banking system and absence or relatively lower degree
of regulation over NBFCs has been one of the main reasons for their growth. During recent years
regulation over their activities has been strengthened.
The merit of non-banking finance companies lies in the higher level of their customer
orientation. They involve lesser pre or post-sanction requirements, their services are marked
with simplicity and speed and they provide tailor-made services to their clients. NBFCs cater to
the needs of those borrowers who remain outside the purview of the commercial banks as a
result of the monetary and credit policy of RBI. In addition, marginally higher rates of interest
on deposits offered by NBFCs also attract a large number of depositors
Regulation of NBFCs
In 1960s, the Reserve Bank made an attempt to regulate NBFCs by issuing directions to the
maximum amount of deposits, the period of deposits and rate of interest they could offer on the
deposits accepted. Norms were laid down regarding maintenance of certain percentage of liquid
assets, creation of reserve funds, and transfer thereto every year a certain percentage of profit,
and so on. These directions and norms were revised and amended from time to time.
In 1997, the RBI Act was amended and the Reserve Bank was given comprehensive powers to
regulate NBFCs. The amended Act made it mandatory for every NBFC to obtain a certificate of
registration and have minimum net owned funds. Ceilings were prescribed for acceptance of
deposits, capital adequacy, credit rating and net-owned funds. The Reserve Bank also developed
a comprehensive system to supervise NBFCs accepting/ holding public deposits. Directions
were also issued to the statutory auditors to report non-compliance with the RBI Act and
regulations to the RBI, Board of Directors and shareholders of the NBFCs.


Chapter 3 - Classification of NBFC
15

NBFCs are categorized
a) in terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs,
b) non deposit taking NBFCs by their size into systemically important and other non-deposit
holding companies (NBFC-NDSI and NBFC-ND) and
c) by the kind of activity they conduct.
Within this broad categorization the different types of NBFCs are as follows:
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.
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 crore, 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;
16

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 Finanace
Companies (IFC) can sponsor IDF-NBFCs.
vii. Non-Banking Financial Company - 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. 60,000 or urban and semi-urban household income not
exceeding Rs. 1,20,000;
b. loan amount does not exceed Rs. 35,000 in the first cycle and Rs. 50,000 in
subsequent cycles;
c. total indebtedness of the borrower does not exceed Rs. 50,000;
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 75 per
cent of the total loans given by the MFIs;
17

g. loan is repayable on weekly, fortnightly or monthly instalments at the choice of
the borrower
viii. Non-Banking Financial Company 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 75 percent of its total assets and its
income derived from factoring business should not be less than 75 percent of its gross
income.













Chapter 4 - Norms for NBFC
4.1 Entities Regulated by RBI
18

The Reserve Bank of India regulates and supervises Non-Banking Financial Companies which
are into the business of
(i) Lending
(ii) Acquisition of shares, stocks, bonds, etc., or
(iii) Financial leasing or hire purchase.
The Reserve Bank also regulates companies whose principal business is to accept deposits.
(Section 45I (c) of the RBI Act, 1934)
50-50 Principal Business Criteria
The Reserve Bank has been given the powers under the RBI Act 1934 to register, lay down
policy, issue directions, inspect, regulate, supervise and exercise surveillance over NBFCs that
meet the 50-50 criteria of principal business. The Reserve Bank can penalize NBFCs for
violating the provisions of the RBI Act or the directions or orders issued by RBI under RBI Act.
The penal action can also result in RBI cancelling the Certificate of Registration issued to the
NBFC, or prohibiting them from accepting deposits and alienating their assets or filing a winding
up petition.
4.2 Entities NOT regulated by RBI
Some financial businesses have specific regulators established by law to regulate and supervise
them, such as, IRDA for insurance companies, Securities Exchange Board of India (SEBI) for
Merchant Banking Companies, Venture Capital Companies, Stock Broking companies and
mutual funds, National Housing Bank (NHB) for housing finance companies, Department of
Companies Affairs (DCA) for Nidhi companies and State Governments for Chit Fund
Companies. Companies which do financial business but are regulated by other regulators, are
given specific exemption by the Reserve Bank from its regulatory requirements, such as,
registration, maintenance of liquid assets, statutory reserves, etc. The Chart below gives the
nature of activities and the concerned regulators.
19

