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Non Banking Financial Companies (NBFCs)

Presentation By Saurabh Suman & Tarun Rai

NBFCs- Overview

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-Legal framework for NBFCs -Regulatory framework for NBFCs -Audit of a NBFCs

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NBFCs Legal Framework

Which is a NBFC?
A company which carried on as its business or part of its business the following activities: - financing - acquisition of securities - hire purchase - insurance - chit fund - mutual benefit company But does not include a company which carries on as its principal business: - agricultural operations, - industrial activities - Sale and purchase of goods - providing of services - purchase, sale and construction of immovable property

Definition of Principal Business


RBI Press Release Dt. April 8, 1999
- If 50% or more of a companys total assets (netted off by intangible assets) are financial assets and - If 50% or more of a companys gross income is from financial assets then the Principal Business of the company is of a NBFC

Legal Framework
Always Remember

NBFC per se is a licensed activity like Banking, Stock Broking, Money Changing. Acceptance of Public Deposits is irrelevant for NBFC test. Income earned & Deployment of Funds are determining factors

RBI Press Release No. 1999-2000/1042 dated 8.2.2000

Registration and Net Owned Fund (Sec 45- IA)


No NBFC shall commence or carry on business of NBFI without obtaining a Certificate of Registration & having minimum Net owned funds
Registration with RBI is mandatory for all companies interested in carrying on non- banking finance activities. Minimum Net Owned funds of Rs.2 Crores.

Computation of Net Owned Fund


Paid up share capital Add : free reserves (created through an allocation of profits) Deduct : accumulated balance of losses : deferred revenue expenditure : other intangible assets Deduct : if the following are in excess of 10% 0f the above

-Investment in shares in shares of subsidiaries, cos., in the same group and other NBFCs
-Book value of debentures, bonds, loans & advances to subsidiaries and cos. in the same group -Deposits with subsidiaries and cos. in the same group

Exemptions from registration


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1. Housing finance company 2. Insurance company 3. Chit Fund company 4. Stock exchange 5. Securitisation and Reconstruction company 6. Mortgage Guarantee Company 7. Nidhi company 8. Mutual Benefit Company 9. Venture capital fund company 10. Micro Finance company 11. Merchant banking company 12.Stock brokers and sub-brokers

Exemption to Venture Capital Fund Companies

Provided they comply with the following conditions:

Hold registration with SEBI under related regulations, Do not accept or hold public deposits.

Exemption to NBFCs engaged in Micro Financing


Provided the following conditions are met:
- providing credit not exceeding Rs.50,000 for a business enterprise and Rs.1,25,000 for meeting the cost of a dwelling unit to any poor person,

- licensed U/S. 25 of the Companies Act, 1956 and


- not accepting public deposits.

Exemption to Merchant banking Companies

Provided they comply with the following conditions:

Registered with SEBI under related regulations, Acquires securities only as a part of its merchant banking business, Does not carry on any other financial activities and Does not accept or hold public deposits

Exemption to Stock Brokers and subbrokers

-Doing the business of stock broker or sub-broker and - holding a valid certificate of registration from SEBI.

Exemption to Core Investment Companies (CICs)

Definition:

-If 90% or more assets are invested in Group Companies (subsidiaries, Associates and JVs) ( as per last audited accounts) - it is not trading in those shares( except for block sale) - does not carry any other NBFI activities and

- it is not accepting or holding any public deposits.

Recent announcement relating to Core Investment Companies

-CICs having asset size of Rs. 100 Crores and more:

-to be considered as systemically important CICs. (CICs-ND-SI)

- all group CICs to be clubbed for calculating the asset size.


- would require registration u/s 45-IA of the RBI Act. - 90% criteria to be seen as investment in equity, preference shares as well as loans to group companies (with only minimum 60% in shares). - can make bank deposits and investment in money market securities and Govt. Securities -Transitory provision: can apply within six months and can continue to carry on business till decision of RBI regarding registration.

Concerned Areas

A large number of NBFCs are working without registration:

Companies working without registration and Companies rejected by RBI still operating.

Penalties:

Imprisonment 1 to 5 years and Fine of Rs. 1 lakh to 5 lakhs.

Registration Process
1.

1.Application for Registration in the prescribed Form containing: Identification Particulars, Capital Funds & Risk Assets, Information on Management. Ann-III 2.MOA, AOA, Board Resolution, Accounts and Business Plan. 3. Application to be filed on line.

