Management of financial services

Variety of Services: The financial services sector provides specialized services such as credit rating, venture capital financing, lease financing factoring, mutual funds, merchant bank

Management of Financial Services

School of Distance Education Bharathiar University, Coimbatore - 641 046

MBA Second Year (Financial Management)

Author: Shankari Parivallal Copyright © 2008, Bharathiar University

All Rights Reserved

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SCHOOL OF DISTANCE EDUCATION

Bharathiar University

Coimbatore-641046

Page No UNIT I

UNIT II

UNIT III

UNIT IV

UNIT V Lesson 13 Securitisation and Recent Developments in Financial Services 197

MANAGEMENT OF FINANCIAL SERVICES

SYLLABUS

UNIT I

Financial services - Meaning - Types - Fund based and Fee based financial services

- Non-Banking Financial Companies - Functions Prudential Norms for NBFCs

UNIT V

Securitisation and Financial Reconstruction and Enforcement of Security interestAct - regulations - Recent developments in the financial Services industry

5 Introduction to Financial Services

UNIT I

7 Introduction to Financial Services

1.2 Meaning of Financial Services

1.2.1 Functions of Financial Services

1.2.2 Characteristics of Financial Services

1.2.3 Constituents of Financial Services Market

1.3 Types of Financial Services

1.3.1 Merchant Banking Era

1.3.2 Investment Companies Era

1.3.3 Modern Services Era

1.3.4 Depository Era

1.3.5 Legislative Era

1.3.6 Flls Era

1.3.7 Problems of Financial Services Sector

1.4 Fund Based and Fee Based Financial Services and Regulatory Framework

1.4.1 The Need for Regulation

1.4.2 Types of Regulatory Framework

1.0 AIMS AND OBJECTIVES

After studying this lesson, you should be able to:

z Comprehend the concept of financial services

z Know about the types of financial services

z Learn about fund based and fee based financial services

8

Management of Financial Services 1.1 INTRODUCTION

Financial services form important constituents of the financial system Financial services, through the system of elements such as financial organizations, financial markets and financial instruments, meet the needs of individuals, institutions and corporate It is through this network that the functioning of the financial system is facilitated

1.2 MEANING OF FINANCIAL SERVICES

Services that are offered by financial service companies are called financial services Financial service companies comprises of both asset management companies and liability management companies Asset management companies include leasing companies, mutual funds, merchant bankers and issue portfolio managers, liability management companies comprise of the bill discounting and acceptance houses

1.2.1 Functions of Financial Services

Following are the objectives of financial services that are generally provided by financial service companies:

1 Raising Funds: Financial services facilitate to raise the required funds from a

host of investors, individuals, institutions and companies For this purpose, various instruments of finance are used The funds are demanded by corporate organizations, individuals, etc

2 Effective Usage of Funds: A number of financial services are available in the

financial markets, which enable the players to ensure an effective usage of the funds raised Financial services also help in the decision making regarding the financing mix Bills discounting factoring, credit rating, e-commerce, and securitization of debts are some of the financial services offered by firms to make sure that there is efficient management of funds

3 Variety of Services: The financial services sector provides specialized services

such as credit rating, venture capital financing, lease financing factoring, mutual funds, merchant banking and insurance Agencies, subsidiaries of financial institutions, banks and insurance companies also extend these services

4 Legal Regulation: There are some agencies that are regulating the financial

services activities In India, agencies like the Securities and Exchange Board of India (SEBI), Reserve bank of India (RBI) and the Department of banking and insurance of the government of India, through various legislations, regulate the operations of the financial service institutions

5 Economic Growth: Financial services contribute greatly to speeding up the

process of economic growth and development This is done through the mobilization of the savings of a cross section of people, for the purpose of diverting them into productive investments In this regard, it is to be noted that a number of developed and developing countries which have a highly organized financial market, have seen a greater rate of savings and investments

1.2.2 Characteristics of Financial Services

Like any other service, financial services have the following characteristics:

1 Intangibility: One of the basic characteristics of financial services is that they are

intangible (lack of physical structure) in nature For financial services to be

9 Introduction to Financial Services

successfully created and marketed, the institutions offering them must have a

good image and the confidence of its clients Quality and innovativeness of

services are the focal point for building credibility and gaining the trust of the

clients

2 Customer Orientation: The institutions providing the financial services study the

needs of the customers in detail Based on the results of the study, they come out

with innovative financial strategies that give due regard to costs, liquidity and

maturity considerations for various financial products This way, financial

services are customer-oriented

3 Inseparability: The functions of producing and supplying financial services have

to be carried out simultaneously This calls for a perfect understanding between

the financial services firms and their clients

4 Perish-ability: Financial services have to be created and delivered to the target

clients They cannot be stored They have to be supplied according to the

requirements of customers Hence, it is imperative that the providers of financial

services ensure a mach between demand and supply

5 Dynamism: The financial services have to be created and delivered on the basis of

socio-economic changes occurring in the economy, such as disposable income

Standard of living, level of education, etc financial services institutions must by

proactive in nature, and evolve new services by visualizing the expectations of the

market

The market for the exchange of financial products and instruments through a wide

variety of players, each one offering a unique type of service, may be designated as

the financial services market

1.2.3 Constituents of Financial Services Market

The financial services market comprises of four major constituents as stated below:

1 Market Players: Financial services offered by a host of intuitions and agencies

that understand and meet the requirements of a wide spectrum of customers The

players include banks, financing institutions, mutual funds, merchant bankers,

stockbrokers, consultants, consultants, underwriters, market makers, etc

2 Instruments: Financial instruments constitute an important part of the financial

services market; the instruments include equity instruments, debt instruments,

hybrid and exotic instruments It is characteristic of a financial services market

that a member of innovative instruments such as zero – coupons bonds etc are

floated, on a continuous basis

3 Specialized Institutions: These include acceptance houses Discount houses

Faction depositories The regulatory bodies include the department of banking and

insurance of the central government bank of India securities and the exchange

board of India, board for industrial and financial reconstruction, etc

4 Regulatory Bodies: The financial services market is regulated by a host of

institutions and agencies The regulatory bodies include: The Department of

Banking and Insurance of the Central Government, Reserve Bank of India,

Securities and Exchange Board of India, Board for Industrial and Financial

Reconstruction

10

Fill in the blanks:

1 One of the basic characteristics of financial services is that they are

………… (lack of physical structure) in nature

2 For financial services to be successfully created and marketed, the institutions offering them must have a good image and the confidence of its…………

3 Quality and innovativeness of services are the focal point for building credibility and gaining the trust of the …………

4 The institutions providing the financial services study the ………… of the customers in detail

1.3 TYPES OF FINANCIAL SERVICES

The growth of financial services in India has taken place under various tags It is outlined below:

1.3.1 Merchant Banking Era

The period between 1960 and 1980 may be called the merchant banking era During this period, financial services such as merchant banking, insurance and leasing services began to grow Merchant bankers carried out the following functions:

1 Identifying project, preparing feasibility reports and developing detailed project reports

2 Conducing marketing, managerial financial and technical analysis on behalf of their clients

3 Assist in designing an appropriate capital structure

4 Acting as a bridge between the capital market and the fund-seeking institutions

5 Underwriting

6 Assisting enterprises in getting their issues listed on the stock exchange

7 Offering legal advice relating to mergers and acquisitions

8 Providing technical advice on leveraged buyouts and takeovers

9 Extending syndication facility as part of arranging project finance

10 Arranging working capital loans

1.3.2 Investment Companies Era

This era marked the setting up of variety of investment institutions and banks The investment companies include the unit trust of India, which is the largest public sector mutual fund in the world, the life insurance corporation of India that initiated the life insurance businesses and the general insurance corporations The life insurance corporation of India has grown as a public monopoly In 1970, insurance, which until then was in the private sector, was nationalized On nationalization, an insurance corporation was set up as a holding company with four subsidiaries to handle the general insurance businesses in the public sector The leasing business started emerging at the close 1970s Although such companies were initially engaged in equipment lease financing, later they undertook leasing operations of different kinds, such as financial, operation and wet leasing

