N B FC S A N D T H E I R R EG U L AT I O N

NBFIs facilitate bank-related financial services, such as investment, risk

pooling, contractual savings, market brokering, etc. and also offer other non-
banking services.

The Reserve Bank of India Amendment Act 1997 defines Non-Banking

Finance Company as:
 A financial institution which is a company registered under the
companies Act, 1956/2013;
 A non-banking institution which is a company and whose principal
business includes receiving of deposits under any
scheme/arrangement/in any other manner or lending in any manner;
 Other non-banking institutions or class of institutions as the RBI may
with the previous approval of the Central Government specify.
 The definition excludes financial institutions as well as institutions which
carry on agricultural operations as their principal business.
Different types of NBFCs are as follows(list is not exhaustive):
 Investment Company (IC): IC means any company which is a financial
institution carrying on as its principal business the acquisition of securities
(invest mostly in group companies).
 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 ₹ 300 crores,
c) has a minimum credit rating of ‘A ‘or equivalent d) and a Capital to
Risk-Weighted Assets Ratio (CRAR) of 15%.
 Systemically Important Core Investment Company: It is an NBFC
carrying on the business of acquisition of shares and securities which
satisfies certain conditions stipulated by the RBI.
 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. The IDF-NBFC raise resources
through the issue of Rupee or Dollar denominated bonds of minimum 5-
year maturity. Only Infrastructure Finance Companies (IFC) can sponsor
IDF-NBFCs.
 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 with certain conditions. (Self help
group)
 Regulation of NBFCs

Registration:
Non-banking Financial company can commence or carry on business of a non-
banking financial institution only after obtaining a certificate of registration
from the RBI and having a Net Owned Funds of ₹ 25 lakhs (₹ Two crore since
April 1999). However to avoid the problem of dual regulation, certain
categories of NBFCs which are regulated by other regulators are exempted
from the requirement of registration with RBI viz. Venture Capital
Fund/Merchant Banking companies/Stock broking companies registered with
SEBI, Insurance Company holding a valid Certificate of Registration issued by
IRDA, Nidhi companies as notified under the Companies Act, 1956, Chit
companies as defined in the Chit Funds Act, 1982,Housing Finance Companies
regulated by National Housing Bank, Stock Exchange or a Mutual Benefit
company.

Hence, these sectoral regulators regulate respective entities and RBI does not
regulate all the NBFCs.

Systemically Important NBFC – Asset size is 500CR or more

Others are not systemically important NBFCs

Powers of RBI over NBFCs

 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.
 The Reserve Bank can penalize NBFCs for violating the provisions of the
RBI Act or the directions or orders issued by RBI under the 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 etc.
 It is illegal for any financial entity to make a false claim of being
regulated by the Reserve Bank to mislead the public to collect deposits.
They will be liable for penal action under the Indian Penal Code in such a
scenario.
→NBFC which are accepting deposits have similar norms related to SLR, CRAR
norms that are applicable to banks

 FDI:

As per the changed FDI policy 2017, under section 47 of the Foreign Exchange
Management Act, 100 percent FDI through automatic route is permitted for
NBFCs.

NBFC crisis and its domino effect on Indian economy

The most important thing to do now is not to shock the system, give
confidence to the industry, bring liquidity into the system and reduce interest
rates.
T V Mohandas Pai | January 31, 2020 | Updated 18:54 IST

There is a decline in consumption which has led to a decline in the GDP growth
(Effective Demand drops => shelf life increases => inventory holding cost
increases => cost of insurance increases => quality drops for some products
and cannot be sold => environment rules come into play for disposal of those
stocks => Working Capital cycle increases => More bank/non-bank funding
(CA-CL increases => recessionary impact). There is no recession because
recession means two-quarters of negative growth. We don't have negative
growth, we have a 5% growth rate. We have to go back to September 2018
when the IL&FS scandal happened.

