ROLE OF NON BANKING FINANCIAL INSTITUTIONS

A Minor Project Report

Submitted in partial fulfillment of the requirements for BBA( Banking and Insurance) Semester III, Programme of G.G.S Indraprastha University, Delhi

Submitted by Kanika Sehgal BBA (Banking and Insurance)- Semester III Enrolment no- 00412201809

Delhi College Of Advanced Studies Shanker Garden, Vikaspuri

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New Delhi- 110008 Declaration

I hereby declare that the minor project report, entitled ROLE OF NON BANKING FINANCIAL INSTITUTIONS , is based on the original study and has not been submitted earlier for any degree or diploma of any institution/university. The work of other author(s), whenever used, has been acknowledged at appropriate place(s).

Place: signature Date:

Candidates

Name: Enrolment no:

Countersigned: Name: Supervisor: Delhi College Of Advanced Studies

Preface
This project has been a great experience to Kanika Sehgal. This work would not have been possible without the help, corporation, constructive suggestion and well wishes of my people. I would like to thanks all of them, as I mention a few here. I own my profound respect to Ms. Priyanka Rao, my project guide and express my deep sense of gratitude and indebtedness for their inspirations, valuable and scholary guidance, imperative suggestion and personal attention at each stage of the work. Their gamut of knowledge dedication towards research, exemplray devotion and trust towards me has been unique and is the prime key behind the success of this project. This personality to work with her, as I will forever cherish the deep interaction I had with her. Finally, I am most grateful to my parents for their moral support, blessings and for being an immense source of inspiration for me all through my life.

Introduction
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Non-bank financial companies (NBFCs) are financial institutions that provide banking services without meeting the legal definition of a bank, i.e. one that does not hold a banking license. Operations are, regardless of this, still exercised under bank regulation. However this depends on the jurisdiction, as in some jurisdictions, such as New Zealand, any company can do the business of banking, and there are no banking licenses issued. Services provided Non-bank institutions frequently :

act as suppliers of loans and credit facilities supporting investments in property trade money market instruments fund private education provide wealth management such as managing portfolios underwrite stock and shares, TFCs and other obligations provide retirement planning advise companies in merger and acquisition prepare feasibility, market or industry studies for provide discounting services e.g., discounting of

of stocks and shares

companies

instruments

However they are typically not allowed to take deposits from the general public and have to find other means of funding their operations such as issuing debt instruments.

Regulation
For European NBFCs the Payment Services Directive (PSD) is a regulatory initiative from the European Commission to regulate payment services and payment service providers throughout the European Union (EU) and European Economic Area (EEA). The PSD describes which type of organizations can provide payment services in Europe (credit institutions (i.e. banks) and certain authorities (e.g. Central Banks, government bodies), Electronic Money Institutions (EMI), and also creates the new category of Payment Institutions). Organisations that are not credit institutions or EMI, can apply for an authorisation as Payment Institution in any EU country of their choice (where they are established) and then passport their payment services into other Member States across the EU.

Classification

Depending upon their nature of activities, non- banking finance companies can be classified into the following categories:

Development finance institutions

Leasing companies

Investment companies

Modaraba companies

House finance company

Venture capital companies

Discount & guarantee houses

A non-bank financial institution (NBFI) is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFIs facilitate bankrelated financial services, such as investment, risk pooling, contractual savings, and market brokering.[1] Examples of these include insurance firms, pawn shops, cashier's check issuers, check cashing locations, currency exchanges, and microloan organizations. Alan Greenspan has identified the role of NBFIs in strengthening an economy, as they provide "multiple alternatives to transform an economy's savings into capital investment [which] act as backup facilities should the primary form of intermediation fail.

In Asia
According to the World Bank, approximately 30% of total assets South Korea's financial system was held in NBFIs as of 1997.[6] In this report, the lack of regulation in this area was claimed to be one reason for the 1997 Asian Financial Crisis.

In the United States

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In 1996, the NBFI sector accounted for approximately $200 billion in transactions in the United States

Scope Of The NBFCs

Non-Banking Financial Companies (NBFCs) Recent years have witnessed significant increase in financial intermediation by the NBFCs. This is reflected in the proposal made by the latest Working Group on Money Supply for a new measure of liquidity aggregate incorporating NBFCs with public deposits worth Rs.20 crores and above for regulatory purposes. NBFCs have been classified into 3 categories:

Those accepting public deposits, those not accepting public deposits but engaged in

financial business, and

crores investment companies with 90 per cent of their total

assets

as investments in the securities of their group/holding/subsidiary companies. The focus of regulatory attention is on NBFCs accepting public deposits. As per the NBFC Acceptance of Public Deposits (Reserve Bank ) Directions, 1998, the quantum of public deposit in respect of NBFCs was linked to credit rating from an approved agency so as to enable the depositor to make informed decision. The NBFCs were also encouraged to broad-base their resources through borrowings from banks and financial institutions, inter-corporate deposits/ loans, secured bonds/debentures, etc., which were exempted from the definition of public deposit. However, the Associations of NBFCs and the apex trade bodies brought to the notice of both the Government and the RBI the problem of asset-liability mismatches caused by frequent downgrading of the credit ratings of NBFCs and the consequent reduction in quantum of permissible public deposits. They also suggested that smaller NBFCs could be exempted from the requirement of credit rating for having public deposits up to a particular limit while larger NBFCs could be allowed higher limits of public deposits subject to minimum investment grade credit rating and higher capital adequacy requirements. The Task Force on NBFCs appointed by the Government of India submitted its report in October, 1998, which recommended rationalization of regulations for NBFCs, improvement of the legislative framework for protecting the interests of depositors and development of NBFCs on sound and healthy lines.

The modified regulatory framework for NBFCs based on the recommendations made by the Task Force provides for the following:

NBFCs with net owned fund (NOF) of less than Rs. 25 lakh

(with or without credit rating) are not entitled to accept public deposits (as hitherto).

The unrated and underrated NBFCs in the category of loan and

investment companies, irrespective of their NOF and CRAR, are not entitled to accept public deposits (as hitherto).

NBFCs in the category of equipment leasing and hire purchase

finance companies with NOF of Rs. 25 lakh and above as well as minimum investment grade credit rating can accept public deposits four times of NOF provided they have CRAR of not less than 10 per cent as on 31.3.1998 and shall have CRAR of not less than 12 per cent as on 31.3.1999.

NBFCs in the category of loan and investment companies with

NOF of Rs. 25 lakhs and above as well as minimum investment grade credit rating can accept public deposits not exceeding 1.5 times of NOF provided they have CRAR of 15 per cent or above with immediate effect.

NBFCs in the category of equipment and hire purchase

companies should endeavour to increase their CRAR to 15 per cent as early as possible. NBFCs in the category of loan and investment companies which do not have minimum CRAR of 15 per cent as on date but otherwise comply with all the prudential norms and

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Have credit rating of AAA may accept or renew public

deposits up to the level outstanding as at the close of business on

December 18, 1998 or 1.5 times of the NOF whichever is

more subject to the condition that they should attain CRAR of 15 per cent by March 31, 2000 and bring down the excess deposits, if any, by December 31, 2001 and

have credit rating of AA/A may accept or renew public

deposits as per the existing provisions of Directions (0.5/1.0 time of their NOF) Major Recommendations of the Task Force on NBFCs The Task Force on Non-banking Finance Companies (NBFCs) submitted its report on October 28, 1998. The major recommendations are as under:

The rising number of defaulting NBFCs and the need for

a quick redressal system call for change in the existing legislative and regulatory framework for NBFCs.