These companies have been exempted from registration and other regulations of RBI in order to
avoid dual regulation on them as they are regulated by other financial sector regulators.
4.3 Principal Business Criteria (PBC)
The Reserve Bank regulates and supervises companies which are engaged in financial activities
as their principal business. 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.
Financial activity as principal business is when a companys financial assets constitute more
than 50 per cent of the total assets and income from financial assets constitute more than 50
percent of the gross income. A company which fulfils both these criteria will be registered as
NBFC by RBI. The term 'principal business' is not defined by the Reserve Bank of India Act.
The Reserve Bank 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 and other trading,
manufacturing or industrial companies are not brought under its regulatory jurisdiction.
Interestingly, this test is popularly known as 50-50 test and is applied to determine whether or
not a company is into financial business.
4.4 Residuary Non-Banking Companies (RNBCs)
Residuary Non-Banking Company is a class of NBFCs whose 'principal business' is to receive
deposits, under any scheme or arrangement or in any other manner. These companies are not
into investment, asset financing or lending. Functioning of these companies is different from
that of NBFCs in terms of method of mobilization of deposits and requirement of deployment
of depositors' funds. These companies, however, have now been directed by the Reserve Bank
not to accept any deposits and to wind up their businesses as RNBCs.
There is no ceiling on raising of deposits by RNBCs. Every RNBC has to ensure that the amounts
deposited with it are fully invested in approved investments. In order to secure the interests of
depositor, such companies are required to invest 100 per cent of their deposit liability into highly
20

liquid and secure instruments, namely, Central/State Government securities, fixed deposits with
scheduled commercial banks (SCB), Certificate of deposits of SCB/FIs, units of Mutual Funds,
etc.
Residuary Non-Banking Company cannot forfeit any amount deposited by the depositor, or any
interest, premium, bonus or other advantage accrued thereon.
The minimum interest an RNBC should pay on deposits should be 5% (to be compounded
annually) on the amount deposited in lump sum or at monthly or longer intervals; and 3.5% (to
be compounded annually) on the amount deposited under daily deposit scheme. Interest here
includes premium, bonus or any other advantage, that an RNBC promises to the depositor by
way of return. An RNBC can accept deposits for a minimum period of 12 months and maximum
period of 84 months from the date of receipt of such deposit. They cannot accept deposits
repayable on demand. However, at present, the two RNBCs in existence (Peerless and Sahara
India Financial Corporation Ltd) have 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.
4.5 Eligible / Ineligible Institutions to accept deposits
Deposits mean monies collected in any manner, other than that collected by way of share capital,
contribution of capital by the partners of a partnership firm, security deposit, earnest money
deposit, advance consideration for purchase of goods, services or construction, loans taken from
banks, financial institutions and money lenders and subscription to chit funds. Monies collected
in any manner other than these would be termed as deposits
Banks, including co-operative banks, can accept deposits. Non-bank finance companies, which
have been issued Certificate of Registration by RBI with a specific license 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 Deposit accepting Certificate of
Registration can accept deposits. They can, however, 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
21

Acceptance of Deposits Rules framed by Central Government under the Companies Act can also
accept deposits also upto 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.
The Reserve Bank specifically authorizes an NBFC to accept deposits. This permission is given
after verifying a registered NBFC's performance for three years. That an NBFC is permitted to
raise deposits from public is specifically mentioned in its certificate of registration. In fact as a
matter of public policy, Reserve Bank has decided that only banks should be allowed to accept
public deposits and as such has since 1997 not issued any Certificate of Registration (CoR) for
new NBFCs for acceptance of public deposits.,
Co-operative Credit Society
Co-operative Credit Societies cannot accept deposits from general public. They can accept
deposits only from their members within the limit specified in their bye laws.
Salary Earners Society
These societies are formed for salaried employees and they can accept deposit only from their
own members and not from general public.
Proprietorship/Partnership Concerns
Proprietorship and partnership concerns are un-incorporated bodies. They are prohibited under
the RBI Act 1934 from accepting public deposits.
Check on unauthorised accepting of Deposit
The Reserve Bank gets to know of NBFCs unauthorizedly accepting deposits or engaged in
lending and investment without its authorization, mainly through complaints and grievances
received from the public, from industry sources and from Exception Reports received from
Statutory Auditors of these companies. The Reserve Bank also gets to know about this through
22