11 Introduction to Financial Services

1.3.3 Modern Services Era

This stage marked the launch of variety financial products and services during the

eighties, these financial services included over-the-counter services, share transfers,

pledging of shares, mutual funds, factoring, discounting venture capital, and credit

rating The mutual fund industry introduced innovative schemes for savings

mobilization on order to encourage the savings habit among the people With their

transparent asset and liability management, mutual funds offer attractive and stable

returns on the investors, money

An important financial service that was introduced in the Indian financial sector was

the credit rating The system of credit rating was designed to boost investor’s

confidence, and encourage their active participation in the capital market operations,

beside promoting sound financial discipline in the system The constitution of venture

capital funds was another landmark development in the Indian financial services

sector Factoring became a popular mode of short-term financing, both in domestic as

well as international trade transactions The entry of commercial banks in the field of

the above services the entire profile of the financial system in India

1.3.4 Depository Era

In order to integrate the Indian financial sector industry with the global financial

services industry, depositories were set up The depository system was introduced

with introduced with a view to promoting the concept of paperless trading though the

de materializations of shares and bonds The stock-lending scheme approved by the

central government in the 1997 -98 budget conceived the idea of setting up a separate

corporation to deal with the trading of Gilt The introduction and popularization of

book-building was also another step forward in the direction of building a strong

financial services sector in India, this step is lively to benefit both the investors and

fund users, similarly, the online trading interface introduced by the Bombay stock

exchange, the Delhi stock exchange, and the computerization of the national stock

exchanges, are all action as the fulcrum for the development of a strong financial

services market in inked, such a measure is expected to give a fillip to paperless

trading, save the investors from the onslaught of jobbers and bookers, and encore

better tax compliance In order to protect investor interest and to pave the way for

regulation, growth and development of financial services, the SEBI issues periodical

guidelines relation t the capital adequacy ration fro merchant bankers and others

players in the financial system

1.3.5 Legislative Era

Several legislations were introduced in order for broad – based development in the

financial services sector The FERA has been replaced by FEMA For – reaching

amendments have been made in the Indian Companies Act, Income Tax Act, etc.,

facilitate safe and orderly trading, and settlement of transactions A landmark

development that took place in the legislative era was the enactment of a separate law

to regulate the Internet trading of securities

1.3.6 Flls Era

The economic reform measures, initiated by the government, necessitated greater free

play for various participants As part of it, divestment guidelines have been issued by

the SEBI in recent time, whereby foreign investors to plunge into the Indian capital

market and contribute to its growth and development

Financial services firms in India are increasingly looking for easy means by which the

Indian corporate sector could mop up capital from the international financial markets

such as London, Luxembourg, New York, etc GDR is the usual route though which

12

Management of Financial Services these portfolio investments have flown to India The Indian financial services

institutions work together with world-level financial services institutions, such as Lehman brothers, Arthur Anderson and Goldman This can be seen as part of their efforts to upgrade to world standards in the matter of management of financial services

1.3.7 Problems of Financial Services Sector

The Indian financial services industry has been taking rapid strides in making its presence felt in various spheres of financial services It is preparing itself to face competition, especially from its global counterparts With the gradual opening up of the economy, this sector is fast integrating with global financial markets, besides effectively tackling the competitions from foreign financial firms in India However, this sector faces many problems As brief description of some of these problems of Merchant Banking and Financial Services are presented below:

1 Lack of Expertise: To be able to understand and implement many of the financial

services schemes Experts are required Despite the presence of a number of institutions and professional bodies, there has been a dearth of personnel with expert knowledge to manage the firms engaged in financial services in India The public sector financial services industry, for instance, is constrained by retractions imposed on salaries, etc and the private sector firms too cannot match the offers made by the foreign financial firms

2 Inadequate Accommodation: Financial services firms require accommodation at

central locations in order to be able to effectively cater to the needs of a wide variety of clients Finding a suitable place in the financial capital of India, Mumbai has become a serious problem due to skyrocketing real estate prices

3 Inadequate Technology: One of the basic problems faced by the Indian financial

services firms is that they lack adequate and time-tested technology to efficiently create and deliver the financial products to the clients For instance relative trade growth of computer and telecommunication technology has constrained the growth of the financial services industry in India considerably in the initial period Institutions and banks lack sufficient networking facility needed ford undertaking the transfer of various instruments

4 Inadequate Quality Service: Rending; financial service efficiently is the

cornerstone of a successful financial services market In fact, the key to survival is

to deliver quality services and products at the right price, at the right place and at the right time This calls for the application of appropriate technology to process a large flow of information to their clients Indian financial services firms need to improve the quality of their services to the satisfaction of their clients Very often there is complaint of high fees and poor quality service The work of credit rating agencies also comes under attack, as the grading furnished by them is often unreliable

5 Captive Organizations: The practice in India is that, lots of financial service

institutions have been set-up as subsidiary organizations of large commercial banks and financial institutions The subsidiary institutions, thus depend on their parent institutions for funds This obligates the parent firms to lend at rates of interest lower than that of the market rates, despite situations where the parent institutions are hard-pressed to raise funds at a higher cost Although such a practice helps the subsidiaries to operate economically with adequate margin, it deprives the parent institutions of making efficient use of their funds, this results

in increased cost of funds being allocated to the financial services subsidiaries, moreover, the practice has failed to provide al level-playing filed to the financial

13 Introduction to Financial Services

services subsidiaries Moreover, the practice has failed to provide a level- playing

field to the financial service enterprises, thus eroding their competitive advantage

6 Restricted Scope of Operations: The scope of operations relating to financial

services is currently restricted to certain segments For instance, the scope of

venture capital operations in India is restricted to providing finance for star up

high – tech projects and to converting R&D efforts into commercial production

Venture capital funds in India are shy of entering the services sector The scope

must be widened to include a variety of services such as supply of seed capital for

expansion and growth, buyouts, turnarounds, mergers and acquisitions, etc, in the

same way, lease financing should not be restricted to operation and financial

lease

7 Limited Innovation: The growth and development of the financial system is

measured in terms of the width and depth of the fanged of products offered by it

There has been limited innovation in the terms of financial services products It is

imperative therefore that the financial services sector works to achieve growth and

development, by innovation and introducing a wide range of financial products to

suit the needs of varying entrepreneurs For instance, a number of tailor –made

and imaginatively designed financial packages may be offered by the venture

capital funds to satisfy the needs of entrepreneurs

Similarly, leasing firms should be encouraged to provide leasing facilities for a

variety of capital equipment, besides ensuring that leasing companies are not

created merely to read in tax shields at movement cost

8 Lack of Sound Institutional Mechanism: An immediate requirement for a

healthy financial services sector is the existence of a sound institutional

mechanism This is important for a broad based and a strong financial system

Moreover, there must be a wide range of financial services The establishment of

a sound institutional mechanism, whereby the existing financial institutions, banks

and insurance companies are allowed to open full-fledged subsidiaries, is called

for

9 Other Problems: The following are some of the other problems faced by the

financial services institutions in India

a Lack of core-competence and insufficient competitive advantage

b Lack of reliable benchmarking thus depriving them of the benefit of

const-cost-reduction and review of processes and procedure governing their

activities

c Indulgence by certain firms in unfair practices including unethical advice to

their clients

Check Your Progress 2

Fill in the blanks:

1 The Indian financial services industry has been taking rapid strides in making

its presence felt in various spheres of ………

2 ……… is preparing itself to face competition, especially from its

global counterparts

3 With the gradual opening up of the economy, this sector is fast integrating

with global financial markets, besides effectively tackling the competitions

from foreign ……… in India

4 The growth and development of the financial system is measured in terms of

……… of the fanged of products offered by it

14

Management of Financial Services 1.4 FUND BASED AND FEE BASED FINANCIAL SERVICES

AND REGULATORY FRAMEWORK 1.4.1 The Need for Regulation

The need for regulation of the functioning of various intermediaries rendering financial services arises on account of the following reasons:

1 Economic Growth: Adequate and proper regulatory framework shall be put in

place for the process of smooth financial intermediation and disintermediation This is an essential requisite for the economy to grow and function smoothly The credit creation function of banking institutions allows the economy to multiply its money circulation to the extent demanded by the economy

Promoting Savings And Investments: The financial services industry, besides

channeling savings into productive investments, helps economic activities to take place without much difficulty

2 Efficient Financial Services: The efficiency with the various constituents of a

financial market redder series Such as the stockbrokers helping investors to sell and buy shares, is critical for the development of financial services and financial markets, for instance, the risk of many unknown event, like fire, flood etc that affect the business is protected by insurance companies, and this allows firms to perform third respective activities with confidence This makes the financial services almost indispensable in running the economy

3 Investor Protection Regulation: Investor protection Regulations of many hues are

required to be put in place in view of the importance of creating, safeguarding and sustaining the interest of the investor, especially the small and individual investors, and thus ensuring economic stability Regulations ensure that every requirement of trading in financial services is strictly companied with by the parties concerned to the utmost benefit of the investors who from the fulcrum of the financial services industry This works to usher in the much-needed confidence among investors in securities trading The financial services firms often take high risk to maximize return, and are thus more susceptible to default There fore, interest of investors may be imperiled by fraud, misfeasance etc which may eventually cause the collapse of an instituting due to mis-management

1.4.2 Types of Regulatory Framework

A broad classification of the regulatory framework relation to financial services sector

1 Institutional Regulations: Institutional regulations, also known as structural

regulations, are those that stem from a host of regulatory institutions set up in financial market by the government Structural regulations call for a host of regulatory institutions The object of these regulations is to promote healthy competition among the players The most important among these is the constitution of the apex agency, the securities and exchange board of India