Extension of the period for attaining minimum Net

Owned Funds (NOF) beyond three years (January 2000) should be made conditional on adequate steps having been taken by the concerned NBFCs. Also, the minimum prescribed NOF of Rs. 25 lakh be considered for upward revision.

The Reserve Bank of India should draw up a time bound and keep States informed of registration

programmed for disposal of applications for registration of NBFCs granted/rejected in respect of NBFCs in the respective States.
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Higher CRAR of 15 per cent for NBFCs seeking public

deposits without credit rating be prescribed by RBI, as against existing 12 per cent for rated NBFCs.

Ceilings for exposures to real estate sector and

investment in capital market, especially unquoted shares, be prescribed by the Reserve Bank of India.

The Reserve Bank of India may stipulate 25 per cent of

reserves of NBFCs to be invested in marketable securities in addition to SLR securities already held by them

Investment in India - Banking - Financial Sector

Financial sector and banking Continuing reforms in the banking sector were aimed at improving the efficiency and financial strength of commercial banks. Net profit of commercial bank Net profits of scheduled commercial banks rose sharply from dols 24 million in 1995-96 to1.2 billion in 1996-97, an increase of 387 percent. Much of the increase was due to marking government securities to market prices, following significant declines in prevailing interest rates. Three public sector banks received capital restructuring loans from the government totaling dols 68 million in 1997-98, enabling those banks to reach a capital adequacy
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ratio

of

percent.

Autonomy package In November 1997, the Indian government announced an autonomy package for financially stronger public sector banks to help them compete more efficiently in a liberalized environment and to accelerate credit creation. Eleven banks qualified forth the autonomy package.

The criteria for administrative autonomy are:

capital adequacy of at least 8 percent; net non-performing assets of less than 9 percent; minimum net owned funds of more than dols 2.5 million (Rs and a net profit for the last three years. Banks that meet the four criteria will be given operational

100 crores);

freedom in most administrative matters.

RBI norms for NBFCs

The RBI has relaxed its norms for non-bank finance companies (NBFCs) with regard to taking deposits from the public. It has allowed equipment leasing and hire-purchase finance companies with investment-grade ratings to access public deposits, raised the ceiling on the amount of public deposits these NBFCs may accept and extended the deadline for full compliance on its regulations by two years, until December 2000. The financial viability of many NBFCs
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continues to be of concern to the government and RBI regulators. There is considerable consolidation activity in this sector as NBFCs adjust to the tougher standards they are being required to meet.

WTO negotiations on financial services:

India made a number of new commitments in the WTO Financial Services agreement concluded in Geneva in December 1997. These modest commitments will come into effect in jan1999. Major features of India's offer include:

granting most favored nation (MFN) status to all foreign dropping a previous MFN exemption on banking; granting 12 new bank branch licenses per year to foreign fitting the 10 percent ceiling on reinsurance by Indian allowing 51 percent foreign investment in financial

banks and financial services companies (including insurance),

banks (up from the present commitment of 8 per year); insurance companies;

consulting, factoring, leasing, venture capital, merchant banking and non-banking finance companies.

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Insurance sector:
In addition, 49 percent foreign equity will be allowed in stock brokerages; and foreign financial services companies, including banks, will be allowed to invest venture capital in India up to 51 percent Legality As part of his 1998-99 budget presentation to Parliament on June 1, the Finance Minister announced his intention to open the insurance sector to competition from Indian private sector companies. He also proposed to convert Insurance Regulatory Authority (IRA) into an independent, statutory body. Both actions will require Parliament to adopt new legislation, including amendments to two Acts which reserve life insurance and general insurance for government owned monopolies. Foreign insurance companies: The government has not yet clarified whether foreign insurance companies will be allowed to participate as minority joint venture partners when the sector is opened up. Many observers believe that the government will allow foreign participation to compensate for a
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of

company's

equity/Insurance.

lack of capital and expertise among likely participants in the Indian private sector.

LIC and GIC:

The government has granted substantial operational autonomy to the Life Insurance Corporation (LIC) and General Insurance Corporation (GIC), both of which have monopoly positions in their respective sectors under current law. LIC can now appoint fund managers/investment advisors both in India and abroad and is allowed to invest 60 percent of its insurance funds in approved market investments. New measures also provide more lenient investment norms, permission to trade in securities subject to prescribed limits and more delegation of operational powers to the four general insurance subsidiaries of GIC.

Capital Account Convertibility: The Tara pore Committee report on Capital Account Convertibility, released in June 1997, recommended a three-year time-frame for complete capital account convertibility of the rupee. The Committee set out the following preconditions for full convertibility:

reduction of the fiscal deficit to 3.5 percent of GDP by an average inflation rate of 3-5 percent for the period

1999-2000;

1997-2000;
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complete deregulation of all interest rates in 1997-98; a reduction in the cash reserve ratio (CRR) to about 3 reduction in the level of banks' non-performing assets

percent;

from an estimated 13.7 percent of total loans in March 1997 (actual NPAswere 17.8 percent of total loans) to 5 percent in 1999-2000; and

the adoption of a transparent exchange rate policy by

2000. There is a general consensus in government and business community that India should not move to capital account convertibility until these conditions have been met, lest India suffer the kind of currency crisis which hit other Asian countries in 1997.

Financial performance of non banking finance companies in India

Introduction The financial system comprises of financial institutions, financial instruments and financial markets that provide an effective payment and credit system and thereby facilitate channelizing of funds from savers to the investors of the economy. In India considerable growth has taken place in the Nonbanking financial sector in last two decades. Over a period of time they are successful in rendering a wide range of services. Initially
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intended to cater to the needs of savers and investors, NBFCs later on developed into institutions that can provide services similar to banks. In India several factors have contributed to the growth of NBFCs. They provide tailor made services to their clients. Comprehensive regulation of the banking system and absence or relatively lower degree of regulation over NBFCs have been some of the main reasons for the growth momentum of the latter. It has been revealed by some research studies that economic development and growth of NBFCs are positively related. In this regard the World Development Report has observed that in the developing counties banks hold a major share of financial assets than they do in the industrially developed countries1. As the demand for financial services grow, countries need to encourage the development NBFCs and securities market in order to broaden the range of services and stimulate competition and efficiency. In India the last decade has witnessed a phenomenal increase in the number of NBFCs. The number of such companies stood at 7063 in 1981, at 15358 in 1985 and it increased to 24009 by 1990 and to 55995 in 1995.2 The main reason for deposits with NBFCs are greater customer orientation and higher rate of interest offered by them as compared to banks. With such a dramatic growth in the numbers of NBFCs it was thought necessary to have a regulatory framework for NBFCs. Slowly the RBI came out with set of guidelines for NBFCs. In one of such step RBI gave definition of NBFCs. According to Reserve Bank (Amendment act, 1997) A Non Banking Finance Company (NBFC) means-

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a financial institution which is a company; a non banking institution which is a company and which has as its principal business the receiving of deposits under any scheme or arrangement or in other manner a lending in any manner;

such other non banking institution or class of such institutions as the bank may with the previous approval of the central government specify. The definition excludes financial institutions which carry on agricultural operations as their principle business. NBFCs consists mainly of finance companies which carry on functions like hire purchase finance, housing finance, investment, loan, equipment leasing or mutual benefit financial operations, but do not include insurance companies or stock exchange or stock broking companies. To encourage the NBFCs that are run on sound business principles, on July 24, 1996 NBFCs were divided into two classes:

equipment leasing and hire purchase companies(finance loan and investment companies.

companies) and

However, the NBFCs segment of finance was less regulated over a period of time. On account of the CRB scam and the inability of some of the NBFCs to meet with the investors demand for return of the deposits the need was felt by the Reserve Bank of India to increase the regulations for the NBFCs. In the light of this background Reserve Bank of India came out with the guidelines on January 2, 1998.
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The salient features of this guideline are given below

The acceptance of deposits has been prohibited for the The extent of public deposit raising is linked to credit for equipment leasing and hire purchase companies it can be

NBFCs having net owned funds less than Rs.25 lakhs. rating and raised

to a higher tune. Interest rate and rate of brokerage is also defined under Income recognition norms for equipment leasing and

the new system.