market intelligence gathered from newspapers or from information gathered by its own Regional
Offices or any other such sources.
RBI has put in place an institutional mechanism at all its Regional Offices to coordinate between
the financial sector regulators in the form of State Level Coordination Committee (SLCC). The
members of SLCC include, State Government officials from the Home and Law Departments,
Registrar of Companies, Regional Directorate of Ministry of Corporate Affairs, National
Housing Bank, SEBI, Registrar of Chits, and ICAI. The SLCC meets every half year to exchange
information on such unauthorized activities of financial entities.
Reserve Bank of India has deregulated interest rates to be charged to borrowers by financial
institutions (other than NBFC- Micro Finance Institution). The rate of interest to be charged by
the company is governed by the terms and conditions of the loan agreement entered into between
the borrower and the NBFCs. However, the NBFCs have to be transparent and the rate of interest
and manner of arriving at the rate of interest to different categories of borrowers should be
disclosed to the borrower or customer in the application form and communicated explicitly in
the sanction letter etc.
4.6 Depositor Protection Issues
A depositor wanting to place deposit with an NBFC must ensure the following before placing
deposits:
i. That the NBFC is registered with RBI and specifically authorized by the RBI to accept
deposits. The depositor should check the list of NBFCs permitted to accept public
deposits and also check that it is not appearing in the list of companies prohibited from
accepting deposits,
ii. NBFCs have to prominently display the Certificate of Registration (CoR) issued by the
Reserve Bank on its site. This certificate should also reflect that the NBFC has been
specifically authorized by RBI to accept deposits. Depositors must scrutinize the
certificate to ensure that the NBFC is authorized to accept deposits.
23

iii. The maximum interest rate that an NBFC can pay to a depositor should not exceed
12.5%. The Reserve Bank keeps altering the interest rates depending on the macro-
economic environment.
iv. The depositor must insist on a proper receipt for every amount of deposit placed with the
company. The receipt should be duly signed by an officer authorized by the company
and should state the date of the deposit, the name of the depositor, the amount in words
and figures, rate of interest payable, maturity date and amount.
4.7 Collective Investment Schemes (CIS) and Chit Funds
Collective Investment Schemes (CIS)
CIS are schemes where money is exchanged for units, be it time share in resorts, profit from sale
of wood or profits from the developed commercial plots and buildings and so on. Collective
Investment Schemes (CIS) do not fall under the regulatory purview of the Reserve Bank.
SEBI is the regulator of CIS. Information on such schemes and grievances against the promoters
may be immediately forwarded to SEBI as well as to the EOW/Police Department of the State
Government.
Chit Fund
The chit funds are governed by Chit Funds Act, 1982 which is a Central Act administered by
state governments. Those chit funds which are registered under this Act can legally carry on chit
fund business. RBI has prohibited chit fund companies from accepting deposits from the public
in 2009. In case any Chit Fund is accepting public deposits, RBI can prosecute such chit funds.


4.8 NBFC accepting Public Deposits
24

There is a ceiling on acceptance of Public Deposits by NBFCs authorized to accept deposits. An
NBFC maintaining required minimum NOF,/Capital to Risk Assets Ratio (CRAR) and
complying with the prudential norms can accept public deposits as follows:
Category of NBFC having minimum NOF of Rs 200 lakhs Ceiling on public deposit
AFC* maintaining CRAR of 15% without credit rating 1.5 times of NOF or Rs 10
crore whichever is less
AFC with CRAR of 12% and having minimum investment grade
credit rating
4 times of NOF
LC/IC** with CRAR of 15% and having minimum investment
grade credit rating
1.5 times of NOF
* AFC = Asset Finance Company
** LC/IC = Loan company/Investment Company

As has been notified on June 17, 2008 the ceiling on level of public deposits for NBFCs
accepting deposits but not having minimum Net Owned Fund of Rs 200 lakh is revised as under:
Category of NBFC having NOF more than Rs 25 lakh but less than
Rs 200 lakh
Revised Ceiling on
public deposits
AFCs maintaining CRAR of 15% without credit rating Equal to NOF
AFCs with CRAR of 12% and having minimum investment grade
credit rating
1.5 times of NOF
LCs/ICs with CRAR of 15% and having minimum investment grade
credit rating
Equal to NOF
Presently, the maximum rate of interest an NBFC can offer is 12.5%. The interest may be paid
or compounded at rests not shorter than monthly rests.
25

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.
