When it happened those who got caught were debenture holders of the
company-- pension fund (retail people’s contribution), mutual fund (retail
people’s contribution) and the lenders from the NBFCs (borrow from
financial institutions, banks, other entities through issue of paper) who had
lent to IL&FS. 40% of the incremental consumer financing last year was done
by the NBFCS, not banks. 25 - 30% of the NBFC money was coming through
funding or Mutual Funds spots.

Mutual Funds used to buy their (NBFCs) papers for 90-120 days (CPs) and give
them money and they used to roll over. Second, they used to place bonds or
mutual fund spots in the market. 45-50% of the NBFC financing was coming
from Mutual funds at that time. But, because mutual funds like DSP, HDFC and
others were hit by the IL&FS scam, they stopped their funding to the NBFC.
When they stopped funding, the NBFCs had to release the money to pay back
whatever is maturing.

Also read: RBI bans NBFCs from charging loan foreclosure penalties from
individual borrowers

The exposure to the NBFC sector came down hence IL&FS happened in the
quarter of October-Dec, 2018 saw a decline in consumption and decline in its
financing and subsequently, the GDP growth rate in Jan-March came down to
5.6 %. It saw the impact there. In the month of October, November and
December, late former finance minister Arun Jaitley was not well, so there was
not much of action happening. RBI was not even thinking about it because it
was undergoing some changes.

In the month of January, February and March we had new a Finance Minister
who was busy with the budget. Then the government went to election mode.
In the months of April, May and June (2019) nothing happened, and after the
NDA2 government was formed they had to make the budget and then the
Kashmir problem happened, which kept the government occupied further. We
had no action from the government all this while.

The market representatives went to meet the government to talk to it about

the liquidity crisis they are faced with all the time. But, the RBI went on
reducing interest rate saying that there was liquidity in the banking system.
Also read: NBFC crisis: Govt issues guidelines for Rs 1-lakh crore partial
guarantee scheme to revive sector

The problem was that lending to consumers was not done by the banks, it was
done by the NBFCs who from September last year till now (2019) have
withdrawn Rs 3 lakh crore from the market, which means about Rs 1.5 to 2
lakh crore has been paid back by them towards their liabilities.

Reliance Capital itself paid back Rs 40,000 crore and DHFL also paid back Rs
40,000 crore and whatever money they were lending they were not getting
back to lend further. So there has been a liquidity squeeze in the market.

Now how did liquidity squeeze manifest itself? It manifested itself in the lack of
purchase of cars and autos, purchase of real estate and construction by real
estate companies (commercial real estate loan (funding to developers)
and retail (direct lending for buying houses). Around 95% of vehicles may
have been financed by the NBFCs or by agents.

How does it work?

You go to a dealership wanting to buy a car and seek finance for it. The NBFC
official grants you a loan immediately. Where you can get a loan instantly by an
NBFC, seeking a loan from a bank takes around 20 days. (Convenience) Hence,
most of the financing was done by the NBFCs which they stopped. Due to this
consumer car loans came down and car purchases also fell subsequently.
(inventory holding increased)

Secondly, the same thing happened in the case of two-wheelers. The two-
wheeler companies in many parts of India were well-financed but their sales
too were affected as the NBFCs were not financed adequately.

Thirdly, the real estate companies were getting money largely from the NBFCs
because they were not getting any lending from the banks. The NBFCs were
giving these companies funds to start new projects, construction and financing
etc. However, after RERA, they could not divert the money given by house
owners hence, they depended on NBFCs even for their working capital
requirements (escrow account is compulsory and funds can be spent only for
the project for which it is taken).

The real estate companies are now stuck because the projects are not going
ahead and subsequently shutting down due to the NBFC crisis. The realtors are
not able to complete the projects.

Also read: Only 6 out of 28 NCD issues of NBFCs fully subscribed between
Sept 2018 to June 2019

The NBFCs also finance car dealers and a part of the supply chain which has
come down because the cars are not selling. As a result, the dealers are also
shutting shop as they are not able to store the inventory and make money.
They are also not getting enough financing to stock the cars and without
stocking cars you cannot sell them off. Hence, there is a chain.

