CHAPTER – I

INTRODUCTION

RATIONALE AND PURPOSE OF STUDY

Plenty of research has been made on the banking industry as also on

the financial institutions in India but Research on Non-Banking Financial

Companies is not only scanty but also badly missing. With this in view the

present research has been undertaken. The topic of research as approved by

the RDC of the University is “GROWTH PROSPECTS OF NON-

BANKING FINANCIAL COMPANIES IN INDIA – An Appraisal of

Select Companies”. In furtherance of this work two leading Non-Banking

Financial Companies have been selected, namely, (i) Housing Development

Finance Corporation Limited (HDFC), and (ii) Sundaram Finance Limited

(SFL). Financials of these two companies have been analysed. Their

progress has been evaluated as also their problems have been discussed in

this thesis. However, some general legal provisions relevant to the NBFC’s

have also been discussed. In brief the objectives of the study are as follows:

1. To study the impact of prudential norms of income recognition on the

profitability and the business of NBFCs in general and of the select

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 companies in particular.

2. To study the growth prospects of NBFCs in the country in general and

of the select units in particular.

3. To study the problems being faced by the NBFCs in general and of

the select units in particular.

4. To make financial appraisal of select companies.

5. To study the different areas of financing available to the NBFCs.

6. To study the impact of control regime on the business prospects of

NBFCs.

7. To suggest measures for the speedy growth of NBFCs in India.

RESEARCH HYPOTHESIS

It is hypothised that the NBFCs are operating under strict control and

vigilance of the Reserve Bank of India. In recent years there have been

frauds and instance of failure of NBFCs in the country. The NBFCs face

severe competition from the banking sector.

PERIOD OF STUDY

The Financial Appraisal of the two select companies has been made to

cover a period of seven years i.e. from 2001-02 to 2007-08. To make a

comparative study of the two companies the period of 7 years is quite in

consonance with the general practice.

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RESEARCH METHODOLOGY

The research methodology is a science and art of studying a problem

systematically. With a view to achieving the objectives of the proposed

study entitled “GROWTH PROSPECTS OF NON-BANKING

FINANCIAL COMPANIES IN INDIA – An Appraisal of Select

Companies”, and testing the hypotheses, secondary data have been

collected from various sources such as annual reports of the concerned

companies, RBI publications, economic journals, the various web sites and

literature available from the Indian Chambers of Commerce. Results

obtained have been shown in the form of averages and percentages. Various

ratios such as the Current Ratio, Quick Ratio, Cash Interval Measure,

Absolute Cash Ratio, Cash Ratio to Current Liabilities, Net Working Capital

to Net Assets Ratio, Debt Ratio, Debt Equity Ratio, Capital Employed To

Net Worth Ratio, Interest Coverage Ratio, Debtors Turnover Ratio, Average

Collection Period, Net Assets Turnover Ratio, Total Assets Turnover Ratio,

Fixed Assets Turnover Ratio, Working Capital Turnover Ratio, Profit Before

Tax Ratio, Operating Expenses Ratio, Return on Total Assets, Return on Net

Assets, Return on Equity, Dividend Per Share, Earnings Per Share, Dividend

Payout Ratio, Dividend Yield, Earnings Yield and Price Earning Ratio have

been computed on the basis whereof the performance of the two companies

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has been made.

MEANING OF NON-BANKING FINANCIAL COMPANIES

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. 1

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). 2

RBI has classified the non-banking sector in the following manner:3

(i) Non-Banking Financial Company – The Principal business is

receiving deposits from the public under any scheme and lending in

any manner.

1
. Taxmann’s, “Statutory Guide For Non-Banking Financial Companies”, Eleventh Edition, Taxmann
Allied Services (P) Ltd., New Delhi, p. 1061.
2
. Ibid, p. 1061.
3
. Quoted by Ruddar Datt K.P.M. Sundharam in His Book, “Indian Economy”, 47th Edition 2003,
Published by S.Chand & Company Ltd.7361, Ram Nagar, New Delhi, p. 828.

