NBFCs

Anuj Jindal

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Contents
Non-Banking Financial Companies (NBFCs) ................................................................................................................. 4
Meaning.................................................................................................................................................................. 4
Difference Between NBFCs and Banks ..................................................................................................................... 4
Exemptions from RBI regulation .............................................................................................................................. 5
Types of NBFCs ....................................................................................................................................................... 5
Regulation of NBFCs ................................................................................................................................................ 8
Regulation-1963 .................................................................................................................................................. 8
Regulation-1997 Onwards ................................................................................................................................... 8
Revised Regulatory Framework in 2014 ............................................................................................................... 9
Regulations-2019 .............................................................................................................................................. 10
Recent Regulations -2021 ......................................................................................................................................... 10
Introducing Scale-based Framework.................................................................................................................. 11
Risk-Based Internal Audit (RBIA) ........................................................................................................................ 13
QUESTIONS ............................................................................................................................................................... 15

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 Non-Banking Financial Companies (NBFCs)

Meaning

 Non-Banking Financial Companies (NBFCs) are the financial institutions, which are
not banks but perform bank like functions especially the financial intermediation by
mobilising the funds and extending credit.
 They play a critical role in the financial system by providing last mile credit
intermediation, absorbing and diversifying risks by catering to segments not serviced
by banks and pioneering innovative financial products.
 Thus, a ‘financial institution’ that is a company is an NBFC. The term financial
institution means any non-banking institution that carries on as its business (or part
of its business) any of the following activities (‘financial activities’):

 Lending or financing for activities other than its own

 Acquisition of shares/stocks/bonds/debentures/securities issued by
Government or local authority
 Leasing or hire-purchase
 Insurance business
 Chit business
 Collection of money
 Acceptance of deposits

but does not include any institution whose principal business is that of agriculture
activity, industrial activity, purchase or sale of any goods (other than securities) or
providing any services and sale/purchase/construction of immovable property.

Difference Between NBFCs and Banks

NBFCs lend and make investments and hence their activities are akin to that of banks;
however there are a few key differences as given below:

i. NBFC cannot accept demand deposits;

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ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques
drawn on itself;

iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not
available to depositors of NBFCs, unlike in case of banks.

Exemptions from RBI regulation

 It is quite clear from the definition of NBFC that even entities such as insurance
companies and stock broking companies etc are NBFCs. However, these entities are
regulated by other regulators.

 Therefore, to avoid dual regulation, the RBI has exempted various categories of
NBFCs which are regulated by other regulators/ government from registration and/or
other requirements. Let us look at some examples:

Types of NBFCs/Activities Regulated by

Venture Capital Fund, Merchant Securities and Exchange Board of
Banking Companies, Stock Broking India (SEBI)
Companies, Mutual Funds,
Collective Investment Schemes (CIS)
Insurance Companies Insurance Regulatory and
Development Authority (IRDA)
Pension Funds Pension Fund Regulatory and
Development Authority (PFRDA)
Mutual Benefit Companies, Nidhi Ministry of Corporate Affairs (MCA)
Companies
Chit Funds State Governments

Types of NBFCs
NBFCs are categorized as follows:

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 Basis of NBFCs
Classification

Liability Size Activity

a) In terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs

b) Non deposit (ND) taking NBFCs by their size into systemically important (SI) [An NBFCs-
ND is categorised as systemically important (i.e. NBFC-ND-SI) if its asset size is ₹ 500 crore
or more ] and other non-deposit holding companies (NBFC-NDSI and NBFC-ND)

c) By the kind of activity they conduct. Within this broad categorization the different types
of NBFCs are as follows:

 Asset Finance Company (AFC): An AFC is a company which is a financial institution

carrying on its principal business of financing real/physical assets supporting
economic activity and income arising therefrom is not less than 60% of its total assets
and total income respectively.
 Investment Company (IC): IC means any company which is a financial institution
carrying on as its principal business the acquisition of securities
 Loan Company (LC): LC means any company which is a financial institution carrying
on as its principal business the providing of finance whether by making loans or
advances or otherwise for any activity other than its own but does not include an
Asset Finance Company.
 Infrastructure Finance Company (IFC): IFC is a non-banking finance company which
deploys at least 75 per cent of its total assets in infrastructure loans, has a minimum
Net Owned Funds of ₹ 300 crore, and has a minimum credit rating of ‘A ‘or
equivalent with a CRAR of 15%.