Chapter 5 - RBI Guidelines for Asset-Liability Management (ALM) system
in NBFCs
26

This note lays down broad guidelines in respect of interest rate and liquidity risks
management systems in NBFCs which form part of the Asset Liability Management
(ALM) function. This is applicable to all NBFCs and Residuary non-banking companies
meeting the criteria of asset base of Rs.100 crores, whether accepting deposits or not, or
holding public deposits of Rs.20 crores or more. Sl.No. Description / Compliance requirement
Comments.
As we are aware, the guidelines for introduction of ALM system by banks and all India financial
intuitions have already been issued by Reserve Bank of India and the system has become
operational. Since the operations of financial companies also give rise to Asset Liability
mismatches and interest rate risk exposures, it has been decided to introduce an ALM system
for the NON- Banking Financial Companies (NBFCs) as well, as part of their overall system for
effective risk management in their various portfolios. A copy of the guidelines for Asset Liability
Management (ALM) system in NBFCs is enclosed.
Is there an Asset Liability Committee (ALCO) consisting of the companys senior
management to decide the business strategy of the NBFC.
1. In the normal course, NBFC'S are exposed to credit and market risks in view of the
asset-liability transportation. With liberalization in Indian financial markets over the last
few years and growing integration of domestic with external markets and entry of
MNC's for meeting the credit needs of not only the corporate but also the retail segments,
the risks associated with NBFC's operations have become complex and large, requiring
strategic management. NBFCs are now operating in a fairly deregulated environment
and are required to determine on their own, interest rates on deposits, subject to the
ceiling of maximum rate of interest on deposits they can offer on deposits prescribed by
the Bank; and advances on a dynamic basis. The interest rates on investments of NBFC's
in Government and other securities are also now market related. Intense pressure on the
management of NBFC's to maintain a good balance among spreads, profitability and
long-term viability. Imprudent liquidity management can put NBFC's earnings and
reputation at great risk.

2. NBFC's need to address these risks in a structured manner by upgrading their risk
27

management and adopting more comprehensive Asset-Liability Management (ALM)
practices than has been done hitherto. ALM, among other function, is also concerned
with risk management and provides a comprehensive and dynamic framework for
measuring, monitoring and managing liquidity and interest rate equity and commodity
price risks of major operators in the financial system that needs to be closely integrated
with the NBFC's business strategy. It involves assessment of various types of risks and
altering the asset-liability portfolio in a dynamic way in order to manage risks.

3. This note lays down broad guidelines in respect of interest rate and liquidity risks
management systems in NBFC's which form part of the Asset-Liability Management
(ALM) function. The initial focus of the ALM function would be to enforce the risk
management discipline i.e. managing business after assessing the risks involved. The
objective of good risk management systems should be that these systems will evolve
into a strategic tool for NBFC's management.

4. The ALM process rests on three pillars:

ALM Information Systems
Management Information Systems
Information availability, accuracy, adequacy and expediency
ALM Organisation
Structure and responsibilities
level of top management involvement
Risk parameters
Risk identification
Risk management
Risk policies and tolerance levels.

5.1 ALM INFORMATION SYSTEMS

28

ALM has to be support by a management philosophy which clearly specifies the risk policies
and tolerance limits. This framework needs to be built on sound methodology with necessary
information system as back up. Thus, information is the key to the ALM process. It is, however,
recognized that varied business profiles of NBFC's in the public and private sector do not make
the adoption of a uniform ALM System for all NBFC's feasible.

NBFC's have heterogeneous organizational structures, capital base, asset sizes management
profile, business activities and geographical spread. Some of them have large number of
branches and agents/ brokers whereas some have unitary offices.