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 DIAGRAM : 1.1
CLASSIFICATION OF NON-BANKING SECTOR

NON-BANKING SECTOR

(i) Non-Banking Financial (ii) Residuary Non-Banking (iii) Non-Banking Non-

Company (NBFCs) Financial Company (RNBC) Financial Company

Equipment Leasing Hire Purchase, Investment

Insurance, Stock Broking, Company, Mutual Benefits Financial Company, i.e.
Lease Financing Nidhi Company, Miscellaneous Non-Banking
Company (e.g. Chit Fund Company)

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(ii) Residuary Non-Banking Company – Receives deposits from the

public under any scheme but it does not belong to any of the

categories mentioned above under NBFC.

(iii) Non-Banking Non-Financial Company – Refers to an industrial

company as defined in the IDBI Act, 1964 or a company whose

principal activity is agriculture, trading, etc. which cannot be called as

financial activity.

LEGISLATIVE CONTROL ON NBFCs4

NBFCs do not have any specific legislation governing them:

(a). Being limited liability companies, they are governed by the

Companies Act, 1956 which does not even contain the definition of a

finance company. Application of general provisions of this Act,

perforce, has invited avoidable violations by NBFCs.

(b). In the matter of deposits, NBFCs are governed by Non-banking

Financial companies (Reserve Bank) Directions, 1997.

(c). Those engaged in merchant banking and portfolio management

services are governed by SEBI.

RBI has found itself inadequately equipped to punish errant NBFCs,

for which it had to look towards the Company Law Department to take

action.
4
. Quoted by Ruddar Datt K.P.M. Sundharam in His Book, “Indian Economy” 47th Edition 2003,
Published by S.Chand & Company Ltd., 7361, Ram Nagar, New Delhi, p. 829.

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 NBFCs have thus been working under a complex web of directives

and guidelines formulated from time to time. Inevitably, some of the

directives are viewed by NBFCs as being formulated in arbitrary manner,

and at odds with practical realities. At the same time, RBI was of the

opinion, that some NBFCs were not following prudential norms and tend to

take undue risks.

In May 1992, RBI constituted a working group under the

chairmanship of Dr. A.C. Shah5 to conduct a comprehensive study of

finance companies and recommend measures to facilitate their healthy

growth. In its report submitted in September 1992, the group recommended

specific regulations for companies with net owned funds of Rs. 50 lakhs and

above and prescribe entry norms for new financial companies. It also

prescribed capital adequacy standards, prudential norms for income

recognition and provisions for bad and doubtful debts.

RBI accepted the group’s recommendations and started implementing

them in phases. In April-May 1993, RBI asked finance companies with net

owned funds of Rs. 50 lakhs and above to get themselves registered with it.

In June 1993, RBI issued guideline on prudential norms to registered

companies. They were asked to attain capital adequacy of six percent by

5
. Quoted by Ruddar Datt K.P.M. Sundharam in His Book, “Indian Economy” 47th Edition 2003,
Published by S.Chand & Company Ltd., 7361, Ram Nagar, New Delhi, p. 830.

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end-March 31, 1994 and 8 percent by end-March 1995. In addition, the

finance companies were required to get a minimum credit rating annually

from one of the approved credit rating agencies. 6

Instead of accepting industry’s demand for a separate and

comprehensive law for NBFCs, the Government of India enacted the

Reserve Bank of India (Amendment) Act, 1997 which confers wide ranging

powers on RBI for controlling the functioning of Non-Banking Financial

Companies. The ordinance defines a non-banking financial company

(NBFC) as a financial institution which is a company or a non-banking

institution which is a company and which has, as its principal business, the

receiving of deposits under any scheme or arrangement and lending in any

manner. Institutions carrying on agricultural or industrial activity as their

principal business are excluded from the definition of NBFC. 7

FUNCTIONS OF NBFCs – NBFCs are doing functions akin to that of

banks; however, there are a few differences, namely:
(i) An NBFC cannot accept demand deposits.

(ii) An NBFC is not a part of the payment and settlement system and as

such an NBFC cannot issue cheques drawn on itself and

6
. Quoted by Ruddar Datt K.P.M. Sundharam in His Book, “Indian Economy” 47th Edition 2003,
Published by S.Chand & Company Ltd., 7361, Ram Nagar, New Delhi, p. 830.
7
. Ibid, p. 830.

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(iii) Deposit insurance facility and Credit Guarantee Corporation is not

available for NBFC depositors unlike in case of banks.