Hire purchase finance companies were liberalized for NPA from overdue for six months to twelve months.

Capital adequacy raised 10% by 31/3/98 and 12% by Grant of loan by NBFCs against the security of its own

31/3/99.

shares is prohibited. The liquid assets are required to be maintained @ 12.5% and 15% of public deposits from 1/4/98 and 1/4/99 respectively. Modifications also came to these norms over a period of time. The provisioning norms for hire purchase and lease companies were changed. Accordingly, credit was to be given to the underlying assets provided as security. The risk weight for investment in bonds of all PSBs and FD/CD/ bonds of PFI is reduced to 20%5 By monetary and credit policy for 1999-2000 the RBI has raised the minimum net
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owned funds limit for new NBFCs to Rs. 2 crores which are incorporated on or after 20/4/99. According to the guideline issued on 8/4/99 the company is to be classified as NBFCs if its financial assets account for more than 50% of its total assets i.e. net of intangible assets and the income from financial assets should be more than 50% of the total income .By 6 June 1999 RBI had removed the ceiling on bank credit to all registered NBFCs which are engaged in the principle business of equipment learning hire purchase,loan and investment activities.

Objectives of the Study:

The classification of NBFCs have been changed over a period of time. The functioning of different categories of NBFCs are not governed by the homogeneous factors. Therefore financial implication can differ for different group of companies.The financial performance of 10 leasing companies has been examined by Seem Saggar8 at disaggregate level and compared with other groups of NBFCs for a period of 1985-90. Moreover, a study by T.S. Harihar9 throws light on the performance of all NBFCs taken together in terms of cost of debt, operating margin, net profit margin, return on net worth, asset turnover ratio etc. The study by Seema Saggar does not reflect the overall performance of NBFCs as it is based on selected 10 companies. The study by Harihar reveals the aggregate performance of NBFCs which does not throw light on the financial performance of different groups of NBFCs. In the light of
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these limitations, the present study attempts to examine the financial performance of different groups of NBFCs separately. The present study attempts to examine the relative financial performance of different groups of NBFCs for the period 1985-86 to 1994-95 in terms of profitability, leverage and liquidity.

The reasons of selecting this period for the purpose of study are:

During this period the number of NBFCs have flourished by The absolute amount of deposits with NBFCs have gone up

leaps and bounds.

from 4956.6 crores to Rs. 85495.1 crores (increase is almost 17 times).

The share of deposits with reporting NBFCs have gone up over

a period of time from 4.78% to 16.49% (The share is as a percentage of total deposits of Reporting NBFCs Non financial companies and scheduled commercial banks).

It also attempts to find out the groups for which majority of the

ratios are same. Data and Methodology For the present study data are collected from various issues of RBI Bulletin11
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regarding Financial and Investment companies. As mentioned above, the period covered in the study is ten year from 1985-86 to 1994-95.

The categories of NBFCs as per published data are:

Trading in shares and investment holdings.(TS+IH)

Hire purchase finance.(HP) Loan finance(LF)

Leasing(L)

For the purpose of analysis, for various ratios mentioned below, average of ten years ratio i.e. 1985-86 to 1994-95 is found for each group separately. To examine whether these ratios differ significantly between different categories of NBFCs, One way Analysis of Variance(ANOVA) is applied. (A detailed justification for use of ANOVA for comparing the industry average is available in Reserve Bank of India Occasional Papers, Volume 16, No. 3,September 95, pp. 223-236) In addition of this Krushkal Wallies test is also applied in order to overcome the precondition of normal distribution in case of ANOVA. The selected ratios are divided in to three broad group: viz. profitability ratios, leverage ratios and liquidity ratios.

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New directions for non banking finance companies

Old wine in old bottle, just a new sticker The Prudential Regulations applicable to NBFCs, both depository and non-depository, and both big and small, have been replaced by a new set of Directions. Background The present regulatory regime for non-banking finance companies (NBFCs) was ushered in 1998 when Non-banking Financial Companies Acceptance of Public Deposits (RBI) Directions 1998 was promulgated. Almost simultaneously, NBFC Prudential Norms (RBI ) Directions were also pronounced. In pursuance of the Governors Mid Term policy statement for 2006-7, an internal committee was constituted within the RBI. The internal group reviewed the existing regulations and there was a notice of proposed rule making (NPR) issued on Nov 3, 2006. Basic purpose of the new Directions

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The key philosophy of the new Directions was regulatory arbitrage, that is, taking advantage of the disparity on the regulations applicable to banks and NBFCs. As is common knowledge, NBFCs have a much lighter regulation than that applicable to banks. Formation of an NBFC is much easier than forming a bank. Foreign direct investments in NBFCs are also much easier than those in case of banks. In terms of powers and functions, NBFCs have substantially similar scope of activities. Other than running checking accounts, NBFCs can do virtually the same things that banks can. In fact, their right to leverage capital is almost the same, as the leveraging power is principally controlled by capital adequacy norms which require 9% minimum capital in case of banks, and 10% in case of NBFCs. If one takes into account the impact of the SLR and CRR applicable to banks, the right of NBFCs to generate business assets is, in fact, more than that in case of banks. A Table showing the regulatory arbitrage in case of banks versus NBFCs is enclosed. Regulatory arbitrage potential has been frowned upon both at international level and national level. IMF has framed principles for regulation of the financial sector, where it suggests that institutions performing similar functions should be subject to similar regulations. With this philosophy in mind, the Nov 3, 2006 NPR classified NBFCs in those that are systemically important (SI). These are the NBFCs that have assets of Rs 100 crores or above. This is in addition to the present classification of NBFCs into deposittaking, and non-deposit-taking NBFCs.
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Two sets of Directions The existing Prudential Directions made distinction between depository and non depository companies, and several of the Directions were not applicable in case of non depository companies. Under the new regime, there are two separate sets of Directions, one applicable to Deposit-taking Companies, and the other applicable to Non-Deposit-taking companies.