15 Introduction to Financial Services

(SEBI) The agency insists that merchant bankers and stock broking institutions

have a separate fund-based activity Te reserve bank of India (RBI), another

structural entity, prescribes the activities that commercial banks could provide to

the investors

2 Prudential Regulations: Regulations relating to internal management of financial

institutions and other financial service organizations regarding capital adequacy,

liquidity and solvency may be called as prudential regulations These regulations

aim at preventing the firms without adequate resources, in this commotion, net

with regulations elating aim at preventing the entry of firm’s service firms is fixed

by the SEBI Similarly the RBI has come out with regulations relating to the

non-banking finance companies in raising public deposits

3 Investor Regulating Regulations: Regulations that are designed to protect the

interests of the small and individual investors, are called investor regulations The

primary objective of these regulations is to promote healthy trading and there by

instill confidence in investor In this connection, the role of SEBI is laudable, as it

comes out with periodic guideline on investor protection

4 Legislative Regulations: These regulation sere contained in the legislative

measures brought out by the government from time to time keeping in mind the

need for all-round development of the financial services industry Some of the

important regulations include – the Banking Regulation Act; Securities Contracts

(Regulation) Act, etc The legislations give birth to various regulatory authorities

that evolve rules, guidelines and regulations that govern the micro aspects and

operational issues

5 Self-regulations: In addition to the regulations, ordained by the regulatory,

institutions, legislations etc there are self-imposed regulations For instance, the

foreign exchange dealers have their own self-regulation, besides being governed

by legislative guidelines Similarly, the merchant bankers association in addition

to SEBI regulation has developed self-regulation that governs their members

1.4.3 Framework of Regulations

The regulatory framework in general aims at ensuring the soundness and safety of

financial institutions, and thus helps maintain the integrity of the transmission

mechanism as well as protection of the consumers of the financial services The

regulations which are in the form of Acts, regulatory authorities, notifications, rules,

directions guidelines and clarifications, ensure freedom of operation, to improve the

efficiency, and also provide adequate scope for innovation, in order to benefit the

investors and other participants

The framework of regulations currently operation in India is elaborated below:

1 Framework For Banking And Financing Services: Banking and financing

institutions engage themselves in the task of mobilizing from the ingestion

community and allocate funds to different users They therefore, conduct two

important activities of the economy, savings and investment, which together

determine its growth The functioning of the banking and financing institutions is

regulated by the central government and the RBI, keeping in mind the need for

friction the growth of the economy along desired lined The RBI takes up the

responsibility of regulation all institutions, through both the RBI Act and the

Banking Regulations Act, that are connected with savings and capital allocation

Further, regulations aim at ensuring the orderly functioning of the institutions that

raise and lend the capital

16

Management of Financial Services 2 Regulations Relating To Banking Institutions: Regulations relating to banking

institutions are as follows:

™ New Branch: Providing sanction for the establishment of new branch

™ Capital: Prescribing the minimum capital, reserves and use of profits and

reserves, distribution of dividends, maintenance of minimum cash reserves and other liquid assets

™ Inspection: Conducting inspection or investigation on the working of the

banks

™ Appointment: Controlling the appointment of chairman and Chief Executive

Officer of private banks and nominating members to the Board of Directors

™ Monetary Policy: Drawing up and implementing the appropriate monetary

and credit policies to effectively regulate the credit flows, and prescribing the amount available for credit by determining cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (STR) Carrying out treasury operations by periodically issuing bonds and REPOS

™ Credit Control: Implementing various credit control measures qualitative

and quantitative, to direct credit flow to different sectors and industries

™ Other Services: Regulating factoring, bill discounting and credit card services

offered by commercial banks and other institutions

3 Regulations Relating to the Non- banking Financial Companies: The

regulations relating to the non-banking financial companies are as follows:

The Non Banking Financial Companies (NBFCs), are chiefly regulated by the RBI, through a host of measures, including, the Banking Laws (Miscellaneous Provisions) Act, 1963 In addition, powers of regulation are also exercised by the RBI, under directives such as, the Non Banking Finance Companies Directions,1977 Miscellaneous Non-Banking Finance Companies Directions,

1977 and Residuary Non-Banking Companies

4 Merchant Banking and Financial Services: Direction 1987 NBFCs include loan

company’s investment companies, hire-purchase finance companies

The need for the regulation of NBFCs has arisen owing to the mushrooming of many unhealthy practices in this segment of the financial system Under the auspices of the above legislation, RBI exercises the following powers on the working of the NBFCs:

™ Reports: Requiring certain categories of NBFCs to register with it, provide

periodical statements on their working and collecting periodic reports and information on matters relating to the functioning of the NBFCs

™ Raising Funds: Prescribing the types of companies which are eligible to raise

funds from the public and prescribing the extent to which the funds could be raise and the terms and conditions thereof

™ Investment: Requirement to invest a certain percentage of the deposits in the

approved securities, and maintain reserve fund Formulating policy and giving directions relating to deployment of funds and capital adequacy norms, accounting standards, provision for bad and doubtful debts, etc

™ Inspection: Conducting inspection of the books of NBFCs and investigation

any aspects relating to the activities of the NBFCs

17 Introduction to Financial Services

™ Punishment: Punishing the erring NBFCs either by imposing penalties or by

suspending or canceling the license or registration, and initiating appropriate

actions against the management of NBCs

Recent regulations implemented by the RBI include: compulsory registration,

capital adequacy norm and mandatory credit rating, etc These steps are aimed at

restricting the mushrooming of companies that raise funds from the public In

addition to the regulations prescribed by the RBI, there are several acts and

regulations that govern different types of non-banking financial companies For

instance, the provisions of the Indian Contract Act, Motor Vehicles Act, Indian

Stamp Act, etc., are to be adhered to by the leasing companies Similarly, the

Indian Contract Act, Sale of Goods Act and Hire-Purchase Act govern

hire-purchase transactions In the same manner, the National Housing Bank (NHB) is

empowered, under the provisions of the NHB Act, 1987, to regulate the housing

finance companies The SEBI also regulates all these companies whenever they

approach the market to raise capital

5 Framework for Insurance Services: The Insurance Act, 1938, which was

administered by the Controller of Insurance, was meant to regulate the insurers

before the nationalization of life and general insurance, and the setting up LIC in

1956 and GIC in 1973 respectively as monolithic institutions The nationalization

of the insurance companies greatly modified the application of the above Act The

regulatory function came to be vested with LIC and GIC

Consequent to the recommendations of the Malhotra Committee, 1993, appointed

by the RBI to suggest measures to improve the efficiency of insurance services in

India, the Insurance Regulatory Authority (IRA) was constituted in 1996 The

IRA has come to exercise the following powers over the working of insurance

companies, both public and private sector

™ Orderly Growth: Regulating, promoting and ensuring orderly growth of the

insurance business

™ Exercise of Powers: Exercising all powers and performing all functions of the

Control of Insurance under the Insurance Act, 1938, LIC Act 1956 and

General Insurance Business (Nationalization) Act, 1972 or any other law

relating to insurance in force at the time

™ Protecting Policyholders: Protecting the interest of policyholders in matters

concerning assigning of policy nomination by policyholders, insurable

interest, settlement of insurance claims, surrender value of policy and other

terms and conditions of contract insurance, besides controlling and regulating

the rates, advantages, terms and conditions that may be offered by the insurer

™ Professionalisation: Promoting and regulating professional organization

connected with the insurance business

™ Information: Calling for information from, undertaking inspection and

conducting enquiries and investigation, including audit of the insurers,

insurance intermediaries and other organizations connected with the insurance

business

™ Books Maintenance: Prescribing the form and manner in which books of

accounts will be maintained and statements of accounts will be rendered by

insurance and other insurance intermediaries

™ Investment: Regulating investment of funds by insurance companies and

regulation of maintenance of margin of solvency

™ Adjudication: Adjudicating disputes between insurers and intermediaries

18

Management of Financial Services 6 Framework for Investment Services: Fund–based activities broadly fall under the

investment services The mutual funds and venture capital funds also fall directly under the investment services Similarly, stock exchanges and stock broking institutions have a close link with the investment activities, and thus regulations

on them could be conveniently discussed along with other direct investment activities The Securities Contracts (Regulations) Act (SCRA), 1956, SEBI Regulations and Reserve Bank of India constitute the regulatory set up

7 Regulation by the SEBI: The SEBI, which was setup in 1988, on the

recommendations of the stock Exchange Reforms committee headed by G.S.Patel,

is entrusted with the following general regulatory powers aimed at promoting the development of the securities market and protecting the interest of investors:

™ Stock Exchanges: Regulating the business of stock exchanges and any other

securities markets

™ Stock Brokers: Regulating the business the working of stock brokers,

sub-brokers, share transfer agent, merchant brokers and other intermediaries who may be associated with the securities market in any manner

™ Investment Schemes: Registering and regulating the working of collective

investment schemes, including mutual funds

™ Investor Protection: Prohibiting fraudulent and unfair trade practices relating

to securities markets, promoting investors education and training intermediaries of securities markets, prohibiting insider trading in securities, regulating substantial acquisition of shares and take-over of companies

™ Information: Calling for information from, undertaking inspection,

conducting enquiries and audits of the stock exchanges, intermediaries and self-regulatory organization in the securities markets

™ SCRA: Performing such functions and exercising such powers under the

SCRA, 1952 as may be delegated to it by the Central Government, levying fees or other charges for carrying out these activities, conducting research for the above purpose and, performing other such functions as may be required

8 SEBI Guidelines: In addition to the general powers of regulation, SEBI also

provides guidelines for some of the specific financial services as described below:

™ Mutual Funds: Regarding mutual funds, the SEBI has broadly categorized

mutual funds into three, as Unit Trust of India, Public Sector and Private

Sector Mutual Funds Market, and Off-shore Mutual Funds The Government

of India established the Unit Trust of India (UTI) in 1964 The UTI is regulated by the UTI Act, 1963, The Reserve Bank of India, Government of India and the SEBI, through their periodical guidelines, govern public sector bank’s mutual funds and private sector and foreign mutual funds operating in India

™ Requirement of compulsory registration of all public and private sector mutual fund companies with the SEBI and approval of individual schemes offered by the mutual funds

™ Separation of mutual funds service from investment activities, that has to be entrusted with a separate company known as Asset Management Company (AMC)

™ Prescribing detailed disclosure norms to ensure transparency in the operation

of mutual funds schemes The SEBI has issued a fresh set of regulations

19 Introduction to Financial Services

governing mutual funds in 1996 Since Mutual Funds are established as a

Trust, the Indian Trust Act, 1882, also regulates them

™ The Reserve Bank of India regulates the Money Market Mutual Funds

(MMMF) and Off-shore Mutual Funds (OMC)

9 Venture Capital Financing: Venture capital institutions participate in the equity

of companies which are not in a position to raise equity capital directly from the

market, either due to new technology or due to small size of the venture in the

initial stage The venture capital institutions sell the equity in the market once the

company establishes its standing in the market, and normally, such public offers

are accompanied with a similar public offering from the company Venture capital

was originally in the form of special schemes of Development Finance Institutions

(DFI) Some of the regulatory features of venture capital financing are as follows:

™ Union Government: Formulation of scheme by the union government under

which, Venture Capital Funds (VCF), Venture Capital Companies (VCC), are

enabled to invest in new enterprises and are eligible for favorable treatment of

capital gains and dividend, requirement of approval of the Government of

India for overseas venture capital companies to operate in India form 1995

under the aegis of Foreign Investment Approval Board (FIAB)

™ CCI: Initial regulatory guidelines from the Controller of Capital (CCI), which

was taken over by the SEBI from 1995

™ SEBI: SEBI’s Venture Capital Funds Regulation 1996, prescribing

compulsory registration of VCF, investment conditions, management of the

company and maintenance of records

™ Inspection: Carrying out the inspection of books, investigating charges and

initiating penal action against the erring VCF

™ I.T.I Act: Regulation of VCFs under the Income Tax Act, wherein the VCFs

are required to apply to the Director of Income Tax (Exemptions) to avail

favorable treatment on dividend income and capital gains which requires the

VCFs to fulfill certain condition laid down under the Act in order to get such

benefits

10 Portfolio Management Services: The Portfolio management services comprise of

the administration of portfolio of securities or funds, of the client Under the SEBI

(Portfolio Managers) Regulations, 1993, detailed guidelines have been issued to

regulate this advisory service According to these regulations, compulsory

registration of portfolio managers before starting their service is required In

addition, the guidelines also require disclosure norms and periodical reporting to

SEBI The portfolio management service of commercial banks is regulated by the

RBI guidelines

11 Stock Broking: Stockbrokers are members of a recognized stock exchange They

enable investors to by and sell securities in the secondary market They also act as

broker to companies that want to raise capital in the primary market The

regulations pertaining to the stock broking service under the Securities Contracts

(Regulation) Act, (SCRA) 1956 and its Rules 1957, SEBI (Brokers and

Sub-brokers) Regulations, 1992 and the by –laws of Stock Exchange are as follows:

™ Qualification: Prescribing the norms of qualification for membership in a

recognized stock exchange, books of accounts to be maintained by the

members, and the minimum number of years the documents and books are to

be maintained under the SCRA

20

Management of Financial Services ™ Registration: SEBI requiring compulsory registration of the members of the

stock exchange and registration of the sub-brokers with the recognized stock exchanges

™ Capital Adequacy: SEBI prescribing net-worth requirement and capital

adequacy norms, books and records to be maintained, and code to be adopted

by the members

™ Inspection: SEBI inspecting books and records, and investigating the

investors and other brokers’ complaints against the stockbroker

™ By Laws: By laws of stock exchanges prescribing the methods of conducting

business and dealing with other members of the exchange, and prescribing methods of settling disputes between the members, and members and investors

™ Working knowledge: Requiring the members of stock exchange to have a

working knowledge of the Negotiable Instruments Act, 1881, Indian Stamp Act, 1889 in force in their respective states, and also the provisions relating to Service Tax introduced in the Finance Act, 1994

12 Framework For Merchant Banking And Other Services: The functioning of the

various intermediaries associated with management of public and rights issue of capital such as merchant bankers, underwriters, brokers, market makers, registers, advisors, collection bankers, market makers, registrar, advisors, collection bankers, advertisement consultant, debenture trustees, credit ration agencies and

so on are regulated by the SEBI guidelines as detailed below:

™ SEBI (Merchant Banker) Regulation, 1992

™ SEBI Rules for underwriters

™ SEBI (Brokers and Sub-brokers) Regulation, 1992

™ SEBI Rules for (Registrars to an Issue and Share Transfer Agents) Rules,

1993

™ SEBI (Bankers to An Issue) Regulations, 1994

™ SEBI (Debenture Trustees) Regulation, 1993

™ Code of Advertisement to Capital Offerings

Check Your Progress 3

Fill in the blanks:

1 ……… and ……… are the objectives of financial services offered by finance companies

2 Examples of financial services are ……… and ………

3 ……… and ……… are instruments used in financial services

4 ……… and ……… are the characteristics of financial services

5 ……… and ……… are the problems faced by Indian financial services sector

13 Regulations Pertaining to the Merchant Bankers and Other Intermediaries

Following are the regulations pertaining to the merchant bankers and other intermediaries:

™ Registration with the SEBI under the relevant regulations before commencing business

21 Introduction to Financial Services

™ Prescription of eligibility norms and registrations, net worth and capital adequacy

norms wherever relevant, and code of conduct

™ Carrying out the inspection of books and records and conduction investigation on

the affairs of the intermediaries, and taking appropriate action against them

wherever required

™ Due compliance with all the guidelines of the SEBI and issuance of the

due-diligence certificate

™ Observance of guidelines under the SEBI Guidelines for disclosure and investor

protection, 1992 relation to issue of capital, and procedure to be followed by the

acquirer and the merchant banker for such acquisition of shares under the SEBI

(Substantial Acquisition of Shares and Take-over) Regulations, 1994

1.5 LET US SUM UP

Financial services refer to services provided by the finance industry The finance

industry encompasses a broad range of organizations that deal with the management

of money Among these organizations are banks, credit card companies, insurance

companies, consumer finance companies, stock brokerages, investment funds and

some government sponsored enterprises

Services that are offered by financial companies are termed as financial services The

financial companies consist of both Asset Management companies and Liability

Management companies Asset Management companies include leasing companies,

mutual funds, merchant bankers and issue or portfolio managers The Liability

management companies include the bills discounting and acceptance houses

The Indian financial services sector has gone through different phases and is being

regulated and monitored by SEBI and the regulations are designed in such a way that

investors’ interest is protected

1.6 LESSON END ACTIVITIES

1 Prepare a study note on the fund based and fee based financial services in India

2 Do a case study with regard to a specific financial service offered by any Indian

bank

1.7 KEYWORDS

Financial Services: These include the range of services offered by a financial

institutions and agencies operating in a financial system

Financial System: A set of closely-knit agents, markets, practices, instruments,

transactions and claims relating to financial aspects of an economy

Financial Instruments: Financial claims such as financial assets and securities that

are dealt in a financial market

1.8 QUESTIONS FOR DISCUSSION

1 What are financial services? State the objectives of financial services

2 Briefly discuss the various types of financial services

3 Outline the status of financial services sector in India

1 Financial services, 2 Indian financial services industry, 3 Financial firms,

4 The width and depth

Management of Financial Services, V K Bhalla, Anmol Publications, New Delhi

Gentle, C.I.S (1993), The Financial Services Industry, Avebury, USA

23 Non-Banking Finance Companies

2.2 Definition of Non-Banking Financial Companies

2.2.1 Reserve Bank of India Act, 1934

Reserve Bank (Amendment Act) 1997 2.2.3 Categories of NBFCs

2.2.4 NBFCs and Banks

2.3 Functions of Non-Banking Financial Companies

2.3.1 Functions of Non-Banking Financial Entities Regulated by the RBI

2.3.2 The NBFCs Functioning in India (Till End-March 2007)

2.3.3 RBI Revises Capital Adequacy, Liquidity and Disclosure Norms for

Non-Banking Financial Companies (NBFCs) 2.3.4 NBFCs to Issue Co-branded Credit Cards

2.3.5 NBFCs to Market and Distribute Mutual Fund Products

2.3.6 Task Force on NBFCs (Vasudev Committee)

2.3.7 Credit Card Operations of NBFCs & Banks

2.3.8 Amendments to NBFC Regulations

2.4 Prudential Norms for NBFCs

2.4.1 Reserve Bank of India, Department of Non-Banking Supervision

Central Office, Centre I, World Trade Centre, Cuffe Parade, Colaba, Mumbai 400 005