5.2 ALM ORGANISATION

(a) Successful implementation of the risk management process would require strong
commitment on the part of the senior management in the NBFC, to integrate basic
operations and strategic decision making with risk management.
(b) The Asset-Liability Committee (ALCO) consisting of the NBFC's senior management
including Chief Executive Officer (CEO) should be responsible for ensuring adherence
to the limits set by the Board as well as for deciding the business strategy of the NBFC
(on the assets and liabilities sides) in line with the NBFC's budget and decided risk
management objectives.
(c) The ALM Support Groups consisting of operating staff should be responsible for
analyzing, monitoring and reporting the risk profiles to the ALCO. The staff should also
prepare forecasts (simulations) showing the effects of various possible changes in
market conditions related to the balance sheet and recommended the action needed to
adhere to NBFC's internal limits.



5.3 LIQUIDITY RISK MANAGEMENT

Measuring and managing liquidity needs are vital for effective operation of NBFCs. By ensuring
29

an NBFC's ability to meet its liabilities as they become due, liquidity management can reduce
the probability of an adverse situation developing. The importance of liquidity transcends
individual institution, as liquidity shortfall in one institution can have repercussions on the entire
system. NBFCs management should measure not only the liquidity positions of NBFCs on an
ongoing basis but also examine how liquidity requirements are likely to involve under different
assumptions.
Experience shows that assets commonly considered as liquid, like Government securities and
other money market instruments, could also become illiquid when the market and players are
unidirectional.

NBFCs holding public deposits are required to invest up to a prescribed percentage (15% as on
date) of their public deposits in approved securities in terms of liquid asset requirement of
section 45-IB of the RBI Act,1934. Residuary Non-Banking Companies (RNBCs) are required
to invest up to 80% of their deposits in a manner as prescribed in the Directions issued under the
said Act. There is no such requirements for NBFCs which are not holding public deposits. Thus
various NBFCs including RNBCs would be holding in their investments portfolio securities
which could be broadly classifiable as 'mandatory securities' (under obligation of law) and other
'non-mandatory securities'.






Chapter 6 - Commercial Bank versus (v/s) Non-banking Financial
Companies
30

While commercial banks and non-banking financial companies are both financial intermediaries
(middleman) receiving deposits from public and lending them. Commercial bank is called as
Big brother while the NBFC is called as the Small brother. But there are some important
differences between both of them, they are as follows:

No. Commercial Banks. Non Bank Financial companies.
1 Issue of cheques:
In case of commercial banks, a cheque
can be issued against bank deposits.

In case of NBFCs there is no facility to
issue cheques against bank deposits.
2 Rate of interest:
Commercial bank offer lesser rate of
interest on deposits and charge less rate
of interest on loans as compared to
NBFCs.


NBFCs offer higher rate of interest on
deposits and charge higher rate of interest
on loans as compared to Commercial
banks.
3 Facilities provided by them:
Commercial banks can enjoy the benefit
of certain facilities like deposit insurance
cover facilities, refinancing facilities, etc.


NBFCs are not given such facilities.




4


Law which governs them:

Commercial banks are regulated by
Banking Regulation Act 1949 and RBI.

NBFCs are regulated by different
regulation such as SEBI, Companies Act,
National Housing Bank, Unit Fund Act
and RBI.
5 Types of assets:


31

commercial banks hold a variety of
assets in the form of loans, cash credit,
bill of exchange, overdraft etc.
NBFCs specialize in one types of asset.
For e.g.: Hire purchase companies
specialize in consumer loans while
Housing Finance Companies specialize in
housing finance only.


Three relevant parameters for comparison:
1) Capital Adequacy norms,
2) Cost of funds,
3) Asset quality
1. Capital adequacy norms were made applicable to NBFCs in 1998
The norms relating to Capital to Risk-weighted Assets Ratio (CRAR) stipulate that every NBFC
shall maintain a minimum capital ratio comprising Tier I and Tier II capital that shall not be less
than 12% of its aggregate risk-weighted assets and of risk-adjusted value of off-balance sheet
items. The total of Tier II capital, at any point of time, shall not exceed 100% of Tier I capital.
On the other hand, banks have a mandate to maintain capital adequacy ratio of 9% of the risk-
weighted assets. The capital adequacy requirement can be met by both Tier I capital (equity)
and Tier II capital (debt and certain reserves). However, the Tier II capital cannot exceed 100%
of the Tier I capital.
2. Cost of funds narrowing gap
Banks enjoy lower cost of funds than NBFCs, but the gap has been narrowing significantly.
Over the years, NBFCs have been able to cut their operating cost of raising funds, significantly.
Also, by aggressively accessing the capital markets, they have reduced their dependence on
high-cost public deposits, to a large extent.
While NBFCs are not allowed to raise low cost funds (savings, current account deposits), they
also are exempted from the reserve requirements, which banks have to maintain in form of CRR,
32