Registration Process-vetting

- Management Background

BOD
Executive Funding

- Track record of other NBFCs in the group - CR from Bankers - Interview of promoters/directors - Definitive business plan - Auditors certificate

Registration Process- rejection & appeal


-Appeal against the RBI Order rejecting the Application to the Central Government, Ministry of Finance - To 1. to dispose of financial assets within 3 years from date of rejection/cancellation. 2. If deposit taking i) repay deposits and ii) report outstanding position on monthly basis (NBS-4) 3. Take up Other objects & change the name 4. Voluntary winding up

Continuance of business of NBFI


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-Certificate from statutory auditors to be submitted to RBI every year. - Confirming that it continue to undertake business of NBFI and therefore requires to hold CoR granted by RBI.

Change in control/management of a NBFC


For all NBFCs: - public notice 30 days before effecting the sale or transfer, - in two newspapers one English and local vernacular language, - jointly by NBFC, transferor and transferee, - within seven days of publication, intimation RBI For Deposit Accepting NBFCs - Prior approval of RBI - Obligation towards deposit holders

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NBFCs Regulatory Framework

Classification of NBFCs
Based on nature of business:
Asset finance companies Investment companies Loan companies Infrastructure finance companies

Asset finance co.(AFC) and Infrastructure finance co.(IFC)


AFC: Financing of physical assets supporting productive economic activities such as automobiles, tractors, earth moving machinery, lathe machines, generator sets, material handling equipments and general purpose industrial machinery. IFC: long term funding for developing or operating and maintaining or developing, operating and maintaining any infrastructure project in road, highway, port, airport inland port, waterways, water supply, irrigation project, water treatment, sanitation and sewage system or solid waste management, telecom services (basic or cellular), network and internet service, transmission or distribution of power, laying down and maintenance of gas, crude oil and petroleum pipelines

Classification of NBFCs
Based on acceptance of Public Deposits
- Deposit holding/accepting Company - Category A - Non-Deposit holding/accepting Company - Category B Based on investment pattern - Investment company (Cat A or Cat B) - Core Investment company - Category C

RBI Regulations for Category A companies

-NBFC Acceptance Of Public Deposit (RB) Directions, 1998 -NBF (Deposit Accepting or Holding) companies Prudential Norms (RB) Directions,2007

- NBFC Advertisement Rules,1977.

NBFC Acceptance Of Public Deposit (RB) Directions, 1998


Regulated deposits and exempt deposits Quantum of deposit Credit rating Advertisement/ Statement in lieu of Advertisement Period of deposit Rate of interest Rate of brokerage

NBFC Acceptance Of Public Deposit (RB) Directions, 1998


Repayment of deposit Regularisation of excess deposit Premature payment of deposits Loan against deposit Default in payment of deposit or interest thereon Interest on overdue deposits Deposit Register Deposit Receipts

NBFC Acceptance Of Public Deposit (RB) Directions, 1998


Percentage of Liquid assets Nature of liquid assets Mode of liquid assets Safe custody of approved securities Floating charge on liquid assets in favour of depositors

NBFC Acceptance Of Public Deposit (RB) Directions, 1998


KYC norms Due diligence of deposit accepting agents/brokers

Returns to be filed with RBI Under NBFC Acceptance of Public Deposit (RB) Directions

-Qtly returns (NBS 3) -Annual Return (NBS 1) -Audited financial statements with directors report

RBI Regulations for Category B companies

-NBF (Non-Deposit Accepting or Holding ) Companies Prudential Norms (RB) Directions, 2007 -Additional rules for NBFCs-ND-SI (having total assets of Rs.100 Crores and above as shown in the last audited Balance Sheet).

Regulatory Framework for CICs-ND-SI

-To maintain prescribed minimum capital ratio and leverage ratio. -Adjusted net worth should not be less than 30% of aggregated risk weighted assets on balance sheet and risk adjusted off balance sheet items. -outside liability should not exceed 2.5 times of its adjusted net worth based on the last audited accounts. Would be entitled to exemptions:

- of maintaining minimum NOF - of prudential norms relating to capital adequacy and exposure norms.

NBFC Prudential Norms

1. Separately for Category A and Category B companies. 2. Additional requirements for Category A companies. 3. Exemptions.