IMPORTANCE OF NBFC’s IN THE ECONOMIC SYSTEM

The Non-Banking Finance Companies (NBFCs), spread all over the

country, and registered with Reserve Bank of India and authorised to accept

public deposits, have joined hands and formed a Self Regulatory

Organization (SRO) under the name of Finance Industry Development

Council (FIDC). FIDC is registered as a Company u/s 25 of Companies

Act, 1956. The main objective of the regulator body is to work towards

bringing discipline amongst our members by enforcing a model code of

conduct, besides presenting a unified face of this sector.

A robust banking and financial sector is critical for activating the

economy and facilitating higher economic growth. Financial intermediaries

like NBFCs have a definite and very important role in the financial sector,

particularly in a developing economy like ours. They are a vital link in the

system. After the proliferation phase of 1980s and early 90s, the NBFCs

witnessed consolidation and now the number of NBFCs eligible to accept

deposits is around 600, down from 40000 in early 1990s. The number of

asset financing NBFCs would be even lower, around 350, the rest are

investment and loan companies. Almost 90% of the asset financing NBFCs

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are engaged in financing transportation equipments and the balance are in

financing equipments for infrastructure projects. Therefore, the role of

non-banking sector in both manufacturing and services sector is significant

and they play the role of an intermediary by facilitating the flow of credit

to end consumers particularly in transportation, SMEs and other

unorganised sectors. NBFCs due to their inherent strengths in the areas of

fast and easy access to market information for credit appraisal, a well-trained

collection machinery, close monitoring of individual borrowers and

personalized attention to each client as well as minimum overhead costs, are

in a better position to cater to these segments. Now, unlike in the past,

NBFCs are very well regulated and supervised.8

The role of NBFCs in creation of productive national assets can

hardly be undermined. This is more than evident from the fact that most of

the developed economies in the world have relied heavily on lease finance

route in their developmental process, e.g., lease penetration for asset creation

in the US is as high as 30% as against 3-4% in India.9

A conducive and enabling environment has been created for the

NBFC industry globally, which has helped it grow and become an essential

8
. Mahesh Thakkar, Director General, Finance Industry Development Council, ”Pre Budget
Memorandum 2007-08.
9
. Mahesh Thakkar, Director General, Finance Industry Development Council, ”Pre Budget
Memorandum 2007-08.

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part of the financial sector for accelerated economic growth of the

countries. This is not the case in our country. It is, therefore, obvious that the

development process of the Indian economy shall have to include NBFCs as

one of its major constituents with a very significant role to play. NBFCs, as

an entity, play a very useful role in channelising funds towards acquisition

of commercial vehicles and consequently, aid in the development of the

road transport industry.

Needless to mention, the road transport sector accounts for nearly

70% of goods movement and 80% of passenger movement across the length

and breadth of the country and the role of NBFCs in the growth and

development of this sector has been historically acknowledged by several

committees set up by the Government and RBI, over the years. In fact,

RBI’s latest report titled “Report on trends on progress of banking in India

2007-2008" observes.

“Notwithstanding their diversity, NBFCs are characterised by their

ability to provide niche financial services in the Indian economy. Because of

their relative organisational flexibility leading to a better response

mechanism, they are often able to provide tailor-made services relatively

faster than banks and financial institutions. This enables them to build up

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a clientele that ranges from small borrowers to an established corporate.

While NBFCs have often been leaders in financial innovations, which are

capable of enhancing the functional efficiency of the financial system,

instances of unsustainability, often on account of high rates of interest on

their deposits and periodic bankruptcies, underscore the need for reinforcing

their financial viability.”10

For foreign investment purposes, the government has specifically

listed certain categories of NBFCs that are eligible to receive foreign

investments. Non-banking financial companies (NBFCs) have become an

integral part of India’s financial system. In recent times, NBFCs have

emerged as lenders to both companies and individuals. When it comes to

lending, NBFCs are generally regarded to be complementary to banks and

are often able to offer better services and products to their customers.

REGISTRATION OF NBFC 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.

To obviate dual regulation, certain categories of NBFCs which are

10
. Mahesh Thakkar, Director General, Finance Industry Development Council,” Pre Budget
Memorandum 2007-08.

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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 u/s 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 (NHB).