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  Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is an NBFC
carrying on the business of acquisition of shares and securities which satisfies the
certain prescribed conditions.
 Infrastructure Debt Fund: Non- Banking Financial Company (IDF-NBFC) : IDF-NBFC is
a company registered as NBFC to facilitate the flow of long term debt into
infrastructure projects. Only Infrastructure Finance Companies (IFC) can sponsor IDF-
NBFCs.
 Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI): NBFC-MFI
is a non-deposit taking NBFC having not less than 85% of its assets in the nature of
qualifying assets which provides Collateral free loans to small borrowers.
 Non-Banking Financial Company – Factors (NBFC-Factors): NBFC-Factor is a non-
deposit taking NBFC engaged in the principal business of factoring i.e. financing of
receivables.
 Mortgage Guarantee Companies (MGC) - MGC are financial institutions for which at
least 90% of the business turnover is mortgage guarantee business or at least 90% of
the gross income is from mortgage guarantee business and they Provide mortgage
guarantees for loans.
 NBFC- Non-Operative Financial Holding Company (NOFHC) is financial institution
through which promoter / promoter groups will be permitted to set up a new bank.
It’s a wholly-owned Non-Operative Financial Holding Company (NOFHC) which will
hold the bank as well as all other financial services companies regulated by RBI or
other financial sector regulators.
 Account Aggregators (AA): They Provide service of retrieving, consolidating,
organising and presenting financial information of its customer. They can only
provide account aggregation services where they act as intermediaries between
companies seeking financial information of its customers and those holding that
data( financial information providers).
 Peer-to-Peer (P2P) Lending Platforms: Carries on the business of a P2P lending
platform i.e. providing loan facilitation services to participants on the platform. They
only provide platform to connect lenders and borrowers and there is no lending from
its own books.
 Housing Finance Company (HFC): They carry on the business of providing finance for
housing and housing projects.

NBFCs- not regulated by RBI

 Insurance companies- regulated by IRDA
 Stock brokers and mutual funds- regulated by SEBI

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  Investment banks/ merchant banks- (wealth management, mergers and acquisitions,
underwriting)- regulated by SEBI
 Venture capitalists- regulated by SEBI
 Nidhi companies, Stock Exchanges, Chit Fund Companies.

Regulation of NBFCs

Regulation-1963
 RBI acquired regulatory and supervisory powers over NBFCs with the insertion of
Chapter III-B in the RBI Act in 1963.
 The insertion was made because the then existing enactments relating to banks did
not provide for any control over companies or institutions, which, although are not
treated as banks, accept deposits from the general public or carry on other business
which is allied to banking.
 The changes were needed for ensuring more effective supervision and management
of the non-banking companies or institutions.

Regulation-1997 Onwards
 The regulation of NBFCs started by RBI in 1963 failed to properly regulate the deposit
taking activity of NBFCs and in 1996 we observed the failure of a large NBFC (CRB
Capital).
 Thus some important amendments were carried out in 1997 like:

 Categorisation of NBFCs into (i) public deposit accepting, (ii) non-public deposit
accepting but engaged in loan, investment, hire-purchase and equipment
leasing, and (iii) non-public deposit accepting core investment companies that
acquire securities/ shares in their own group companies comprising not less
than 90 per cent of their total assets but not trading in these securities/ shares
 Compulsory registration with RBI and maintenance of minimum Net Owned
Fund (NOF) for companies satisfying the ‘principal business’ criteria.
 Maintenance of liquid assets by NBFCs accepting public deposits.
 Creation of a Reserve Fund by all NBFCs by transfer of 20 per cent of their net
profit every year.
 Powers of RBI to determine Policy and issue directions to NBFCs
 Conduct of Special Audit of the accounts of NBFCs etc.