Deposit-taking companies: what is new and what is not

The rather long name of Directions for depository NBFCs is NonBanking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 given the two pairs of brackets, it would even be difficult to think of an easy call name but lets call them Depository NBFCs Prudential Directions (DNPD). First, quickly, a few things where would have expected amendments, but there are none. Basle II norms are being implemented in India soon, but the capital norms in the DNPD norms are still the same as under Basle I. Norms relating to securitization and the capital requirements in case of securitization had been brought by RBI in Feb 2006, and these are applicable to NBFCs too. There is nothing in DNPD relating to securitization while it is certain that the securitization norms are applicable to NBFCs, there might, at least, have been a cross reference. In fact, even the limits on investment in
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real estate and unquoted equity shares, which have been talked about as the feature change in the Norms, were also there in the earlier regulations. The word asset finance companies seems to be a new coinage in place of the old-fashioned equipment leasing and hire purchase companies but there is no difference as regards the percentages permitted for Asset Finance companies and Loan & Investment companies that latter have a limit of 20% while the former have a limit of 10% of net owned fund. The main new feature of the DNPD norms is disclosure of capital market exposure in case of systemically important NBFCs. These NBFCs have to make monthly disclosures of their capital market disclosure within 7 days of the end of the month. The other new feature is several provisions applicable in case of project loans to infrastructure companies, which will have limited applicability to only a few NBFCs. These norms certainly dont apply to funding of infrastructural assets or leasing of excavators and tillers. Non-deposit companies: what is new and what is not The major change here is that exemptions from the Prudential norms are not applicable for a non-depository company which is systemically important. That is to say, if it systemically important, even though non-depository, it has to comply with all of the Directions for Non-depository NBFCs is Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 (we will call them NNPD). If it nondepository and systemically non-important, it has to comply with all such norms, minus capital adequacy and concentration limits. There is
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no significant difference between the two sets of norms hence, it is quite intriguing as to why the two separate set of norms were needed at all. The disclosure of capital market is not required in case of nondepository companies, even though they might be systemically important.

ANALYSIS AND INTERPRETATION

BANKING VERSUS NON-BANKING COMPANIES

REGULATORY ARBITRAGE IN INDIA

Banks NBFCs Functional restrictions Carrying on checking accounts, remittance functions and typical retail banking Permitted Not permitted Acceptance of term deposits Permitted, subject to term restrictions (short term deposits are accepted by banks) Permitted subject to limitations, but the term of deposit is at least 1 year. Licensing restrictions Need for a license Any new bank needs a license. Licensing norms are tightly controlled and generally, it is perceived to be quite difficult to get a license for a bank. It is comparatively much easier to get

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registration as an NBFC. Besides, there are some 30000 NBFCs currently registered, many of which may be available for sale.

Ownership structure/ change in ownership Indian ownership Not more than 10% of capital in a bank may be acquired without the approval of the RBI While prior intimation of a takeover is required in case of NBFCs, there is no need for express permission for a change in voting control. There is no limit as to the percentage holding permitted in case of NBFCs Foreign ownership Upto 74% capital in banking companies may be acquired for foreign owners. 100% capital may be held by foreign owners subject to minimum capitalization requirements under FDI norms

Credit control and sectored asset restrictions SLR/ CRR norms Substantial part of assets of banks is blocked due to statutory liquidity ratio (SLR) and cash reserve ratio (CRR). These are periodically changed to control the expansion of M3 in the economy. Only 15% of the deposit liabilities of NBFCs is to be held in certain permitted securities. Sectored exposures Periodic regulations place
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limits on the extent to which banks may invest in capital market and other specific segments. There are certain segments in which banks need to allocate minimum percentage of their assets. Very scanty limitations have been placed on assets of NBFCs. Investment in real estate and unquoted equity shares is controlled. Capital market exposure is only required to be reported. The activities of non-banking financial companies (NBFCs) in India have undergone qualitative changes over the years through functional specialization. The role of NBFCs as effective financial intermediaries has been well recognized as they have inherent ability to take quicker decisions, assume greater risks, and customize 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 other companies, and borrowings by issue of non-convertible debentures, etc. Consequently, the share of non-bank deposits in
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household sector savings in financial assets, increased from 3.1 per cent in 1980-81 to 10.6 per cent in 199596. In 1998, the definition of public deposits was for the first time contemplated as distinct from regulated deposits and as such, the figures thereafter are not comparable with those before.

Non banking financial companies

The importance of NBFCs in delivering credit to the unorganized sector and to small borrowers at the local level in response to local requirements is well recognized. The rising importance of this segment calls for increased regulatory attention and focused supervisory scrutiny in the interests of financial stability and depositor protection (Box 6.1).In response to the perceived need for better regulation of the NBFC sector, the Reserve Bank of India (RBI) Act, 1934 was amended in 1997, providing for a comprehensive regulatory framework for NBFCs. The RBI (Amendment) Act,1997 conferred powers on the RBI to issue directions to companies and its auditors, prohibit deposit acceptance and alienation of assets by companies and initiate action for winding up of companies. The Amendment Act provides for compulsory registration with the RBI of all NBFCs, irrespective of their holding of public deposits, for commencing and carrying on business of a non-banking financial institution; minimum entry point norms; maintenance of a portion of deposits in liquid assets; and creation of reserve fund and transfer of 20 per cent of profit after tax but before dividend annually to the fund. Accordingly, to monitor the financial health and prudential functioning of NBFCs, the RBI issued directions to
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companies on: acceptance of public deposits; prudential norms like capital adequacy, income recognition, asset classification, provisioning for bad and doubtful assets, exposure norms and other measures. Directions were also issued to the statutory auditors to report non-compliance with the RBI Act and regulations to the RBI, and Board of Directors and shareholders of the NBFCs. An Overview of Regulation of NBFCs

Mission to ensure that the financial companies function on healthy

lines, these companies function in consonance

Basic Structure of Regulatory and Supervisory Framework Prescription of prudential norms akin to those

applicable to banks, Submission of periodical returns for the purpose of off-site surveillance, 251

Regulatory Norms and Directions for NBFCs

Important Statutory Provisions of Chapter III B of the RBI Act as applicable to NBFCs
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Certificate of Registration No company, other than those the RBI, can commence or ea the business of

exempted by

non-banking financial institution without obtaining a CoR RBI. The pre-requisite for eligibility for such a CoR is that the NBFC f have a minimum NOF of Rs. 25 lakh (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 companys compliance with the c enumerated in Section 45-1A of the RBI Act

Maintenance of Liquid Assets NBFCs have to invest in approved securities, valued at a not exceeding

unencumbered

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.

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 deposit 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

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appropriation can be made from the fund ft purpose without prior written approval of RBI. Deposit Acceptance Related Regulations Ceiling on quantum of public Loan and investment companies 1.5 times of NOF if the company deposits has NOF of Rs. 25 lakh, minimum investment grade (MIG) credit rating, complies with all the prudential norms and has CRAR of 15 percent. Equipment leasing and hire purchase finance companies - if company has NOF of Rs. 25 lakh and complies with all the prudential norms.

with MIG credit rating and 12 per cent CRAR - 4 without MIG credit rating but CRAR 15 per cent

times of NOF

or above - 1.5 times of NOF, or Rs. 10 crores, whichever is less. 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 not less than 10 per cent in approved securities and

34

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:

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 255 Non-Banking Financial Companies 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 amount out of ALDs as per their discretion. However, to avoid strain, in complying with 100% directed investments by companies, 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
35

participant (registered with SEB1).Effective October 1, 2002, government securities are to be necessarily held by NBFCs either in Constituents Subsidiary General Ledger Account with a scheduled commercial 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. Period of Deposits No demand deposits NBFCs RNBCs MNBCs (chit Funds) Ceiling of deposit rate NBFCs, MNBCs - 11.0 per cent per annum (effective March 4,2003) RNBCs - Minimum interest of 4.0 per cent on daily deposits and 6.0 per cent on other than daily deposits. Interest may be paid or compounded at periods not shorter than monthly rests. Advertisement methodology Every company which accepts deposits by advertisement has to acceptance of deposits/public comply with the advertisement rules prescribed in this regard, deposits the deposit acceptance form should contain certain prescribed information, issue receipt for deposits and maintain a deposit register. etc. 12 to 60 months 12 to 84 months 6 to 36 months

36

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

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

Capital to Risk Assets Ratio The NBFCs holding/accepting public deposits are required to (CRAR) maintain CRAR as under: Equipment leasing companies/hire purchase finance companies

(with MIG credit rating) 12 percenT Equipment leasing companies/hire purchase finance companies

(without MIG credit rating) 15 percent

Loan/investment companies 15 percent

RNBCs 12 per cent CRAR comprises tier I and tier II capital. To 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
37

(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 256 Manual on Financial and Banking Statistics Capital not to exceed tier I capital General 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.