NBFC Prudential Norms


Accounting policies Accounting standards Revenue recognition

NBFC Prudential Norms


Investment in land & building Investment in shares Policy on investment and disclosure Income from investment Exposure to capital market

NBFC Prudential Norms


Classification of debtors Provisioning norms Disclosure Accounting for Repossessed assets

NBFC Prudential Norms

Policy for call/demand loans


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- Period - Interest - Renewal - Reporting and approval

NBFC Prudential Norms

Concentration of loans/investment

- single borrower - more than one borrowers in one group


- investment in one company - investment in more than one companies in a group

NBFC Prudential Norms

Schedule to the Balance Sheet

- to be appended to the Balance sheet prescribed under the Companies Act, 1956 - showing loans and advances and deposits outstanding and overdue - borrower groupwise classification of all assets, lease, HP and Loans and advances - Investor groupwise classification of all investment in shares and securities - information on NPAs.

NBFC Prudential Norms

Communications to RBI (DNBS)

Change in director ship Change in ownership Change in address of registered office Change in statutory auditors Deposit accepting branch- opening & closure

Directions for fair practices


- Code for Fair Practices - To be framed and adopted by BOD - To be filed with RBI - To be publicised

Returns to be filed with RBI Under Prudential Norms Directions

Half yearly returns (NBS-2)

Other Returns

Returns to Fraud Monitoring Cell.

Information regarding prevention of money laundering under PMLA.


AIR information under Income Tax Act.

Monitoring by RBI

Off-site surveillance

Returns Auditors Reports Market intelligence

On-site surveillance

Inspections Special audits

NBFCs

Issues relating to audit

AUDIT OF NBFCs- Issues

Regulatory framework for auditors Reporting requirements for auditors

AUDIT OF NBFCs- Regulatory Framework

Compliance of the provisions of:


The Companies Act, 1956 The Reserve Bank of India Act, 1934 The Income Tax Act, 1961 Rules and Directions framed under these Acts. Disclosure requirements of SEBI( by listed cos.)

Compliance of Auditing & Assurance Standards

AUDIT OF NBFCs- Legal &Regulatory Framework

-Compliance of legal framework by NBFCs

-Compliance of various directions given under the Act:


-For deposit accepting or holding NBFCs -For non- deposit accepting or holding NBFCs

-For SI-ND-NBFC.

Good Corporate Governance

-Rotation of partners of statutory auditors audit firm of companies with deposits of Rs. 50 Crores and more -Rotation after every three years -Companies may incorporate terms in the letter of appointment to ensure compliance

AUDIT OF NBFCs- Regulatory Framework

Compliance of Auditing & Assurance Standards:

While discharging attestation function, it is duty of the member of the Institute to ensure that AASs are followed in audit of information covered by their audit reports. In case AASs could not be followed, the report should draw attention to the material departure.

AUDIT OF NBFCs- Regulatory Framework

Compliance of Auditing & Assurance Standards:

SA310 SA250 SA700

Knowledge of the Business. Consideration of Laws & Regulations in an Audit of financial statements. The Auditors Report on Financial Statements.

AUDIT OF NBFCs- Reporting Requirements

Under the Companies Act, 1956 Report under Section 227(2) Report required by the Companies (Auditors Report) Order, 2003 Compliance of accounting standards.

AUDIT OF NBFCs- Reporting Requirements

Under the Income Tax Act, 1961

Tax Audit Report under section 44AB

Reporting Requirements under the RBI Act

Section 45MA powers & duties of auditors -Duty of the auditor to enquire whether prescribed statements, information or particulars relating to deposits have been furnished to RBI -If not satisfied on enquiry, to make report to the Bank giving details of deposits, -Annual return of deposits, half yearly returns on prudential norms to be certified and filed.

Reporting Requirements under the RBI Act

Section 45MA: Powers & duties of auditors NBFC Auditors Report(RB) Directions, 2008

( Notification 201 dated 18.9.2008) in terms of section 45MA(1A)

AUDIT OF NBFCs- Reporting Requirements


-Special Report to the Board of Directors of the co. in terms of Para 2 of NBFC Auditors Report ( RB) Directions, 2008. -Exceptional Report to the RBI in specific circumstances in terms of Para 5 of NBFC Auditors Report( RB) Directions, 2008. -Schedule to the Balance sheet in terms of Prudential Norms Directions,2007. -Periodical Certified Returns to RBI.

Other Certificates to NBFCs

-Yearly Certification of carrying of NBFC business - Certification attached to Annual Return and Half Yearly Returns

AUDIT OF NBFCs

Guidance Note on the Duty Cast on the Auditors under Section 45MA of the Reserve Bank of India Act, 1934 issued by ICAI Section 58B (4AA) of RBI Act- if any auditor fails to comply with any direction given or order made under section 45MA, he shall be punishable with fine which may extend to five thousand rupees.