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  The Reserve Bank tightened the regulatory structure over the NBFCs, with rigorous
registration requirements, enhanced reporting, and supervision. The Bank also took a

policy stance to not register new public deposit accepting NBFCs and encourage the
existing ones to convert to non-deposit taking NBFCs.

 Further, in 1999 capital requirement for fresh registration was enhanced from ₹ 25
lakh to ₹ 2 crore.

 In 2006, considering the increasing significance of the sector, the Reserve Bank
introduced differential regulation and classified NBFCs with asset size of ₹ 100 crore
and above as ‘Systematically Important NBFC-ND (NBFC-ND-SI)’. Prudential
regulations such as capital adequacy requirements and exposure norms were made
applicable to them.

Revised Regulatory Framework in 2014

 The regulatory framework for the sector was reviewed in 2014 .The key changes in
the revised regulatory framework were as follows:

 Requirement of minimum NOF of ₹ 2 crore for legacy NBFCs.

 Revision of the threshold of systemic importance from ₹100 crore to ₹ 500
crore and inclusion of multiple NBFCs within the same group.
 Differentiated regulatory approach based on customer interface and source of
funds.
 At one end of the spectrum, entities with asset size less than ₹500 crore
and not accessing public funds with no customer interface were
exempted from prudential and business conduct regulations.
 At the other end, entities accessing public funds with customer
interface were subjected to full slew of regulations.
 Harmonisation of asset classification norms for Deposit taking Non-Banking
Financial Company (NBFC-D) and Systemically Important Non-Deposit taking
Non-Banking Financial Company (NBFC-ND-SI) with banks.
 Review of corporate governance and disclosure norms leading to constitution
of Board Committees (Audit Committee, Nomination Committee, and Risk
Management Committee) and rotation of audit partners every three years
applicable for NBFC-D and NBFC-ND

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Regulations-2019
 In 2019, certain amendments enumerated below were again carried out to Chapter
III-B of the RBI Act, which strengthened RBI’s supervisory powers.

 Reserve Bank may notify different amount of NOF to different categories of

NBFCs with minimum NOF between ₹ 25 lakh and ₹ 100 crore
 RBI can remove Directors of NBFC (other than Government owned NBFCs)
 RBI can supersede the BOD of NBFC (other than Government owned NBFCs
 RBI can remove or debar an auditor of NBFC for a max. period of 3 years at a
time
 Resolution of NBFCs through amalgamation, reconstruction, splitting into
various activities, etc.

Recent Regulations -2021

 Failure of any large and deeply interconnected NBFC is capable of transmitting shocks
into the entire financial sector and cause disruption. Under the circumstances,
regulatory framework for NBFCs needs to be reoriented to keep pace with the
changing realities.

 The Reserve Bank of India (RBI) has proposed to tighten rules for major non-bank
lenders to prevent a collapse in one of them from affecting the financial system.
 The RBI has proposed to classify the non-banking financial companies (NBFCs) into
four categories, depending on their systemic importance and potential risk to the
stability of the financial system. The triggers for such an action are:
(i) Comprehensive risk perception: Once an NBFC crosses the thresholds for
identified parameters (size, leverage, interconnectedness, complexity, and
supervisory inputs), it should be subject to proportionately higher regulation.

(ii) Size of operations: If the balance sheet size of an NBFC breaches a certain
threshold, as identified by the Reserve Bank, it should be regulated at a higher
pedestal, as it will have higher in-built degree of systemic significance.

(iii)Activity of NBFCs: Certain NBFCs are unlikely to pose any systemic risk on account
of their activities and hence could be regulated relatively lightly. For eg NBFCs that do

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 not have either access to public funds or NBFCs like NBFC-P2P lending platforms,
NOFHC (bank holding company) that don’t pose systemic risk.

Introducing Scale-based Framework

 The framework can be understood in the form of a pyramid.