2.4.2 New Directions for Non-Banking Finance Companies

24

Management of Financial Services 2.0 AIMS AND OBJECTIVES

After studying this lesson, you should be able to:

z Understand the meaning of Non-Banking Financial Companies

z Discuss about the functions of the Non-Banking Financial Companies

z Learn about the recent norms for Non-Banking Financial Companies

2.1 INTRODUCTION

Non-banking finance companies, which are heterogeneous in nature in terms of activity and size are important financial intermediaries and an integral part of the Indian financial system The main advantages of NBFCs lie in the lower transaction costs, quick-decision making, customer- orientation and prompt provision of services They have been able to carve out a niche for themselves in meeting the credit needs of both wholesale and retail customers Their number has gone up from 7,063 in 1941 to 51,929 in 1996 of these only 20% used to submit returns to the RBI In 1996, the regulated deposits of NBFCs amounted to Rs 38,110 crores Aggregate public deposits of 1547 NBFCs holding public deposits amounted to Rs 20,428.93 crores as

on March 31, 1999; and as a proportion to deposits with commercial banks they constituted 2.9% Non-banking deposits as a proportion of household savings in gross financial assets rose from 3.1% in 1980-81 to 7.4% in 1998-99 NBFCs attracted a large number of small investors since the rate of return on deposits with them was relatively high NBFCs are quite flexible in meeting the credit needs of specific sectors like equipment leasing, hire purchase, housing finance and consumer finance, where gaps between the demand and supply of funds have been high and where established financial entities are not easily accessible to borrowers The growth in number of NBFCs was facilitated by the ease of entry, limited fixed assets and absence of any need to hold inventories While their functions and the services they render are different, the common feature is acceptance of deposits from the public, borrowing from banks and in the case of companies organized as public limited companies, accessing the capital market

2.2 DEFINITION OF NON- BANKING FINANCIAL COMPANIES

2.2.1 Reserve Bank of India Act, 1934

Chapter III B, Section 45-I, Definitions

In this chapter, unless the context otherwise requires:

[(a) "business of a non-banking financial institution" means carrying on of the business of a financial institution referred to in clause (c) and includes business of a non-banking financial company referred to in clause (f);]

[(aa)] "company" means a company as defined in section 3 of the Companies Act,

1956 (1 of 1956) and includes a foreign company within the meaning of section 591

of that Act;

(b) "corporation" means a corporation incorporated by an Act of any Legislature; [(bb) "deposit" includes and shall be deemed always to have included any receipt of money by way of deposit or loan or in any other form, but does not include:

(i) amounts raised by way of share capital;

25 Non-Banking Finance Companies(ii) amounts contributed as capital by partners of a firm;

(iii) amounts received from a scheduled bank or a co-operative bank or any other

banking company as defined in clause (c) of section 5 of the Banking Regulation

Act, 1949 (10 of 1949);

(iv) any amount received from:

(a) the Development Bank,

(b) a State Financial Corporation,

(c) any financial institution specified in or under section 6A of the Industrial

Development Bank of India Act, 1964 (18 of 1964), or

(d) any other institution that may be specified by the Bank in this behalf;

(v) amounts received in the ordinary course of business, by way of:

(a) security deposit,

(b) dealership deposit,

(c) earnest money, or

(d) advance against orders for goods, properties or services;

(vi) any amount received from an individual or a firm or an association of individuals

not being a body corporate, registered under any enactment relating to money

lending which is for the time being in force in any State; and

(vii) any amount received by way of subscriptions in respect of a chit

Explanation I: "Chit" has the meaning assigned to it in clause (b) of section 2 of the

Chit Funds Act, 1982 (40 of 1982)

Explanation II: Any credit given by a seller to a buyer on the sale of any property

(whether movable or immovable) shall not be deemed to be deposit for the purposes

of this clause;

(c) "financial institution" means any non-banking institution which carries on as its

business or part of its business any of the following activities, namely:

(i) the financing, whether by way of making loans or advances or otherwise, of any

activity other than its own;

(ii) the acquisition of shares, stock, bonds, debentures or securities issued by a

government or local authority or other marketable securities of a like nature;

(iii) letting or delivering of any goods to a hirer under a hire-purchase agreement as

defined in clause (c) of section 2 of the Hire-Purchase Act, 1972 (26 of 1972);

(iv) the carrying on of any class of insurance business;

(v) managing, conducting or supervising, as foreman, agent or in any other capacity,

of chits or kuries as defined in any law which is for the time being in force in any

State, or any business, which is similar thereto;

(vi) collecting, for any purpose or under any scheme or arrangement by whatever

name called monies in lump sum or otherwise, by way of subscriptions or by sale

of units, or other instruments or in any other manner and awarding prizes or gifts,

whether in cash or kind, or disbursing monies in any other way, to persons from

whom monies are collected or to any other person,

26

Management of Financial Services [but does not include any institution, which carries on as its principal business:

(a) agricultural operations; or (aa) industrial activity; or;]

(b) the purchase or sale of any goods (other than securities) or the providing of any services; or

(c) the purchase, construction or sale of immovable property, so, however, that no portion of the income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons;

[Explanation: For the purposes of this clause, "industrial activity" means any activity

specified in sub-clauses (i) to (xviii) of clause (c) of section 2 of the Industrial Development Bank of India Act, 1964 (18 of 1964)];

(d) "firm" means a firm as defined in the Indian Partnership Act, 1932 (9 of 1932);

(e) "non-banking institution" means a company, corporation or co-operative society

[(f) "non-banking financial company" means- (i) a financial institution which is a company;

(ii) 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 any other manner, or lending Tiny manner;

(iii) such other non-banking institution or class of such institutions, as the bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.]

2.2.2 Reserve Bank (Amendment Act) 1997

According to the Act, “A Non Banking Finance Company (NBFC) Means

1 A finance institution which is a company

2 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 any other manner or lending in any manner

3 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 besides institutions, which carry on agricultural operations as their principal business

Now–a–days a Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by Government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property A non-banking institution which is a company and which has its principal business of receiving deposits under any scheme or arrangement or any other manner, or lending in any manner is also a non-banking financial company (Residuary non-banking company)

27 Non-Banking Finance Companies

Non-banking financial company is an obscure term for many people Let's understand

what a non-bank financial company in detail is and understand functions associated

with it Non-bank financial companies (NBFCs) are referred as the fiscal

organizations, which grant banking services but nowhere acts like an authorized bank

NBFCs do not possess a banking certificate Still, it processes and practices are

implemented as per the bank bylaw Hence, NBFCs practices as a bank with no bank

regulation Nonetheless, this relies on the authority, for instance in New Zealand, any

corporation can carry out the trade of banking, and requires no banking certificates

NBFCs offer various types of services which may be financially useful Non-bank

organizations often operate as loan brokers and credit services and helps investments

in assets and belongings NBFCs deals in capital market instruments and finances

private edification It also helps in assets administration such as handling portfolios of

stocks and shares and covering stock and shares, and other responsibilities and

retirement planning NBFCs suggest corporations in union and achievement organize

feasibility, studies market or industry for companies and reducing services such as cut

rate of instruments

On the other hand, NBFCs are characteristically not permitted to acquire down

payments from the common people Hence they are required to stumble on different

ways of financial supporting their processes, for instance supplying liability

instruments

A non- banking investment corporation can be categorized into the following groups

depending upon their characteristic of actions which are development investment

organizations, rental corporations, investment business, modaraba companies, house

business companies, venture capital companies, and discount & assurance addresses

2.2.3 Categories of NBFCs

Non-banking finance companies consist mainly of finance companies, which carry on

hire purchase finance, housing finance, investment, loan, equipment leasing or mutual

benefit financial companies but do not include insurance or stock exchanges or stock

broking companies

The non-bank finance companies are categorized into:

1 An equipment leasing company (EL)

2 A hire purchase company (HP)

3 A housing finance company (HFC)

4 An investment company (IC)

5 A loan company (LC)

6 A mutual benefit financial company (MBFC) i.e Nidhi companies

7 A miscellaneous non-banking company, i.e Chit fund companies

8 A residuary non-banking company is a company which receives any deposit under

any scheme or arrangement, by whatever name called, in one lump sum or in

instalments or in any other manner and which does not fall into any of the above

categories

Finally, a non-banking, non-financial company is defined as an industrial concern or a

company whose principal activity is agricultural operations or trading in goods and

services or real estate and which is not classified as a financial or a miscellaneous or a

residuary non-banking company

28

Management of Financial Services 1 Mutual Benefit Finance Companies (MBFCs): Mutual benefit finance

companies (nidhis) were exempt from most of the provision of the Reserve Bank’s, NBFC’s directions However, the RBI imposed on July 8, 1996 a ceiling

of 15 percent interest rate on deposits and prohibited them from issuing advertisements in any form and paying any brokerage for soliciting deposits NBFCs’ deposit interest rates were freed on August 24, 1996 along with the rationalization measures for registered NBFCs The ceiling however does not apply unless MBFCs have positive net owned funds (NOFs) as on March 31,