TABLE : 1.1
NUMBER OF NBFCS REGISTERED
WITH THE RESERVE BANK OF INDIA
Number of
End-June NBFCs-D
Registered NBFCs
1999 7,855 624
2000 8,451 679
2001 13,815 776
2002 14,077 784
2003 13,849 710
2004 13,764 604
2005 13,261 507
2006 13,014 428
2007 12,968 401
2008 12,809 364
Source: Report on Trend and Progress of Banking in India, 2007-08, p. 232.

Different Kinds of NBFC’s - Originally, NBFC registered with RBI

were classified as (i) Equipment leasing company; (ii) Hire-purchase

company; (iii) Loan company and (iv) Investment Company. With effect

from December 6, 2006 the above NBFCs registered with RBI have been

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reclassified as:- (i) Asset Finance Company (AFC), (ii) Investment

Company (IC) and (iii) Loan Company (LC).

An Asset Finance Company (AFC) may 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 therefrom is not less than 60% of its total assets and total

income respectively. 11

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 lakhs (raised to Rs. 2 crores w.e.f. April 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

11
. Taxmann’s, “Statutory Guide For Non-Banking Financial Companies”, Eleventh Edition, Taxmann
Allied Services (P) Ltd., New Delhi, p. 1061-62.

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

satisfied.

REQUIREMENTS FOR ACCEPTING PUBLIC DEPOSITS

All NBFCs are not entitled to accept public deposits. Only those

NBFCs holding a valid Certificate of Registration with authorization to

accept Public Deposits can accept / hold public deposits. NBFCs authorized

to accept/hold public deposits besides having minimum stipulated Net

Owned Fund (NOF) should also comply with the Directions such as

investing part of the funds in liquid assets, maintain reserves, rating etc.

issued by the Bank.

RATE OF INTEREST AND PERIOD OF DEPOSIT

Yes, there is a ceiling on acceptance of Public Deposits. An NBFC

maintaining required NOF/Capital to Risk Assets Ratio (CRAR) and

complying with the prudential norms can accept public deposits as follows;

Category of NBFC having minimum Ceiling on public

NOF of Rs. 2 crores deposit
AFC* maintaining CRAR of 15% 1.5 times of NOF or Rs.
without credit rating 10 crores whichever is
less
AFC with CRAR of 12% and having minimum
investment grade credit rating 4 times of NOF
LC/IC** with CRAR of 15% and having
minimum investment grade credit rating 1.5 times of NOF

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 From June 17, 2008 the ceiling on level of public deposits for NBFCs

accepting deposits but not having minimum Net Owned Fund (NOF) of Rs.

2 crores has been revised as under:

Category of NBFC having NOF more than Rs. 25 Revised Ceiling on

lakhs but less than Rs. 2 crores public deposit
AFCs maintaining CRAR of 15% without credit rating Equal to NOF
AFCs with CRAR of 12% and having minimum
investment grade credit rating 1.5 times of NOF
LCs/ICs with CRAR of 15% and having minimum
investment grade credit rating Equal to NOF

Presently, the maximum rate of interest an NBFC can offer is 12.5%.

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.

On and from April 24, 2007, no Non-Banking Financial Company

shall invite or accept or renew public deposit at a rate of interest exceeding

twelve and half per cent (12.5%) per annum. Interest may be paid or

compounded at rests which shall not be shorter than monthly rests. On and

From September 18, 2003, no non-banking financial company shall invite or

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accept or renew repatriable deposits from Non-Resident Indians in terms of

Notification No. FEMA/5/2000 RB dated May 3, 2000 under Non-Resident

(External) Account Scheme at a rate exceeding the rate specified by the

Reserve Bank of India for such deposits with scheduled commercial banks.

The period of above deposits shall be not less than one year and not more

than three years.

IMPORTANT REGULATIONS RELATING

ACCEPTANCE OF DEPOSITS BY NBFCS

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.

(i) NBFCs cannot offer interest rates higher than the ceiling rate

prescribed by RBI from time to time. The present ceiling is 12.5 per

cent per annum. The interest may be paid or compounded at rests not

shorter than monthly rests.

(ii) NBFCs can not offer gifts / incentives or any other additional benefit

to the depositors.

(iii) NBFCs (except certain AFCs) should have minimum investment

grade credit rating.

(iv) The deposits with NBFCs are not insured.

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(v) The repayment of deposits by NBFCs is not guaranteed by RBI.