 The bottom of the pyramid comprises of :

 NBFCs with assets of up to Rs 1,000 crore ( from earlier 500 crore)
 It can consist of NBFCs, currently classified as non-systemically important
NBFCs (NBFC-ND), NBFCP2P lending platforms, NBFCAA, NOFHC and Type I
NBFCs.
 RBI has raised the net-owned funds requirement for these NBFCs to ₹20 crore
from ₹2 crore earlier and also proposed that they can transition to the new
regulation over a period of five years.
 The existing non-performing loan classification norm for these NBFCs will be
changed to 90 days from 180 days now.
 NBFC-Middle Layer
 As one moves up, the next layer can consist of NBFCs currently classified as
systemically important NBFCs (NBFC-ND-SI), deposit taking NBFCs (NBFC-D),
HFCs, IFCs, IDFs, SPDs and CICs.

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  The regulatory regime for this layer shall be stricter compared to the base
layer.
 RBI has proposed no changes to the existing capital requirement for these
NBFCs, which currently stands at 15% with minimum tier-I of 10%.
 The regulator has suggested that NBFCs with 10 or more branches will be
required to adopt core banking solution.
 It has also put certain restrictions on lending. These NBFCs cannot provide
loans to companies for buyback of securities.

 NBFC-Upper layer
 Going further, the next layer can consist of NBFCs which are identified as
systemically significant. This layer will be populated by NBFCs which have large
potential of systemic spill-over of risks and have the ability to impact financial
stability.
 These NBFCs will have to implement differential standard asset provisioning
and also the large exposure framework as applicable to banks.
 Scheduled commercial banks are on a Basel III framework which provides for
minimum requirements for Common Equity Tier 1 (CET 1) capital. It is felt that
CET 1 could be introduced for NBFC-UL to enhance the quality of regulatory
capital.
 NBFC-Top layer

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  This layer is currently empty.
 However, RBI can move an NBFC to this category if it feels that there is an
unsustainable increase in the systemic risk spill-overs from specific NBFCs in
the upper layer.
 These NBFCs will be subject to higher capital charge, including capital
conservation buffers.

Risk-Based Internal Audit (RBIA)

 An effective Risk-Based Internal Audit (RBIA) is an audit methodology that links an
organisation's overall risk management framework and provides an assurance to the
Board of Directors and the Senior Management on the quality and effectiveness of
the organisation’s internal controls, risk management and governance related
systems and processes.
 The essential requirements for a robust internal audit function include sufficient
authority, proper stature, independence, adequate resources and professional
competence.
 The introduction of Risk-Based Internal Audit (RBIA) system was mandated for all
Scheduled Commercial Banks (except Regional Rural Banks) in 2002.

 RBI has now (in 2021) decided to adopt the RBIA framework for the following Non-
Banking Financial Companies (NBFCs) and Primary (Urban) Co-operative Banks (UCBs)
as well:

 All deposit taking NBFCs, irrespective of their size;

 All Non-deposit taking NBFCs (including Core Investment Companies) with asset
size of ₹5,000 crore and above; and
 All UCBs having asset size of ₹500 crore and above.

 The RBIA framework shall be implemented by such entities by March 31, 2022
 The RBIA Guidelines are intended to enhance the efficacy of internal audit systems
and processes followed by the NBFCs and UCBs.
 Further, in order to ensure smooth transition from the existing system of internal
audit to RBIA, the concerned NBFCs and UCBs may constitute a committee of senior
executives with the responsibility of formulating a suitable action plan. The
committee may address transitional and change management issues and should
report progress periodically to the Board and senior management.
 The internal audit function should broadly assess and contribute to the overall
improvement of the organization’s governance, risk management, and control

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 processes using a systematic and disciplined approach. The function is an integral
part of sound corporate governance.