1996, will be able to repay the amount of their liabilities including the interest payable to their depositors and have the ratio of NOF to deposits not exceeding 1:20 as on the date of application

Again on January 15, 1997, the prescribed ratio of NOF to deposits not exceeding 1: 20 was made applicable only on the incremental deposit liabilities after January

15, 1997 However, MBFCs with NF to deposit ratio of 1:20 or less on January

15, 1997, should not exceed the prescribed ratio of 1:20 on the aggregate deposit liabilities Regulation of Non-banking companies

2 The Four Categories of NBFCs: The four categories of non-bank finance

companies (EL,HO, IC, and LC) submit statutory annual schedules and returns to the Reserve Bank The Reserve Bank has issued a separate set of directions of financial, miscellaneous and residuary non-banking companies governing their deposit acceptance activity The activity of deposit acceptance by non-banking, non-financial companies (manufacturing companies) is being regulated by the Government of India, under (Acceptance of Deposits) Rule 1975, framed under Section 58A of the companies Act

The regulation of the deposit acceptance activities was undertaken initially to effectively, supervise, control and regulate them In order to moderate the deposit mobilization of NBFCs and protect depositors, the quantum of deposits was linked to Net Owned Fund (NOF) which the aggregate of the paid-up capital ad free reserves reduced by balance of loss, deferred revenue expenditure and other intangible assets Investments in same group or other NBFC beyond 10% of owned fund were also excluded from NOF The regulations did not extend to the assets side of NBFCs

3 Financial Sector Reform: In view of the important role of NBFCs in the financial

system, the need for subjecting them to financial reform was felt The committee

on the Financial System recognized that NBFCs should have prudential norms and guidelines as in the case of commercial banks For this purpose, a working Group on Financial Companies was constituted in May 1992 under the chairmanship of Dr A.C Shah The major recommendations of the Working Group are:

™ Category-wise classification of financial companies may be abolished and uniform regulations applied to all companies

™ Regulatory attention by the RBI may be confined to companies with net owned funds of Rs 50 lakhs and above

™ As regards new financial companies’ entry norms, minimum net owned funds

of Rs 50 lakhs and a cooling period before accepting deposits have been suggested

™ The regulations should be on the asset side, such as limit on credit concentration

29 Non-Banking Finance Companies

™ Capital adequacy standards may be laid down based on risk assessment of

assets and credit conversation factors for off-balance sheet items

™ The exempted category of deposits should be removed and all deposits should

be brought under the regulatory framework A clear distinction should be

made possible and borrowing form banks / institutions

™ Non-banking financial companies may be allowed to accept deposits for

periods ranging from 12 months to 84 months

™ Prudential norms for income recognition, transparency of accounts and

provision for bad and doubtful debts may be prescribed

™ The Bank implemented some of the recommendations with modifications and

introduced a number of change from April 12, 1993

™ In the first phase, the minimum period of deposits of NBFCs has been brought

down from over 24 months to 12 months and maximum period to 84 months

in the case of residuary non-banking companies The definition of regulated

deposits was widened to include intercorporate deposits, borrowing through

issue of debentures, and monies received from directors or shareholders of

private limited companies, which were earlier under the exempt category

4 Maintenance of liquid assets: Hire purchase finance and equipment leasing 10

percent of deposits out of which 5 percent in government securities; and residuary

non-banking companies 10 percent of deposits in government securities within the

limit of 70 percent investment in approved securities

Registration: Companies with net owned funds of Rs 50 lakhs and above have been

advised to register with the RBI

2.2.4 NBFCs and Banks

So far as the Financial Regulation of Systemically Important NBFCs and Banks’

Relationship with them are concerned, the Non Banking Financial Companies

(NBFCs) play a crucial role in broadening access to financial services, enhancing

competition and diversification of the financial sector They are increasingly being

recognised as complementary to the banking system, capable of absorbing shocks and

spreading risks at times of financial distress

The application of different levels of regulations to the activities of banks and NBFCs,

and even among different categories of NBFCs, has given rise to some issues arising

out of this uneven coverage of regulations

The Reserve Bank of India had, therefore, set up an Internal Group to examine the

issues relating to level playing field, regulatory convergence and regulatory arbitrage

in the financial sector Based on the recommendations of the Internal Group and

taking into consideration the feedback received thereon, it was decided to put in place

a revised framework to address the issues pertaining to the overall regulation of

systemically important NBFCs and the relationship between banks and NBFCs

Accordingly, a draft of the proposed guidelines were issued vide letter

DBOD.No.FSD.556/ 24.01.02/ 2006-07 dated November 3, 2006, seeking feedback

from banks and NBFCs The draft guidelines were open for comments till close of

business on November 17, 2006 On the basis of the feedback received, the draft

guidelines have been suitably revised and are now issued for further comments by

December 7, 2006

1 The Difference Between NBFCs & Banks: NBFCs are doing functions akin to

that of banks, however there are a few differences:

(i) A NBFC cannot accept demand deposits;

30

Management of Financial Services (ii) It is not a part of the payment and settlement system and as such cannot issue

cheques to its customers; and (iii) Deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks

2 NBFC’s Registration with RBI: In terms of Section 45-IA of the RBI Act, 1934,

it is mandatory that every NBFC should be registered with RBI to commence or carry on any business of non-banking financial institution as defined in clause (a)

of Section 45 I of the RBI Act, 1934

However, to obviate dual regulation, certain category of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI viz Venture Capital Fund/Merchant Banking companies/Stock broking companies registered with SEBI, Insurance Company holding a valid Certificate

of Registration issued by IRDA, Nidhi companies as notified under Section 620A

of the Companies Act, 1956, Chit companies as defined in clause (b) of Section 2

of the Chit Funds Act, 1982 or Housing Finance Companies regulated by National Housing Bank

3 Different Types of NBFCs Registered with RBI:

The NBFCs that are registered with RBI are:

(i) equipment leasing company;

(ii) hire-purchase company;

(iii) loan company;

(iv) investment company

With effect from December 6, 2006 the above NBFCs registered with RBI have been reclassified as:

(i) Asset Finance Company (AFC) (ii) Investment Company (IC) (iii) Loan Company (LC) AFC would be defined as any company which is a financial institution carrying on

as its principal business the financing of physical assets supporting productive / economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipments, moving on own power and general purpose industrial machines Principal business for this purpose is defined

as aggregate of financing real/physical assets supporting economic activity and income arising there from is not less than 60% of its total assets and total income respectively

The above type of companies may be further classified into those accepting deposits or those not accepting deposits

Besides the above class of NBFCs the Residuary Non-Banking Companies are also registered as NBFC with the Bank

4 Requirements for Registration with RBI: A company incorporated under the

Companies Act, 1956 and desirous of commencing business of non-banking financial institution as defined under Section 45 I(a) of the RBI Act, 1934 should have a minimum net owned fund of Rs 25 lakh (raised to Rs 200 lakh w.e.f April

31 Non-Banking Finance Companies

21, 1999) The company is required to submit its application for registration in the

prescribed format along with necessary documents for Bank’s consideration The

Bank issues Certificate of Registration after satisfying itself that the conditions as

enumerated in Section 45-IA of the RBI Act, 1934 are satisfied

5 List of Registered NBFCs and Instructions Issued to NBFCs: The list of

registered NBFCs is available on the web site of Reserve Bank of India and can

be viewed at www.rbi.org.in The instructions issued to NBFCs from time to time

are also hosted at the above site Besides, instructions are also issued through

Official Gazette notifications Press Release is also issued to draw attention of the

public/NBFCs

6 NBFCs’ Requirements for Accepting Public Deposits: All NBFCs are not

entitled to accept public deposits Only those NBFCs holding a valid Certificate of

Registration with authorisation to accept Public Deposits can accept/hold public

deposits The NBFCs accepting public deposits should have minimum stipulated

Net Owned Fund and comply with the Directions issued by the Bank

7 Ceiling on Acceptance of Public Deposits: There is ceiling on acceptance of

Public Deposits A NBFC maintaining required NOF/CRAR and complying with

the prudential norms can accept public deposits as follows:

Category of NBFC Ceiling on public deposits

AFCs maintaining CRAR of 15% without credit

rating AFCs with CRAR of 12% and having

minimum investment grade credit rating

1.5 times of NOF or Rs 10 crore whichever is less 4 times of NOF

LC/IC with CRAR of 15% and having minimum

investment grade credit rating

1.5 times of NOF

Presently, the maximum rate of interest a NBFC can offer is 11% The interest may be

paid or compounded at rests not shorter than monthly rests

The NBFCs are allowed to accept/renew public deposits for a minimum period of 12

months and maximum period of 60 months They cannot accept deposits repayable on

demand

The RNBCs have different norms for acceptance of deposits which are explained

elsewhere in this booklet

8 NBFCs Regulations for Depositors at the Times of Investment: Some of the

important regulations relating to acceptance of deposits by NBFCs are as under:

i) The NBFCs are allowed to accept/renew public deposits for a minimum

period of 12 months and maximum period of 60 months They cannot accept

deposits repayable on demand

ii) NBFCs cannot offer interest rates higher than the ceiling rate prescribed by

RBI from time to time The present ceiling is 11 per cent per annum The

interest may be paid or compounded at rests not shorter than monthly rests

iii) NBFCs cannot offer gifts/incentives or any other additional benefit to the

depositors

iv) NBFCs (except certain AFCs) should have minimum investment grade credit

rating

v) The deposits with NBFCs are not insured

vi) The repayment of deposits by NBFCs is not guaranteed by RBI

32

Management of Financial Services vii) There are certain mandatory disclosures about the company in the Application

Form issued by the company soliciting deposits

It is important to clarify here about: What is ‘deposit’ and ‘public deposit’? Is it

defined anywhere?