(vi) Certain mandatory disclosures are to be made about the company in

the Application Form issued by the company soliciting deposits.

Acceptance of Deposits from NRIs.

Effective from April 24, 2004, NBFCs cannot accept deposits from

NRIs except deposits by debit to NRO account of NRI provided such

amount does not represent inward remittance or transfer from NRE / FCNR

(B) account. However, the existing NRI deposits can be renewed. An

unrated NBFC, except certain Asset Finance companies (AFC), cannot

accept public deposits. An exception is made in case of unrated AFC

companies with CRAR of 15% which can accept public deposit without

having a credit rating upto a certain ceiling depending upon its Net Owned

Funds. An NBFC may get itself rated by any of the four rating agencies

namely, CRISIL, CARE, ICRA and FITCH Ratings India Pvt. Ltd.

CREDIT RATING

With the implementation of the New Capital Adequacy Framework

(Basel II) for the banking system linking their capital requirement to the

rating of borrowers’ loan portfolios, SFL has obtained bank loan ratings. All

the Medium and Short Term borrowings are rated “AAA”/“A1+”/“P1+”

(highest ratings), while the Long term borrowings are rated “AA+”. This

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will ensure that SFL continues to raise resources on competitive terms. The

summary of ratings is furnished below:

TABLE : 1.2
SUMMARY OF CREDIT RATINGS OF SFL
NATURE OF BORROWINGS RATINGS
ICRA CRISIL FITCH
Fixed Deposits MAAA FAAA ––
Non-Convertible Debentures (NCDs) –– –– ––
Medium Term NCDs MAAA –– ––
Long Term NCDs LAA+ AA+ ––
Short Term Debt / Commercial Paper A1+ P1+ ––
Subordinated Debt LAA+ AA+ ––
Sanctioned Bank Limits LAA+ LAA+ –– ––
Long Term Bank Loans –– –– AA+ (Ind)
Short Term Bank Loans –– –– FI+ (Ind)
Source : Annual Report of SFL, 2007-08, p. 7.

While ICRA and FITCH have assigned “Stable outlook” for their long

term ratings, CRISIL have assigned “Negative outlook.

DEFAULT IN REPAYMENT OF DEPOSITS

If an NBFC defaults in repayment of deposits, the depositor can

approach Company Law Board or Consumer Forum or file a civil suit in

a court of law to recover the deposits. There is no Ombudsman for hearing

complaints against NBFCs. However, in respect of credit card operations of

an NBFC, if a complainant does not get satisfactory response from the

NBFC within a maximum period of thirty (30) days from the date of lodging

the complaint, the customer will have the option to approach the Office of

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the concerned Banking Ombudsman for redressal of his grievances.

PRUDENTIAL REGULATIONS APPLICABLE TO NBFCs

The Reserve Bank of India has issued detailed directions on

prudential norms; vide Non-Banking Financial Companies Prudential

Norms (Reserve Bank) Directions, 1998. The directions inter alia, prescribe

guidelines on income recognition, asset classification and provisioning

requirements applicable to NBFCs, exposure norms, constitution of audit

committee, disclosures in the balance sheet, requirement of capital

adequacy, restrictions on investments in land and building and unquoted

shares.

The NBFCs having assets of Rs. 100 crores and above but not

accepting public deposits are required to submit a Monthly Return on

important financial parameters of the company. All companies, not

accepting public deposits have to pass a board resolution to the effect that

they have neither accepted public deposit nor would accept any public

deposit during the year.

RBI has powers to cause Inspection of the books of any company

and call for any other information about its business activities. For this

purpose, the NBFC is required to furnish the information in respect of any

change in the composition of its Board of Directors. Address of the company

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and its Directors and the names and official designations of its principal

officers and the name and office address of its Auditors. With effect from

April 1, 2007 non-deposit taking NBFCs with assets of Rs. 100 crore and

above were advised to maintain minimum CRAR of 10% and also comply

with single/group exposure norms. The companies have to achieve CRAR of

12% by March 31, 2009 and 15% by March 31, 2010.

NBFCs Exempted From Registration

Housing Finance Companies, Merchant Banking Companies, Stock

Exchanges, Companies engaged in the business of stock-broking/ sub-

broking, Venture Capital Fund Companies, Nidhi Companies, Insurance

Companies and Chit Fund Companies are NBFCs but they have been

exempted from the requirement of registration under section 45-IA of the

RBI Act, 1934 subject to certain conditions.