SLR. Going forward, better managed NBFCs will be able to raise funds at very competitive
rates.
3. Asset quality stringent norms for NBFCs too, in line with banks
Reserve Bank of India (RBI) has prescribed prudential norms for income recognition, asset
classification and provisioning for the advances portfolio of NBFCs, which would propel them
to achieve greater consistency and transparency in their published accounts.











Chapter 7 - The current status of Non- Banking Financial Companies
7.1 Prudential Norms
33

The Reserve Bank put in place in January 1998 a new regulatory framework involving
prescription of prudential norms for NBFCs which deposits are taking to ensure that these
NBFCs function on sound and healthy lines. Regulatory and supervisory attention was focused
on the deposit taking NBFCs (NBFCs D) so as to enable the Reserve Bank to discharge its
responsibilities to protect the interests of the depositors. NBFCs - D are subjected to certain bank
like prudential regulations on various aspects such as income recognition, asset classification
and provisioning; capital adequacy; prudential exposure limits and accounting / disclosure
requirements. However, the non-deposit taking NBFCs (NBFCs ND) are subject to minimal
regulation.
The application of the prudential guidelines / limits is thus not uniform across the banking and
NBFC sectors and within the NBFC sector. There are distinct differences in the application of
the prudential guidelines / norms as discussed below:
i) Banks are subject to income recognition, asset classification and provisioning norms;
capital adequacy norms; single and group borrower limits; prudential limits on capital
market exposures; classification and valuation norms for the investment portfolio; CRR
/ SLR requirements; accounting and disclosure norms and supervisory reporting
requirements.
ii) NBFCs D are subject to similar norms as banks except CRR requirements and
prudential limits on capital market exposures. However, even where applicable, the
norms apply at a rigour lesser than those applicable to banks. Certain restrictions apply
to the investments by NBFCs D in land and buildings and unquoted shares.
iii) Capital adequacy norms; CRR / SLR requirements; single and group borrower limits;
prudential limits on capital market exposures; and the restrictions on investments in land
and building and unquoted shares are not applicable to NBFCs ND.
iv) Unsecured borrowing by companies is regulated by the Rules made under the Companies
Act. Though NBFCs come under the purview of the Companies Act, they are exempted
from the above Rules since they come under RBI regulation under the Reserve Bank of
India Act. While in the case of NBFCs D, their borrowing capacity is limited to a
34

certain extent by the CRAR norm, there are no restrictions on the extent to which NBFCs
ND may leverage, even though they are in the financial services sector.

7.2 Financial Linkages between Banks and NBFC
Banks and NBFCs compete for some similar kinds of business on the asset side. NBFCs offer
products/services which include leasing and hire-purchase, corporate loans, investment in non-
convertible debentures, IPO funding, margin funding, small ticket loans, venture capital, etc.
However NBFCs do not provide operating account facilities like savings and current deposits,
cash credits, overdrafts etc.
NBFCs avail of bank finance for their operations as advances or by way of banks subscription
to debentures and commercial paper issued by them.
Since both the banks and NBFCs are seen to be competing for increasingly similar types of some
business, especially on the assets side, and since their regulatory and cost-incentive structures
are not identical it is necessary to establish certain checks and balances to ensure that the banks
depositors are not indirectly exposed to the risks of a different cost-incentive structure. Hence,
following restrictions have been placed on the activities of NBFCs which banks may finance:
i) Bills discounted / rediscounted by NBFCs, except for rediscounting of bills discounted by
NBFCs arising from the sale of
a) Commercial vehicles (including light commercial vehicles); and
b) Two-wheeler and three-wheeler vehicles, subject to certain conditions;
c) Investments of NBFCs both of current and long term nature, in any company/entity by
way of shares, debentures, etc. with certain exemptions;
ii) Unsecured loans/inter-corporate deposits by NBFCs to/in any company.
iii) All types of loans/advances by NBFCs to their subsidiaries, group companies/entities.
iv) Finance to NBFCs for further lending to individuals for subscribing to Initial Public
Offerings (IPOs).
35