The term ‘deposit’ is defined under Section 45 I(bb) of the RBI Act, 1934 ‘Deposit’ includes and shall be deemed always to have included any receipt of money by way of deposit or loan or in any other form but does not include:

z amount raised by way of share capital, or contributed as capital by partners of a firm;

z amount received from scheduled bank, co-operative bank, a banking company, State Financial Corporation, IDBI or any other institution specified by RBI;

z amount received in ordinary course of business by way of security deposit, dealership deposit, earnest money, advance against orders for goods, properties or services;

z amount received by a registered money lender other than a body corporate;

z amount received by way of subscriptions in respect of a ‘Chit’

Paragraph 2(1)(xii) of the Non-Banking Financial Companies Acceptance of Public Deposits ( Reserve Bank) Directions, 1998 defines a ‘ public deposit’ as a ‘deposit’ as defined under Section 45 I(bb) of the RBI Act, 1934 and further excludes the following:

z amount received from the Central/State Government or any other source where repayment is guaranteed by Central/State Government or any amount received from local authority or foreign government or any foreign citizen / authority / person;

z any amount received from financial institutions;

z any amount received from other company as inter-corporate deposit;

z amount received by way of subscriptions to shares, stock, bonds or debentures pending allotment or by way of calls in advance if such amount is not repayable to the members under the articles of association of the company;

z amount received from shareholders by private company;

z amount received from directors or relative of the director of a NBFC;

z amount raised by issue of bonds or debentures secured by mortgage of any immovable property or other asset of the company subject to conditions;

z the amount brought in by the promoters by way of unsecured loan;

z amount received from a mutual fund;

z any amount received as hybrid debt or subordinated debt;

z any amount received by issuance of Commercial Paper

Thus, the directions have sought to exclude from the definition of public deposit amount raised from certain set of informed lenders who can make independent decision

33 Non-Banking Finance Companies

2.3 FUNCTIONS OF NON-BANKING FINANCIAL

COMPANIES

The Reserve Bank of India is entrusted with the responsibility of regulating and

supervising the Non-Banking Financial Companies by virtue of powers vested in

Chapter III B of the Reserve Bank of India Act, 1934 The regulatory and supervisory

objective, is to:

a ensure healthy growth of the financial companies;

b ensure that these companies function as a part of the financial system within the

policy framework, in such a manner that their existence and functioning do not

lead to systemic aberrations; and that

c the quality of surveillance and supervision exercised by the Bank over the NBFCs

is sustained by keeping pace with the developments that take place in this sector

of the financial system

It has been felt necessary to explain the rationale underlying the regulatory changes

and provide clarification on certain operational matters for the benefit of the NBFCs,

members of public, rating agencies, Chartered Accountants etc To meet this need, the

clarifications in the form of questions and answers, is being brought out by the

Reserve Bank of India (Department of Non-Banking Supervision) with the hope that it

will provide better understanding of the regulatory framework

The functions and 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 household sector

savings in financial assets, increased from 3.1 per cent in 1980-81 to 10.6 per cent in

1995-96 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 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 lo 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

34

Management of Financial Services 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 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 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

non-2.3.1 Functions of Non-Banking Financial Entities Regulated by the RBI

The developments in the NBFC sector in terms of policies and performance during 2001-02 and for the subsequent periods (to the extent information is available) are discussed in the subsequent paragraphs Non-banking financial entities partially or wholly regulated by the RBI include: (a) NBFCs comprising equipment leasing (EL), hire purchase finance (HP), loan (LC), investment (1C) (including primary dealers3 (PDs)) and residuary non-banking (RNBC) companies; (b) mutual benefit financial company (MBFC), i.e nidhi company;(c) mutual benefit company (MBC), i.e potential nidhi company; (d) miscellaneous non-banking company (MNBC), i.e chit fund company

1 Registration: In terms of the RB1 Act, 1934, registration of NBFCs with the RBI

is mandatory, irrespective of whether they hold public deposits or not The amended Act (1997) provides an entry point norm of Rs 25 lakh as the minimum Net Owned Fund (NOF), which has been revised upwards toRs.2 crore for new NBFCs seeking grant of CoR on or after April 21, 1999 Certain types of financial companies, viz., insurance companies, housing finance companies, stock broking companies, chit fund companies, companies notified as ‘nidhis’ under Section 620A of the Companies Act, 1956 and companies engaged in merchant banking activities (subject to certain conditions), however, have been exempted from the requirement of registration under the RBI Act, as they are regulated by other agencies Accordingly, as at the end of March 2006, RBI received 38214 applications of which 13873 we reapproved and 24134 were rejected The rest of the applications are pending at different stages of processing Of the total approvals, only 434companies have been permitted to accept/ hold public deposits Moreover, all NBFCs holding public deposits, whose applications for Certificate of Registration (CoR) have been rejected or CoR shave been cancelled, have to continue repaying the deposits on due dates and dispose of their financial assets within three years from the date of rejection of application/ cancellation of certificate or convert themselves into non-banking non-financial companies within the same period

2 Supervision: The RBI has instituted a strong and comprehensive supervisory

mechanism for NBFCs The focus of the RBI is on prudential supervision so as to ensure that NBFCs function on sound and healthy lines and avoid excessive risk taking The RBI has put in place a four-pronged supervisory framework based on:

i On-site inspection; ii Off-site monitoring supported by state-of the art technology; iii Market intelligence; and iv Exception reports of statutory auditors

of NBFCs The thrust of supervision is based on the asset size of the NBFC and whether it accepts/ holds deposits from the public The system of on-site examination put in place during 1997 is structured on the basis of assessment and evaluation of CAMELS (Capital, Assets, Management, Earnings, Liquidity, and

35 Non-Banking Finance Companies

Systems and Procedures) approach and the same is akin to the supervisory model

adopted by the RBI for the banking system Market intelligence system is also

being strengthened as one of the important tools of supervision This process of

continuous and on-going supervision is expected to facilitate RBI to pick up

warning signals, which can result in triggering supervisory action promptly The

returns being submitted by the NBFCs arc reviewed and re-looked at intervals to

widen the scope of information so as to address the requirements either for

supervisory objectives or for furnishing the same to various interest groups on the

important aspect of the working of these companies The companies not holding

public deposits arc supervised in a limited manner with companies with asset size

of Rs.100 crore and above being subjected to annual inspection and other

non-public deposit companies by rotation once in every 5 years The exception reports,

if any, from the auditors of such companies coupled with adverse marketing

formation and the sample check at periodical intervals are the main tools for

monitoring the activities of such companies vis-à-vis the RBI regulations

3 Policy Developments: The RBI introduced a number of measures to enhance the

regulatory and supervisory standards of this sector, to bring them on par with

commercial banks over a period of time The regulatory norms, applicable to

NBFCs are presented in Box 6.2 Regulatory measures adopted during the year

aim at aligning the interest rates in this sector with the rates prevalent in the rest of

the economy, tightening prudential norms, standardizing operating procedures and

aligning the RBI’s regulations with the requirements of the amended Companies

Act

4 Directions applicable to NBFCs: The RBI has issued comprehensive deposit

acceptance and asset side regulations as under for the NBFCs While all the

prudential norms are applicable to public deposit accepting/holding NBFCs only,

some of the regulations are applicable to non-deposit accepting companies

5 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 12.5per cent per annum

effective November 1, 2001and further to 11% effective from March 2003

6 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 classification of an NBFC into equipment

leasing and hire purchase finance company

7 Alignment of the RBI’s 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 crore and more, those with paid up capital of

not less than Rs.5 crore have to constitute Audit Committees Such committees

would 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

36

Management of Financial Services 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

8 Liquid Asset Securities of NBFCs: Effective from October 1, 2002, all NBFCs

should necessarily hold their investments in government securities either in Constituent’s 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 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/ demat account Government securities held in physical form were to be dematerialized by October 31, 2002

9 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 (i) 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 (ii) the leases written up to March 31, 2001 would continue to be governed by the prudential norms relating to leased assets, as hitherto

10 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

11 Prudential Regulation: 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 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& 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

37 Non-Banking Finance Companies

12 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 crore 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

13 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 in 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

14 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 crore and above as also NBFCs with asset size of Rs