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

Credit/investment concentration Single borrower exposure

limits credit - 15 percent of owned norms fund Investments - 15 percent of owned fund Single group - 25 percent of owned
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limits credit fund borrower - 25 percent of owned limits credit fund

exposure

Composite (credit and investments) exposure limits Single borrower- 25 percent of owned fund borrowers
o Exposure

Single group of- 40 percent of owned fund

norms also applicable to own group companies and

subsidiaries.
o Includes

all forms of credit and credit related and certain other to be treated as credit for the purpose of

receivables as also off balance sheet exposures.

o Debentures/bonds

prudential norms but as investments for the purpose of balance sheet and compliance with investment obligations.

Reporting System: Half yearly Half-yearly returns to be

submitted as at the end of March and return September every year, oTime allowed for submission - 3 months from the due date,
39

o 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

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

Income Recognition Norms The recognition of income on the

NPA is allowed on cash basis only. The unrealized income recognised earlier is required to be reversed. 257 Non-Banking Financial Companies

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 Restrictive Norms Loans against own shares not allowed

Policy on demand/call loans Companies to frame a policy for

demand and call loans relating to cut-off date for recalling the

40

loans, the rate of interest, periodicity of such interest, periodical reviews of such performance, etc.

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. Accounting for investments All NBFCs to have a well defined investment policy.

Investments classified into two categories

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

Current investments to be classified into

quoted and unquoted.
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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: Equity shares (at lower of cost or break up value or fair value)

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

investee company is not available for the last two years

Preference shares at lower of cost or face value Government securities at carrying cost Mutual Fund units at net asset value (NAV) for each scheme

And Commercial paper (CP) at its carrying cost

Provisioning for Non-Performing Standard assets - No

provision Sub-Assets Loans and Advances 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

42

on the age of the doubtful assets Loss asset - 100 per cent of the outstanding 258 Manual on Financial and Banking Statistic

Provisioning for Non-Performing _ Unsecured portion to be fully provided for Assets Equipment Lease and _ Further provisions on net book value (NBV) of EL/HP assets Hire Purchase accounts _ Accelerated additional provisions against NPAs NPA 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 NBV Value 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.

Risk Weights and Credit _ Risk - weights to be applied to all

assets except intangible Conversion factors assets

Risk - weights to be applied after netting off the provisions held Risk - weights are 0, 20 and 100. Assets deducted from owned fund like exposure to subsidiaries

against relative assets.

or companies in the same group or intangibles to be assigned 0 per cent risk - weight.

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Exposures to all-India financial institutions (AIFIs) at 20 pecent Off-balance sheet items to be factored at 50 or 100 and then

risk -weight and all other assets to attract 100 per cent risk - weights.

converted for risk - weight.

Disclosure requirements 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.

The provisions shall be distinctly indicated under separate

heads of accounts as under:

provisions for bad and doubtful assets; and provisions for depreciation in investments. Such provisions shall not be appropriated from the general

provisions and loss reserves held, if any, by the NBFC.

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.

Nidhis and Chit Fund companies exempted.

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Interest Rates
Keeping in view interest rates prevalent in the financial sector, the ceiling on interest rates on deposits payable by NBFCs, including chit fund companies and nidhi companies, was reduced from 16 per cent per annum to 14 per cent per annum effective April 1, 2001 and further to 12.5 per cent per annum effective November 1, 2001 and further to 11% effective from March 2003. Classification of NBFCs as Equipment Leasing and Hire Purchase Finance Companies In response to representations from NBFCs, it was decided to include loans and advances against hypothecation of automobiles, aircrafts and ships registered with the specified authorities in the aggregate of equipment leasing and hire purchase assets for the purpose of 259 NonBanking Financial Companies classification of an NBFC into equipment leasing and hire purchase finance company. Alignment of the RBIs Regulations with Companies (Amendment) Act, 2000 Changes were effected in the RBI directions to NBFCs to align with those contained in the Companies Act, 1956, as amended by the Companies (Amendment) Act, 2000. Accordingly, all NBFCs were advised to report to the Company Law Board the defaults, if any, in repayment of matured deposits or payment of interest to small depositors within 60 days of such default. In addition to NBFCs with asset size of Rs.50 crores and more, those with paid up capital of not less than Rs.5 crores have to constitute Audit Committees. Such committees would
45

have the same powers, functions and duties as laid down in Companies Act, 1956. Moreover, some NBFCs, which were hitherto private limited companies holding public deposits, have now become public limited companies under the Companies Act. Such NBFCs have to approach the RBI after obtaining a fresh certificate of incorporation from the Registrar of Companies, for change of name in the CoR to reflect their status as public limited companies. Liquid Asset Securities of NBFCs Effective from October 1, 2002, all NBFCs should necessarily hold their investments in government securities either in Constituents Subsidiary General Ledger Account (CSGL) with a scheduled commercial bank or Stock Holding Corporation of India Ltd. (SHCIL) or in a dematerialized account with depositories [National Securities Depository Ltd. (NSDL)/ Central Depository Services (India) Ltd. (CDSL)] through a depository participant registered with SEBI. The facility of holding government securities in physical form, therefore, stands withdrawn. Government guaranteed bonds, which have not been dematerialized may be kept in physical form till such time these are dematerialized. Only one CSGL or a dematerialized account can be opened by any NBFC. In case the CSGL account is opened with a scheduled commercial bank, the account holder has to open a designated funds account (for all CSGL related transactions) with the same bank. In case the CSGL account is opened with any of the non-banking institutions indicated above, the particulars of the designated funds account (with a bank) should be intimated to that institution. The NBFCs maintaining the CSGL/designated funds accounts will be required to ensure availability of clear funds in the designated
46

funds accounts for purchases and of sufficient securities in the CSGL account for sales before putting through the transaction. No further transactions in government securities should be undertaken by NBFCs with any broker in physical form with immediate effect. All further transactions of purchase and sale of government securities have to be compulsorily through CSGL/demit account. Government securities held in physical form were to be dematerialized by October 31, 2002. Accounting Standards In terms of Accounting Standard (AS) 19 (Accounting for Leases) issued by the Institute of Chartered Accountants of India (ICAI), it was clarified that

The prudential norms applicable to hire purchase assets would,

mutatis mutandis, be applicable to the financial leases written on or after April 1, 2001 and

the leases written up to March 31, 2001 would continue to be

governed by the prudential norms relating to leased assets, as hitherto. Statutory Auditors NBFCs have to reiterate in their letter of appointment to statutory auditors their statutory responsibility to report directly to the RBI the violations, if any, of the provisions of the RBI Act or Directions issued there under, noticed by them in the course of their audit.