v) Bridge loans of any nature, or interim finance against capital/debenture issues and/or in the
form of loans of a bridging nature pending raising of long-term funds from the market by way
of capital, deposits, etc. to all categories of Non-Banking Financial Companies, i.e. equipment
leasing and hire-purchase finance companies, loan and investment companies, Residuary Non-
Banking Companies (RNBCs).
vi) Should not enter into lease agreements departmentally with equipment leasing companies as
well as other Non-Banking Financial Companies engaged in equipment leasing.

7.3 Structural Linkages between Banks and NBFCs
Banks and NBFCs operating in the country are owned and established by entities in the private
sector (both domestic and foreign), and the public sector.
Some of the NBFCs are subsidiaries/ associates/ joint ventures of banks including foreign
banks, which may or may not have a physical operational presence in the country. There has
been increasing interest in the recent past in setting up NBFCs in general and by banks, in
particular.
Investment by a bank in a financial services company should not exceed 10 per cent of the banks
paid-up share capital and reserves and the investments in all such companies, financial
institutions, stock and other exchanges put together should not exceed 20 per cent of the banks
paid-up share capital and reserves.
Banks in India are required to obtain the prior approval of the concerned regulatory department
of the Reserve Bank before being granted Certificate of Registration for establishing an NBFC
and for making a strategic investment in an NBFC in India. However, foreign entities, including
the head offices of foreign banks having branches in India may, under the automatic route for
FDI, commence the business of NBFI after obtaining a Certificate of Registration from the
Reserve Bank.
NBFCs can undertake activities that are not permitted to be undertaken by banks or which the
banks are permitted to undertake in a restricted manner, for example, financing of acquisitions
36

and mergers, capital market activities, etc. The differences in the level of regulation of the banks
and NBFCs, which are undertaking some similar activities, gives rise to considerable scope for
regulatory arbitrage. Hence, routing of transactions through NBFCs would tantamount to
undermining banking regulation.
This is partially addressed in the case of NBFCs that are a part of banking group on account of
prudential norms applicable for banking groups.
















Chapter 8- Findings
37

8.1 NBFCs future in India
The passage of the Banking Laws Amendment Bill 2011, has put NBFC stocks in the spotlight.
This is true especially of those companies who are actively seeking a banking license. One more
factor that has added to the enthusiasm are the recent recommendations by the RBI for the NBFC
sector. A panel headed by the former deputy governor of RBI, Usha Thorat has made certain
recommendations which will tighten the ropes on the NBFC sector as a whole but ensure a better
and safer functional environment. Here are some recommendations which will help in
strengthening the NBFC sector going forward:
Tier -1, or core capital of NBFCs, has been pegged at 12% from 7.5% now.
The new provisioning rules will be 90 days instead of 180 days.
The risk weights for NBFCs not sponsored by banks could be raised to 150% for capital
market exposures and 125% for commercial real estate (CRE) exposures.
A minimum asset size of over Rs 50 crore is required for registering a new NBFC.
The panel has stipulated the maintenance of a statutory liquidity ratio of 15% of
aggregate deposits for deposit accepting NBFCs, besides, making applicable ALM
guidelines to those holding deposit of Rs 20 crore and above.
Existing NBFCs will be given a period of 2 years with milestones for achieving the
minimum threshold of Rs 25 crore of financial assets.
All registered NBFCs, both deposit taking and non-deposit taking, should maintain high
quality liquid assets in cash, bank deposits available within 30 days, money market
instruments maturing within 30 days, investment in actively traded debt securities.
Any change in shareholding of 25%, or more, will have to be approved by the RBI
besides a suitable tax deduction on provisions.
Financial entities having an asset size of Rs 1000 crore or above, holding financial assets
which constitute 50% of the total assets OR generate financial income which as a
proportion of the gross income is at least 50%, will need to be registered and regulated
by the Bank.
As per the extant regulatory framework, the Bank has stipulated the maintenance of a
statutory liquidity ratio of 15% of aggregate deposit for deposit accepting NBFCs,
38