Housing Finance Companies are regulated by National Housing Bank,

Merchant Banker/Venture Capital Fund Company/stock-exchanges/stock

brokers/sub-brokers are regulated by Securities and Exchange Board of India

(SEBI), and Insurance companies are regulated by Insurance Regulatory and

Development Authority. Similarly, Chit Fund Companies are regulated by

the respective State Governments and Nidhi Companies are regulated by

Ministry of Corporate Affairs, Government of India.

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SPECIAL PROVISIONS –
Information to be included in the Board’s report

(1) In every report of the Board of Directors laid before the company in a

general meeting under sub-section (1) of section 217 of the

Companies Act, 1956 (1 of 1956), there shall be included in the case

of a non-banking financial company, the following particulars or

information, namely:-

(i) The total number of accounts of public deposit of the company which

have not been claimed by the depositors or not paid by the company

after the date on which the deposit became due for repayment; and

(ii) The total amounts due under such accounts remaining unclaimed or

unpaid beyond the dates referred to in clause (i) as aforesaid.

(2) The said particulars or information shall be furnished with reference

to the position as on the last day of the financial year to which the

report relates and if the amounts remaining unclaimed or undisbursed

as referred to in clause (ii) of the preceding sub-paragraph exceed in

the aggregate a sum of rupees five lakh, there shall also be included in

the report a statement on the repayment of the amounts due to the

depositors remaining unclaimed or undisbursed. 12

12
. Taxmann’s, “Statutory Guide For Non-Banking Financial Companies”, Eleventh Edition, Taxmann
Allied Services (P) Ltd., New Delhi, p. 1072.

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MAJOR RECOMMENDATIONS OF
THE TASK FORCE ON NBFCS

The Task Force on Non-banking Finance Companies (NBFCs)

submitted its report on October 28, 1998. The major recommendations were:

 The rising number of defaulting NBFCs and the need for a quick

redressal system call for change in the existing legislative and

regulatory framework for NBFCs.

 Extension of the period for attaining minimum Net Owned Funds

(NOF) beyond three years (January 2000) should be made conditional

on adequate steps having been taken by the concerned NBFCs. Also,

the minimum prescribed NOF of Rs. 25 lakh be considered for

upward revision.

 The Reserve Bank of India should draw up a time bound programme

for disposal of applications for registration of NBFCs and keep States

informed of registration granted/rejected in respect of NBFCs in the

respective States.

 Higher CRAR of 15 per cent for NBFCs seeking public deposits

without credit rating be prescribed by RBI, as against existing 12 per

cent for rated NBFCs.

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 Ceilings for exposures to real estate sector and investment in capital

market, especially unquoted shares, be prescribed by the Reserve

Bank of India.

 The Reserve Bank of India may stipulate 25 per cent of reserves of

NBFCs to be invested in marketable securities in addition to SLR

securities already held by them. The following ceilings may be

prescribed for public deposits in respect of different categories of

NBFCs.

INTRODUCTION TO HDFC LTD.

Housing Development Finance Corporation Limited (HDFC) was

incorporated in 1977 by Hasmukhbhai Parekh, with the primary objective of

meeting a social need - that of promoting home ownership by providing

long-term finance to households for their housing needs. HDFC was

promoted with an initial share capital of Rs. 100 million. HDFC’s

distribution network spans 243 outlets that include 49 offices of HDFC’s

distribution company, HDFC Sales Private Limited. In addition, HDFC

covers over 90 locations through its outreach programmes. HDFC’s

marketing efforts continue to be concentrated on developing a stronger

distribution network. Home loans are also marketed through HDFC Sales,

HDFC Bank Limited and other third party Direct Selling Agents (DSA).

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 To cater to non-resident Indians, HDFC has an office in London and

Dubai and service associates in Kuwait, Oman, Qatar, Sharjah, Abu Dhabi,

Al Khobar, Jeddah and Riyadh in Saudi Arabia. The primary objective of

HDFC is to enhance residential housing stock in the country through the

provision of housing finance in a systematic and professional manner, and to

promote home ownership. Another objective is to increase the flow of

resources to the housing sector by integrating the housing finance sector

with the overall domestic financial markets.