Prudential Regulation
47

Some NBFCs were granting demand/call loans with an open period or without any stipulation regarding the rate of interest and servicing, resulting in problems of compliance with prudential norms relating to income recognition, asset classification and provisioning in respect of such loans. Accordingly, guidelines were issued to obviate such difficulties and to ensure that all such loans are appropriately classified and the position of NPAs are truly reflected in the financial statements of NBFCs. The concept 260 Manual on Financial and Banking Statistics of past due would be done away with in respect of the definition of NPA for NBFCs effective from March 31, 2003, which would be reflected in the half-yearly return on prudential norms and the balance sheet as on March 31, 2003. In terms of NBFCs Directions on Prudential Norms, the NBFCs accepting/holding public deposits have to ensure maintenance of minimum prescribed capital to risk-weighted assets ratio (CRAR) at all times. The format for the report of the auditors has accordingly been amended. In order to obviate the probability of applying divergent yardsticks for identification of potential threat of non-recoverability of loans, RBI has prescribed objective criteria for classification of assets as loss assets. Submission of Returns by NBFCs Several NBFCs have been lax in timely submission of the returns to the RBI. Action has been contemplated against such NBFCs initially those with public deposits of Rs.50 crores and above - for non-submission of returns. The action may include imposing penalties as provided in the RBI Act, 1934 as also launching court proceedings against the errant companies, besides considering rejection/ cancellation of the CoR.
48

Protection of Depositors Interest With a view to protecting the interest of depositors, it was decided to issue press advertisements in cases where winding up petitions filed by the RBI have been admitted I Court and provisional liquidators have been appointed or where criminal complaints have been filed by the RBI and summons have been issued by the Court.

Asset Liability Management Based on the guidelines issued in July 2001, effective March 31, 2002 asset liability management system in all NBFCs with public deposits of Rs. 20 crores and above as also NBFCs with asset size of Rs. 100 crores and above has been made operational. Instructions were also issued to the effect that the first return as on September 30, 2002, should be submitted by the NBFCs to the RBI latest by October 31, 2002.

Amendments to NBFC Regulations

To All Non-Banking Financial Companies including Residuary NonBanking Companies

Amendments to NBFC Regulations As you are aware, Reserve Bank has put in place a comprehensive regulatory and supervisory framework in January 1998, in terms of which certain measures were taken for protecting the interests of depositors and
49

for ensuring that the NBFCs function on sound and healthy lines. Reserve Bank has since received a number of suggestions for fine tuning the regulations with a view to enhancing the protection to the interests of the depositors and ensuring that the NBFCs continue to play their legitimate role in the Indian Financial System. Accordingly, the following changes are being effected in the regulations : Statutory changes NBFCs engaged in micro-financing activities In the backdrop of the need for a suitable national policy framework for implementation of many credit linked poverty alleviation programmes to meet the needs of hard core and asset less poor, a High Powered Working Group on Micro Financing in India was constituted by NABARD to recommend a policy framework for sustainable growth of micro finance in the country with participation of community based organizations at the grass root level. The Task Force submitted its Report on October 18, 1999. The Working Group has, inter alia, recommended that the policy and regulatory framework should give a fillip to the Self Help Groups (SHGs) or NonGovernmental Organisations (NGOs) engaged in micro-financing activities. Accordingly, it has been decided to exempt such NBFCs which are engaged in Micro financing activities,

licensed under Section 25 of the Companies Act, 1956 and which are not accepting public deposits from the purview of Sections 45-IA (registration), 45-IB (maintenance of liquid assets) and 45-IC (transfer of profits to Reserve Fund) of RBI Act, 1934.

Un-notified nidhi companies

50

A Nidhi company notified under section 620-A of the Companies Act is classified at present as "Mutual Benefit Financial Company" by RBI and regulated by the Bank for its deposit taking activities and by DCA for its operational matters as also the deployment of funds. These Companies enjoy exemption from core provisions of the RBI Act viz. requirement of registration, maintenance of liquid assets and creation of reserve fund, and RBI Directions except those relating to interest rate on deposits, prohibition from paying brokerage on deposits, ban on advertisements and the requirement of submission of certain Returns. Such companies, however, are allowed to deal with their shareholders only, for the purpose of accepting deposits and making loans. There are a number of companies functioning on the lines of Nidhi companies but not yet notified by DCA. As RBI Directions to classify them as loan companies disallowed them the special dispensation available to Notified Nidhi companies; Bank and the Government received representations from a large number of such companies and their associations. Government decided to give them a special dispensation and notified that applications of companies incorporated on or before January 9, 1997 shall be considered for notifying as Nidhi Company under section 620-A of the Companies Act, 1956 only if they have minimum NOF of Rs.10 lakh or more. These companies shall be required to have net owned fund of Rs.25 lakh by December 31, 2002 like companies already declared as Nidhis. Government has also clarified that NOF shall have the same meaning as assigned to it in the RBI Act, 1934. Thus a new class of companies has been created i.e. the potential Nidhi companies. To distinguish them from the notified Nidhi companies ( Mutual Benefit

51

Financial Companies) the term Mutual Benefit Companies (MBC) is being used.

Since the notified nidhi companies are exempted from the provisions of Section 45-IA (Compulsory Registration with RBI), Section 45-IB (Maintenance of Liquid Assets) and Section 45-IC (Creation of Reserve Fund), it has been decided on the lines of Government advice to exempt the MBCs in existence as on January 9, 1997 and having NOF of Rs.10 lakh from the above mentioned provisions of the Act in terms of powers vested with the Bank under Section 45 NC of the Act and also from those provisions of NBFC Directions on Acceptance of Public Deposits and Prudential Norms which do not apply to notified nidhi companies.

Government NBFCs

There are a number of Government NBFCs which fall within the ambit of RBI Regulations. The Government Department or the Ministry or the Bureau of Public Enterprises to which such companies are attached, are expected to prescribe the norms for their operations on healthy lines and monitor their financial health. Such companies being Government companies pose little supervisory concern regarding repayment of the deposits held by them and protection of interests of the depositors. Needless to mention, all these companies are required to be audited by the statutory auditors as per the provisions of Companies Act and the irregularities, if any, in their functioning are brought to the notice of Government by the auditors for corrective steps.

Although, we do not intend to discriminate among the NBFCs on the basis of ownership but in view of the role being played by these companies in discharge of their social obligations and the norms prescribed for their working by their respective supervisory departments
52

and for avoiding dual control over them, we have decided, in consultation with Government, to exempt the Government companies as conforming to Section 617 of the Companies Act from applicability of the provisions of RBI Act relating to maintenance of liquid assets and creation of reserve funds, and the Directions relating to acceptance of public deposits and prudential norms. The requirement of statutory registration of these companies under Section 45-IA of the RBI Act, 1956 shall, however, continue.

Term deposits with banks to be reckoned as part of liquid assets along with Government papers The NBFCs have been voicing their problems in securing desired lots of Government securities in small towns and localities in the country. In order to increase operational ease in maintenance of liquid assets, the NBFCs have been permitted to maintain upto 5 percent of the public deposits in the form of term deposits with scheduled commercial banks out of present requirement of 15 percent of public deposits to be invested in liquid assets. It is expected that it would enable the NBFCs in establishing a relationship with their bankers and securing services as the banker. These instructions are effective retrospectively from the first day of the quarter beginning January 1, 2000.

The NBFCs are, however, advised to strictly adhere to the requirements of maintenance of liquid assets. It may also be reiterated that the NBFCs holding public deposits should scrupulously furnish the liquid asset return on quarterly basis and the delay in submission or non submission thereof would be viewed seriously and the concerned NBFC would expose itself to levy of penal interest and adverse action under Section 58-B(6) of the RBI Act.
53

Additional terms and conditions for grant of Certificate of Registration Prior RBI approval for changes in names of NBFC.