What has been the impact on auto sector?

According to a Kotak Mahindra report, the total auto and car sales figure in the
country is about Rs 5 lakh crores. The monthly sales may be around Rs 40,000
crore. Now a 20% decline in the Rs 5 lakh crore sales figure would sum up to
about Rs 1 lakh crore which is financing.

Hence, there is negative growth. Although, around Rs 60,000 crore financing

has come back, out of which dealership may be around Rs 10,000 to Rs 15,000
crore and the NBFC sector has built a Rs 1 lakh crore liquidity in its balance
sheet. Liquidity in the balance sheet means the NBFCs keep the money to pay
back their liabilities.

They are not lending but they are paying back their liabilities. And since they
are paying back their liabilities, there is a problem. Since the NBFCs are
building the liquidity to pay back their liabilities so that they do not default,
the money is not going to the market. (Rollover has reduced)

What should be done?

The government has to come out with a scheme where the NBFCs can sell their
assets and raise liquidity but if they sell goods, their balance will shrink and
they will have to put up margins. The better thing is to find out which are the
good NBFCs to which banks can give good credit lines to lend, particularly to
the auto and real estate sector where they can put up 25% of their money and
get 75% in return. The banks can explore receivables so that the money that
comes can be used to payback the bank loans and not diverted.

We need liquidity to be pumped up at the point of lending which is an NBFC.

Now, that is not happening as the SBI Chairman Rajnish Kumar said very clearly
that he has Rs 1 lakh crore surplus money which he is not ready to lend.
However, the problem is that he cannot lend. He is scared to do so because he
has to lend to the NBFCs only and has to find out which ones to lend to and
give the lines of credit to. That's how it has to be done.

What we see is a liquidity squeeze in the economy. Consumption has come

down because of this. There is not enough liquidity in the system. At present,
the total bank lending in the system is Rs 97 lakh crore out which the total
NBFC book is Rs 24 lakh crore.

The RBI should monitor the total lending including NBFCs apart from the banks
on a fortnightly basis. The apex bank only monitors banks currently. It should
also oversee the NBFCs and look at the system liquidity including both NBFCs
and banks so that the borrowings can pick up in the economy. This, however, is
a challenge the government has to address urgently. Unless the NBFCs are
given the lines of credit, they are not going to pick up pace.

Talking about the Iron & Steel industry, the auto and real estate sectors are the
biggest consumers of building material like cement which is used by a lot of
companies and creates a lot of jobs. Hence, jobs could also come down in
other sectors of the economy.

The situation is such that now even the consumption of the FMCG products is
coming down but that's not a valid argument because that is seasonal. Soumya
Kanti, Chief Economic Advisor, SBI has written an article where he has given
data to explain all this. However, the bigger problem is the big consumption
items and that is where the government has to apply its mind.
But first, the government needs to solve the liquidity problem. Secondly, what
it has to do is to assure the industries that it is not going to shock them
anymore. Industries do not have the capacity to take any kind of shock
anymore. They were shocked with demonetisation, GST, RERA and IBC and
now they got the NBFC liquidity shock. Most industries are giving up as they
don't know what to do as nobody is listening to them.

On the top of all this is tax terrorism which is a very big thing because in the
last 5 years, the tax disputes in NDA 1 have doubled around Rs 3.5 lakh crore
to 6 lakh crore. Tax authorities are losing 80% of the cases at the appeal stage
which are all found to be bogus claims. Why bogus claims because the targets
are too high. The government couldn't meet the target last year and the target
for this year is very high.

When the economy is growing at 8% including inflation, expecting the tax

collection to go up by 16-17% is difficult. Hence, the tax authorities go ahead
and extort people as they are under pressure to achieve their targets.

The Central Board of Direct Taxes (CBDT) terrorises tax officers who then turn
to the citizens. This is becoming a big problem everywhere. Refunds in the tax
system are not coming through, GST refunds are not coming and on top of that
everybody wants to meet their targets.