 Historically, the internal audit system in NBFCs/UCBs has generally been

concentrating on transaction testing, testing of accuracy and reliability of accounting
records and financial reports, adherence to legal and regulatory requirements, etc.
However, in the changing scenario, such testing by itself might not be sufficient.
Therefore, in addition to selective transaction testing, an evaluation of the risk
management systems and control procedures in various areas of operations is
needed. This will also help in anticipating areas of potential risks and mitigating such
risks.
 The Board of Directors (the Board) / Audit Committee of Board (ACB) of NBFCs and
the Board of UCBs are primarily responsible for overseeing the internal audit function
in the organization. The RBIA policy shall be formulated with the approval of the
Board and disseminated widely within the organization.
 The risk assessment process should include identification of inherent business risks in
various activities undertaken, evaluation of the effectiveness of the control systems
for monitoring the inherent risks of the business activities.
 The risk assessment may make use of both quantitative and qualitative approaches.
While the quantum of credit, market, and operational risks could largely be
determined by quantitative assessment, the qualitative approach may be adopted for
assessing the quality of overall governance and controls in various business activities.

NBFCs being financial service intermediaries are exposed to risks arising out of counterparty
failures, funding and asset concentration, interest rate movements and risks pertaining to
liquidity and solvency.

Further, the inter-connectedness of NBFCs with other participants in financial markets has
increased over time with greater access to public funds. Consequently, risks of the NBFC
sector can easily be transmitted to the rest of the financial system and vice-versa.

While regulations for NBFCs are simpler and lighter as compared to banks, there is a
continuous evaluation done to ensure that NBFC regulations commensurate with the
systemic impact that NBFCs can cause and certain financial market activities do not remain
out of the regulatory purview.

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 QUESTIONS

Q.1) What does ‘It’ refer to here?

1. It is a financial institution, which is not a bank but performs bank like functions
especially the financial intermediation by mobilising the funds and extending
credit.
2. It helps by providing last mile credit intermediation, absorbing and
diversifying risks by catering to segments not serviced by banks.

[a]Financial Leverager
[b] Statutory corporation
*[c] Non Banking Financial Company
[d] Clientele banking
[e]Financial Intermediary

Q.2) Shriram Transport firm the India’s largest player in commercial vehicle finance
is a leader in organized financing of pre-owned trucks. It has a vertically integrated
business model and offers a number of products which include: Pre-owned CV
financing, New CV financing and other loans like accidental repair loans, tyre loans
and working capital finance, etc.

After reading out the case of Shriram Transport what interpretation can you draw
about the type of business organisation that Shriram group is ?

[a] Transporter
*[b] NBFC
[c] Bank
[d] Cooperative Society
[e] Venture Capitalist

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Q.3) Which of the following statements correctly states the functions that can be
performed by NBFCs?

1. Lending or financing for activities other than its own

2. Acquisition of debentures/securities issued by Government
3. Leasing or hire-purchase
4. Insurance and chit business

[a] Only 1
[b] 1 and 2
[c] 1 and 3
[d] 1, 2 and 4
*[e] all of the above

Q.4) Which of the following statement is/are incorrect about Types of NBFCs ?

1. On the basis of activities NBFCs can be classified as Deposit and Non-Deposit

accepting NBFCs.
2. On the basis Liabilities NBFCs can be classified as systemically important and non
systemically important NBFCs
3. On the basis of size NBFCs can be classified as Non deposit taking NBFCs
systemically important (SI) and other non-deposit holding companies.

[a] Only 1
[b] Only 3
*[c] 1 and 2
[d] 2 and 3
[e] none of the above

Q.5) RBI has come up with a new regulatory scale based structure for regulation of NBFCs
in January 2021. Identify the correct statements with respect to such regulations from the
below stated ones.

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1. The RBI has proposed to classify the non-banking financial companies (NBFCs) into
3 categories, depending on their systemic importance and potential risk to the
stability of the financial system.

2. The NBFC Top Layer NBFCs comprises of systemically important NBFCs (NBFC-ND-
SI), deposit taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, SPDs and CICs.

3. The NBFC base layer comprises of NBFCs with assets of up to Rs 1,000 crore.

[a] Only 1
*[b] Only 3
[c] 1 and 2
[d] 2 and 3
[e] all are correct

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