Instances have been brought to our notice of some NBFCs changing

their name, more particularly to add InfoTech tag with a view to taking advantage of the capital market sentiments, which may not only jeopardize the interest of the depositors, but also of the investors. Such a change in the name and the business plan of the company may also result into the principal business of the NBFC becoming non-financial, thereby affecting its eligibility for grant and holding of Certificate of Registration under Section 45-IA (4) of the RBI Act. It has, therefore, been decided in the public interest that an NBFC intending to change its present name would need to obtain prior permission of RBI before approaching the Registrar of Companies for change of name. Any violation of these directions would attract serious action against the company as provided for under the RBI Act including cancellation of the Certificate of Registration if already granted, or rejection of its application for registration, as the case may be. Submission of information on Permanent Account Numbers (PAN) allotted by I.T. Department in respect of all the Directors of NBFCs .

There are reports of some companies including NBFCs vanishing

after mobilization of capital, deposits, etc. from public, raising grave supervisory concerns. Since the present regulatory framework is aimed at ensuring that registration is granted only to serious and bonafide players in the NBFC sector, it has been decided to place on record details of
54

Permanent Account Number issued by Income Tax Authorities, of each of the directors of all NBFCs whether registered or whose applications for Certificate of Registration are pending with the Bank. All the NBFCs are, therefore, advised to furnish the information to the respective Regional Office of RBI within 2 months of the receipt of this letter failing which the grant or continuance of the Certificate of Registration would be reconsidered. Change in management and mergers/amalgamation

Amendments to NBFC Directions on Acceptance of Public Deposits

Need for introduction of the depositors of NBFCs - It has been brought to the notice of the Bank that some of the NBFCs were holding benami deposits. In order to curb this practice, it has been decided that the NBFCs should obtain proper introduction of the new depositors before opening their deposit accounts and accepting the deposits. They should also obtain written confirmation from their introducers. In the absence of such introduction, any other document of identity of the prospective deposit holders may be obtained and kept on their record the evidence on which they have relied upon for the purpose of such introduction.

Minimum period of hybrid debt capital instruments and subordinated debts for exclusion from the description of public deposits . A few NBFCs
55

introduced new deposit products, one of which was the subordinated debts having a maturity period of 17 months. The intention was to avoid the application of SEBI regulations applicable to the issue of debentures and those provisions of the RBI directions applicable to acceptance of public deposits because the hybrid debt capital instruments and subordinated debts issued by an NBFC are treated as part of Tier II capital in terms of the Prudential Norms Directions and by virtue thereof, they would be exempt from the meaning of `public deposit. It has, therefore, been decided that the subordinated debt instruments with a minimum maturity period of 60 months or above at the time of their initial offer which are unsecured and subordinated to the claims of other creditors,are free from restrictive clauses,are not redeemable at the instance of the holder or without the consent of the supervisory authority of the NBFC, will only be exempted from the definition of public deposits.

Deposits received from joint shareholders by a private limited company Some of the private limited NBFCs have reportedly started accepting deposits from all the joint shareholders. This practice has been found to be irregular, undesirable and circumventing the NBFC Directions on Acceptance of Public Deposits. Accordingly, it has been decided that the deposits accepted by a private limited NBFC from the first named shareholders will only be exempted from the purview of public deposit. The deposits accepted from the rest of the joint shareholders will be treated as public deposit.

56

Control over opening and closing of branches Absence of control on opening/closing of branches/offices by the NBFCs and non specification of operational area of their agents have raised many regulatory concerns. Indiscriminate opening of branches not only increases risk for protection of depositors interest, it creates supervisory difficulties for RBI as the registered office of the company may be in the jurisdiction of one Regional Office of RBI whereas major chunk of business may be in the jurisdictional area of other Regional Offices and thus the actual operations of the company remain unnoticed by the Regional Office having jurisdiction over the companys affairs. Similarly, sudden closure of branches also evokes adverse public reaction. Though a strict control over opening of branches/offices by NBFCs or non-specification of area of operations of agents is neither intended nor desirable in the present era of liberalization, a surveillance over opening and closing of branches/offices is considered necessary from the view point of prudential supervision and protecting the interests of depositors. Accordingly, it has been decided that NBFC other than RNBCs

an NBFC having a Certificate of Registration and otherwise entitled to accept public deposits as per NBFC Directions on Acceptance of Public Deposits is allowed to open its branch/office or allow its agents to operate for mobilization of public deposits

within the State where its registered office is situated if its NOF is upto Rs.50 crores; and

57

any where in India if its NOF is more than Rs.50 crores and its fixed deposits programme has been rated by one of the approved credit rating agencies at 'AA' or above. RNBCs

An RNBC registered with the Bank and otherwise complying with all the statutory requirements is allowed to open additional branches/offices and/or allow its agents to operate for mobilization of deposits

Within the State of the location of its registered office if its NOF is upto Rs.50 crores; and

Any where in India if its NOF is above Rs.50 crores. Prior intimation to RBI and public notice

The NBFCs/RNBSs would be required to give 30 days notice to RBI prior to the opening of any branch/office for mobilization of public deposits within the specified area of operation and prior public notice of three months in leading newspapers before closing a branch. However, it is clarified that the area of operation of the agents, if appointed by the company for mobilization of public deposits, would be congruous with the area of operation of the branch/office to which such agents are attached. A system of reporting the name, address, date of opening and deposits held at each existing branch as also information on opening and closing of branches has been put in place. These directions are applicable prospectively to the existing as well as new NBFCs/RNBCs. For the purpose of abundant clarification, it is advised that these Directions govern only the deposit taking activities of the companies. Opening of branches or
58

engaging the services of agents for other than deposit taking business is not intended to be governed by RBI.

Responsibilities of the Auditors to report to RBI on compliance with branch control directions In keeping with the existing policy of RBI to enlist the support of the statutory auditors in ensuring compliance by the NBFCs of the RBI regulations, the auditors of these companies have been entrusted with the responsibility of direct reporting to RBI, along with other contraventions, if any, on the matters of non-compliance with the directions of RBI on control over opening and closing of branches and engaging the services of agents for mobilization of public deposits by the NBFCs.

Amendments to NBFC Directions on Prudential Norms

Compulsory Internal Audit System and Constitution of Audit Committees On the lines of scheduled commercial banks, it has been decided that all NBFCs having asset size of Rs.50 crores or above should have compulsory internal audit system accountable to the Chief Executive Officer of the company. All these companies should also mandatorily constitute an Audit Committee from among the members of their Board of Directors. This provision is applicable to all NBFCs whether holding/accepting public deposits or not.

Information on suit filed accounts In order to monitor the level of loan delinquencies in the NBFC sector, NBFCs are being advised to furnish, in

59

their Prudential Norms Return, information on suit filed/decreed debts by and against them. Other decisions/clarifications It has been felt necessary to issue the following further instructions / clarifications for information and necessary action :

Need for disclosure of information relating to aggregate dues from the companies in the same group and other entities We had vide our Notification dated December 18, 1998 prescribed that every NBFC should include in its advertisement the information relating to exposure to its group companies and associates as per the recommendations of the Task Force on NBFCs. It has been recently brought to our notice that some of the NBFCs are still using the application forms in the old formats for soliciting deposits. It is clarified that the above disclosures should be included in the application form for soliciting deposits without any further delay.