100 crore 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

2.3.2 The NBFCs Functioning in India (Till End-March 2007)

With the exit of many NBFCs from deposit taking business, the total number of

NBFCs, consisting of NBFCs-D (deposit taking NBFCs), residual non-banking

companies (RNBCs), mutual benefit companies (MBCs), miscellaneous non-banking

companies (MNBCs) and Nidhi companies registered with RBI declined from 13,014

at end-June 2006 to 12,968 at end-June 2007 The number of NBFCs-D declined from

428 at end-June 2006 to 401 at end-June 2007 (Table 5.9).5.39 Despite the significant

decline in the number of reporting NBFCs-D, the assets, public deposits and net own

funds of NBFCs increased by Rs 12,549 crore, Rs 2,074 crore and Rs 795crore,

respectively The ratio of deposits of reporting NBFCs to the aggregate deposits of

SCBs dropped to 0.95 per cent at end-March 2007 from 1.07 percent at end-March

2006

Table 2.1: Non-banking Financial Companies Registered with RBI (number)

Source: Economic Survey 2007-08

Total assets/liabilities of NBFCs-D (excluding RNBCs) sharply increased by 29.8

percent (Rs 49,097 crore) at end-March 2007 from Rs 37,828 crore at end-March

2006 On the liabilities side, the highest increase was achieved by “other liabilities”

(98.4 per cent) followed by “borrowings” (31.4 per cent) and “paid-up capital”

38

Management of Financial Services (27.8 per cent) On the assets side, significant increase was achieved by “other assets”

(98 percent) followed by investment (74.5 per cent) Bill discounting business declined by 83.2 per cent during 2006-07.5.41 During 2006-07, there was a turn around in the financial performance of NBFCs-D largely on account of substantial increase in fund-based income (26.8 per cent) compared to an increase of 5.3 per cent during 2005-06 Fee-based income, however, continued the declining trend observed during the previous year (during 2006-07 income from this source declined by 7.6 per cent on top of the decline of 61.2 per cent in 2005-06) The overall income of NBFCs-

D during 2006-07increased by 25.7 per cent compared to the decline of 0.1 per cent during 2005-06.5.42 The percentage increase of operating expenditure of NBFCs-D during 2006-07 was marginally higher at 33.9 per cent compared to33.6 per cent during 2005-06 However, financial expenditure and other expenditure recorded substantial increases of 30.5 per cent and 22.3per cent, respectively, during 2006-07,

as compared to increases of 0.3 per cent and nil, respectively, during 2005-06 Net profit (profit after tax) declined by 6.7 per cent in 2006-07.5.43 The asset quality of NBFCs-D continued to improve during 2006-07 Gross NPAs and net NPAs as percentage of gross advances of reporting NBFCs-D declined to 1.9 per cent and 0.4 percent, respectively, at end-March 2007 compared to 3.6 per cent and 0.5 per cent, respectively, atend-March 2006.5.44 Capital adequacy ratio norms were made applicable to NBFCs in 1998 Accordingly, rated NBFCs were required to maintain a minimum capital (consisting of Tier-I and Tier-II capital) of12 per cent (15 per cent in the case of unrated deposit taking loan/investment companies) of the risk-weighted assets and of risk-adjusted value of off-balance sheet items Total of Tier-II capital cannot exceed 100 per cent of Tier-I capital at any point of time The number of NBFCs-D with a CRAR less than 12 per cent declined to 13 at end-March 2007 from

of the evolution and integration of the financial sector, Reserve Bank of India had decided that all systemically relevant entities offering financial services ought to be brought under a suitable regulatory framework to contain systemic risk

Therefore, as a first step, in a notification dated December 12, 2006 all NBFCs – ND with an asset size of Rs 100 crore and more as per the last audited balance sheet were considered as systemically important NBFC – ND (NBFC-ND-SI) and specific regulatory framework involving prescription of capital adequacy and exposure norms was put in place from April 01, 2007 for such NBFCs-ND-SI

On a review of the experience with the regulatory framework, RBI in notification dated August 1, 2008, decided to enhance the capital adequacy requirement and put in place guidelines for liquidity management and reporting, as also norms for disclosures

1 Capital Adequacy: NBFCs – ND – SI were advised to maintain a minimum

Capital to Risk- Assets Ratio (CRAR) of 10% with effect from April 01, 2007 However, in view of recent international developments, the risks associated with highly leveraged borrowings and reliance on short term funds by some NBFCs to fund long gestation assets, concerns have arisen regarding the enhanced systemic risk associated with the activities of these entities Keeping in view the importance of providing adequate capital charge for the same in order to enhance

39 Non-Banking Finance Companies

the cushion for any shocks, it has been decided to increase the minimum capital to

risk assets ratio (CRAR) for NBFCs-ND-SI from the present prescription of 10%

They are advised to achieve 12% CRAR by March 31, 2009 and further 15%

CRAR by March 31, 2010

2 Disclosure in the Balance Sheet: In the light of the concerns as expressed above,

the disclosure norms in respect of NBFCs-ND-SI have been reviewed and it has

been decided that such Systemically Important NBFCs-ND shall make additional

disclosures in their Balance Sheet from the year ending March 31, 2009 relating

to:

i Capital to Risk Assets Ratio (CRAR)

ii Exposure to real estate sector, both direct and indirect

iii Maturity pattern of assets and liabilities

3 Asset Liability Management (ALM) – Reporting: To address concerns regarding

Asset Liability mismatches and interest rate risk exposures, an ALM System was

introduced for the Non-Banking Financial Companies (NBFCs) as part of their

overall system for effective risk management in their various portfolios vide

Company Circular DNBS (PD).CC.No.15 /02.01 / 2000-2001 dated June 27,

2001 While it was stated therein that the guidelines would be applicable to all

NBFCs irrespective of whether they are accepting / holding public deposits or not,

to begin with, NBFCs meeting the criteria of asset base of Rs.100 crore (whether

accepting / holding public deposits or not) or holding public deposits of Rs 20

crore or more (irrespective of their asset size) as per their audited balance sheet as

of March 31, 2001 were required to put in place the ALM System The companies

were advised that the guidelines should be fully operationalised by the year

ending March 31, 2002 A system of half yearly reporting was also put in place

for NBFCs holding public deposits

2.3.4 NBFCs to Issue Co-branded Credit Cards

(RBI notification dated 4th December 2006)

In order to strengthen the NBFC sector by allowing diversification of their area of

business, Reserve Bank of India has decided to allow Non-Banking Financial

Companies (NBFCs), selectively, registered with the Reserve Bank of India to issue

co-branded credit cards with scheduled commercial banks, without risk sharing, with

prior approval of the Reserve Bank , for an initial period of two years and a review

thereafter NBFCs fulfilling the following minimum requirements are eligible to

apply:

(i) Minimum net owned fund of Rs.100 crore;

(ii) The company should have made net profit as per last two years audited balance

sheet;

(iii) The percentage of net NPAs to net advances of the NBFC as per the last audited

balance sheet should not be more than 3%;

(iv) The non-deposit-taking NBFCs (NBFCs-ND) should have CRAR of 10% and

deposit-taking NBFCs (NBFCs-D) should have CRAR of 12% or 15%, as

applicable to the company

In addition, the NBFCs would be required to adhere to the following stipulations:

i) Operational Aspects:

a The role of the NBFC under the tie-up arrangement should be limited only to

marketing and distribution of the co-branded credit cards The co-branded

40

Management of Financial Services credit card issuing bank would be subject to all the instructions / guidelines

issued by its concerned regulatory authority

b The co-branded credit card issuing bank would be solely responsible for fulfillment of KYC requirements in respect of all co-branded cards issued under the tie-up arrangement

c The risks, if any, involved in co-branded credit cards business should not get transferred to the business of the NBFC;

d The co-branded credit card account should be maintained by the customer with the bank and all the payments by the co-branded card holders should be

in the name of the bank; account if any maintained by the user with the NBFC should not be debited for settlement of dues arising out of co-branded credit card;

e The NBFC entering into tie-up should be guided by the need to ensure confidentiality of the customer’s accounts The co-branding NBFC should not reveal any information relating to customers obtained at the time of opening the account and the co-branded credit card issuing bank should not be permitted to access any details of customers’ accounts that may violate NBFCs ‘secrecy obligations

f The bank issuing the card should put in place suitable mechanism for the redressal of customer grievances Customer complaints arising out of deficiency in the credit card service shall be the responsibility of the bank

g Legal risk, if any, arising out of court cases, damages, etc shall be borne by the issuing bank

ii) Other Aspects:

a The NBFC should have put in place guidelines on fair practices code b) The NBFC should be adhering to Know Your Customer Guidelines and provisions

of prevention of Money Laundering Act; c) The NBFC should be complying with Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 and/or Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998, any other instructions and provisions of RBI Act, 1934 to the extent applicable to the NBFC concerned;

d The NBFC should comply with other terms and conditions as the Bank may specify in this behalf from time to time

2.3.5 NBFCs to Market and Distribute Mutual Fund Products

(RBI notification dated 4th December 2006) Besides the above, the NBFCs would be required to adhere to the following stipulations:

c The participation by a company’s customer in mutual fund products is purely

on a voluntary basis and this information should be stated in all publicity material distributed by the company in a prominent way There should be no