besides, making applicable ALM guidelines to those holding deposit of Rs 20 crore and
above.
If we look at the last of the salient feature mentioned above, it states that entities having more
than Rs 1000 crore or more in assets should be regulated. The impact this recommendation will
have is that, going forward it will ensure that only serious players remain in the business. The
CAR which is pegged at 12% will address the regulatory arbitrage between banks and NBFCs.
By addressing the statutory liquidity ratio the panel has ensured that the cash and liquidity gaps
are addressed well.
At present, as per RBI data there are 12371 registered NBFCs as of November 2012. Out of
these, 12104 is non-deposit taking NBFCs while 265 take deposits from retail investors. Going
forward, the industry may witness some kind of a consolidation that will see many small players
with regional reach being acquired by the larger ones.

8.2 Conversion of NBFCs into private sector banks
An NBFC with a good track record desiring conversion into a bank should satisfy the following
criteria:
The NBFC should have a minimum net worth of Rs.200 crore in its latest balance sheet
which will stand increased to Rs.300 crore within three years from the date of
conversion.
The NBFC should not have been promoted by a large Industrial House or
owned/controlled by public authorities, including Local, State or Central Governments.
The NBFC should have acquired a credit rating of not less than AAA rating (or its
equivalent) in the previous year.
39

The NBFC should have an impeccable track record in compliance with RBI
regulations/directions and in repayment of public deposits and no default should have
been reported.
The NBFC desiring conversion into bank should have capital adequacy of not less than 12 per
cent and net NPAs of not more than 5 per cent.
The NBFC on conversion to a bank will have to comply with Capital Adequacy Ratio
and all other requirements such as lending to priority sector, promoters contribution,
lock-in period for promoters stake, dilution of promoters stake beyond the minimum,
NRI and foreign equity participation, arms length relationship, etc. as applicable to
banks.















40

Conclusion
NBFCs have been playing a very important role both from the macroeconomic perspective and
the structure of the Indian financial system. NBFCs are the perfect or even better alternatives to
the conventional Banks for meeting various financial requirements of a business enterprise. They
offer quick and efficient services without making one to go through the complex rigmarole of
conventional banking formalities.
However to survive and to constantly grow, NBFCs have to focus on their core strengths while
improving on weaknesses. They will have to be very dynamic and constantly endeavour to
search for new products and services in order to survive in this ever competitive financial
market.
Since NBFCs have been kept outside the purview of SARFAESI Act, a reform in this area is
quite urgently needed. A suitable legislative amendment extending the operation of the said Act
to NBFCs too would go a long way in fortifying the faith of the investors and which in turn
would greatly contribute to the growth of this Sector. The coming years will be very crucial for
NBFCs and only those who will be able to face the challenge and prove themselves by standing
the test of time will survive in the long run.
It is encouraging that the NBFC sectors importance is finally being acknowledged across FS
market constituents as well as the regulator. However, the importance attached to the sector is
often transcending into misplaced exuberance. Over simplified and vague drivers for NBFC
valuations such as strategic fit and customer base, can never substitute dispassionate business
analytics. A rational assessment of the intrinsic values of NBFCs factoring issues such as past
performance, structural weaknesses of the sector (for instance funding disadvantages), along
with an identification of real capabilities are essential to ensure that the equilibrium between
price paid and value realized is reached to the extent possible. In the absence of this, India is
sure to witness the re-opening of the NBFC horror story albeit with a new chapter on the erosion
of NBFC investment values affecting investors across categories.

Ratings of the NBFCs whose profitability and asset quality was affected due to the crisis were
supported by their strong parentage. Based on the parental strength some players have raised
further equity and also managed to re-align their business models while maintaining their
solvency. overall positive outlook on the sector due to the better ALM position, focus on
relatively safer asset classes and the demonstrated acceptance of the sector as systemically
important by the regulator. The crisis has imposed an overall sense of caution even for the newer
entrants in the market. Also going forward higher capital adequacy norms will put a fairly
conservative cap on the leverage of the sector thereby improving the credit profile of many
entities (NBFC-NDSI)