Clarification on interpretation of the requirement of credit rating By an amendment made on 18 December 1998 to 4(4) of the NBFC Directions on Acceptance of Public Deposits, the NBFCs in the category of equipment leasing and hire purchase finance (EL/HP) having minimum CRAR of 15% have been permitted to accept public deposits without credit rating. Some of the NBFCs have pointed out that Paragraph 4(1)(i) of the Directions prohibits all NBFCs from accepting public deposits, if they have not obtained the minimum investment grade credit rating. It is clarified that the regulatory provisions for acceptance of public deposits by EL/HP NBFCs
60

are contained in paragraph 4(4) of the Directions. Accordingly, 4(1)(i) of the Directions is being modified.

Extension of time period to NBFCs having NOF of less than Rs.25.00 lakh The NBFCs still having NOF below the prescribed minimum level of Rs.25.00 lakh and whose applications for grant of Certificate of Registration are pending with the RBI are allowed time upto January 9, 2000 as provided in the RBI Act, to achieve the minimum NOF. All such NBFCs are advised that this time limit has expired on January 9, 2000. It is further clarified that RBI may not, in the normal course, grant extension of time to those NBFCs which have not attained the prescribed minimum NOF of Rs. 25 lakh by the above stipulated date and accordingly their application may not be considered for registration. Those of the NBFCs which have since achieved the minimum level of NOF should inform Reserve Bank. Submission of Returns on liquid Assets by NBFCs not holding/accepting public deposits In the wake of certain disquietening reports that some of the NBFCs holding public deposits were not furnishing the liquid asset returns, Bank had stipulated in January 1999 that all NBFCs (including those not holding public deposits) should also submit liquid asset returns to the Bank. The NBFCs not holding/accepting public deposits were advised to file Nil reports. We have received requests from various quarters that the requirement for the NBFCs not holding public deposits to furnish the above mentioned return should be done away with. As the auditors of these companies continue to be responsible to report to RBI through exception reports in regard to the violation of the provisions of the RBI Act/Directions including non-submission of the return on liquid assets, it has been decided that the NBFCs not holding public deposits need not furnish the return to RBI on and from the quarter ended December 1999.
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Provisioning against NPAs - Income reversal to be shown on Prudential Norms Return We have received queries from some of the NBFCs and their auditors regarding disclosure of the amount of income reversed on NPAs which was earlier taken to the credit of profit and loss account. We clarify that the amount may be disclosed in the Prudential Norms Return Part F, Item II.(A)(i)(a) col. (3) against the head "entire amount taken to the credit of profit and loss account before the asset became NPA and remaining unrealized". Aggregate ceiling on investments in unquoted shares We have prescribed a prudential ceiling of 10 per cent of owned funds on investments in unquoted shares by equipment leasing/hire purchase finance companies and 20 per cent in the case of loan/investment companies if they are accepting/holding public deposits. Some of the companies are treating such ceilings as exposure norms against individual investee company. It is clarified that the aforementioned ceilings are aggregate ceilings on investments in the unquoted shares of all the investee companies taken together.

Issue of secured debentures by NBFCs outside the purview of description of public deposits The provisions of 2(1)(xii)(f) read asunder : "any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the company; or by any other asset or with an option to convert them into shares in the company provided that in the case of such bonds or debentures secured by the mortgage or any immovable property or secured by other assets, the amount of such bonds or debentures shall not exceed the market value of such immovable property/other assets".

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The above provisions have been interpreted by some of the NBFCs in different manner. It is advised that the debentures which are partly secured, the debentures which are secured by assets of a third party,

the debentures which have matured for redemption but have not been redeemed and are overdue, and the debentures against which a charge has not been created in favor of the independent debenture Trustees (other than debenture holders) within the stipulated period of 90 days and extended period of further 90 days shall be treated as part of public deposits.

A copy each of the amending Notifications No. 134-140 is enclosed. You are requested to ensure meticulous compliance with the regulatory framework.

Please acknowledge the receipt of this letter to the General Manager/Deputy General Manager of the Regional Office of the Department of Non-Banking Supervision under whose jurisdiction the registered office of your company is located.

Conclusion
On the basis of the study, it can be concluded that there exists a significant difference in the profitability ratios, leverage ratios and liquidity ratios of various categories of NBFCs. When all categories are taken together, null hypothesis is accepted for only three ratios indicating thereby that there does not exist a significant difference in only three ratios. From this it follows that the ratios for all categories of NBFCs are generally different from each other.
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The analysis of variance along with the details about average ratios may become a useful guide to companies to decide about diversification or continuation in the same line of business considering overall profitability within the regulatory framework. In brief, different categories of NBFCs behave differently and it is the entrepreneurs choice in the light of behavior of some the parameters which go along with the category of NBFC. NBFCs consists mainly of finance companies which carry on functions like hire purchase finance, housing finance, investment, loan, equipment leasing or mutual benefit financial operations, but do not include insurance companies or stock exchange or stock broking companies. NBFIs facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering.[1] Examples of these include insurance firms, pawn shops, cashier's check issuers, check cashing locations, currency exchanges, and microloan organizations.

Research Methodology
Types of Research The research includes different options. They are: Exploratory research: It is usually a small-scale study undertaken to define the exact nature of a problem and to gain a better understanding of the environment

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within which the problem has occurred. It is the initial research, before more conclusive research is undertaken. Descriptive research: It is to provide an accurate picture of some aspects of market environment. Descriptive research is used when the objective is to provide a systematic description that is as factual and accurate as possible. It provides the number of time something occurs, or frequency, lends itself to satisfied calculations such as determining average number of occurrences. Casual research: If the objective is too determined which variable might be causing a certain behavior that is whether there is a cause and effect relationship between variable, casual research must be undertaken. In order to determine causality, it is important to hold the variable that is assumed to cause the change in the other variable constant and than measure the changes in the variable. This type of research is very complex and the researcher can never be completely certain that there are no other factors influencing the casual relationship, especially when dealing with people's attitudes and motivation.This research is about understanding the market stand and also find the strength & weakness of the products of three insurance companies by making, comparing analysis of the products of the companies, mainly descriptive research methodology are adopted. Descriptive research was adopted since it provides accurate picture about some aspect of market environment such as which brand is performing well and what the company can do to improve its market share.

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Sampling Procedure How should the respondents be chosen to obtain a representative sample and non-probability sample can be drawn, they are Judgment sample: The researcher selects population numbers who are good prospects for accurate information. For collection of research data judgment-sampling technique is used where all of them are employees of the three insurance companies as they are good prospect for accurate information. Actual Collection Of Data

Data Sources: The sources of data include either secondary data or primary data and even sometimes the combination of both.The present study is more concentrated on both primary & secondary data. Primary data Primary data is collected through face-to face interaction with employees of the insurance companies, by meeting them in personal. Secondary data The secondary data used for their study are inclusive of the data collected from the internet, catalogues and brochures and magazines. Methodology The study will conduct on the bases of survey through questionnaires given to respondents. Sampling Design
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Population: Delhi SampleSize: Population of 100 has been selected for the study conducted. Statistical Tools: Correlation.

Bibliography

Books
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CMIE Database programming with MS Office,MS office,Visual vmpro software Important websites

www.google.com, www.licindia.com
Magazine Yogkshem Magazine, Outlook Express,Business today, Finance & Banking Money Outlook News Paper Business standard, Times of India, Economic times, Hindustan times

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