At present, the company’s offerings range from hassle-free home

loans and deposit products, to property related services and a training

facility. HDFC also offers specialised financial services to the customer base

through partnerships with some of the best financial institutions worldwide.

HDFC has a staff strength of 1445 (as on 31st March, 2008), which includes

professionals from the fields of finance, law, accountancy, engineering and

marketing. HDFC has the following subsidiaries, namely, HDFC

Developers Limited, HDFC Investments Limited, HDFC Holdings Limited,

HDFC Trustee Company Limited, HDFC Realty Limited, HDFC Property

Ventures Limited, HDFC Sales Private Limited, HDFC Ventures Trustee

Company Limited, HDFC Venture Capital Limited, HDFC ERGO General

Insurance Company Limited, HDFC Standard Life Insurance Company

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Limited, GRUH Finance Limited, HDFC Asset Management Company

Limited, HDFC Bank Limited.

INTRODUCTION TO SUNDARAM FINANCE LTD.

Sundaram Finance Ltd incorporated in 1954 has grown today into one

of the most trusted financial services groups in India. Today, the activities of

the group span savings products like Deposits and Mutual Funds, Car and

Commercial Vehicle Finance, Insurance, Home Loans, Software Solutions,

Business Process Outsourcing, Truck Finance, Fleet Cards and Logistics

Services. The Company was incorporated in 1954, with the object of

financing the purchase of commercial vehicles and passenger cars. The

company was started with a paid-up capital of Rs.200 Lakhs and later went

public in 1972.

The Company's shares were listed in the Madras Stock Exchange in

1972 and in the National Stock Exchange (NSE) in January 1998.

Subsequently, the equity shares of the Company have been delisted from

Madras Stock Exchange Limited (MSE) with effect from January 27, 2004,

in accordance with SEBI (Delisting of Securities) Guidelines, 2003, for

voluntary delisting.

A Certificate of honour was given by the ICFA , in recognition of the

Company's efforts to set a trail blazing record of investor rewards, fostering

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the equity cult on ethical lines among the top hundred investor rewarding

companies in India for the period 1990-95. SFL has the following

subsidiaries, namely, Sundaram BNP Paribas Home Finance Limited,

Sundaram BNP Paribas Asset Management, Company Limited, Sundaram

BNP Paribas Trustee Company Limited, Sundaram Finance Distribution

Limited (SFDL), LGF Services Limited, Sundaram Infotech Solutions

Limited (SISL), Sundaram Business Services Limited (SBSL), Infreight

Logistics Solutions Limited (Infreight).

MEANING OF FINANCIAL STATEMENTS

Financial Statements of NBFCs– Present Status and Issues
A complete set of ‘Financial Statements’ normally includes a balance

sheet, a statement of profit and loss, cash flow statement and other

statements and explanatory material that are an integral part of the financial

statements. They may also include supplementary schedules and information

based on or derived from, and expected to be read with, such statements.

Financial reporting in the form of financial statements to users of

financial information is universally accepted as an important end-product of

the accounting process. External financial reporting is becoming

increasingly a critical factor in business with the increase in separation

between the promoters and management of a public limited company on one

side and large number of scattered shareholders on the other.

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 Similarly, present and prospective investors/creditors of a company

place high reliance on the external financial reporting for their decision-

making process. A mere application of proper accounting methods and

procedures in the preparation of financial statements do not automatically

ensure fairness of financial statements unless the financial information

relevant to various users is properly disclosed therein. Users of the financial

statements, particularly those who are relatively less sophisticated in

technical matters of accounting, depend heavily upon the disclosures made

in the financial statements when it comes to understanding and interpreting

the financial information.

DIAGRAM : 1.2
RELATIONSHIP BETWEEN BALANCE SHEET, INCOME
STATEMENT AND CASH FLOW STATEMENT

Balance Sheet
as on March
31, 2008

Income Statement from April 1, 2008, to March 31, 2009

FULL YEAR 2008-2009

Cash Flow Statement from April 1, 2008, to March 31, 2009

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 Therefore, the critical question that has been debated all along in the

evolution of the accounting process is: What should be the level that may be

considered as fair disclosure keeping in mind, among other things, the nature

and volume of financial information, the target user groups, objectives

sought to be achieved, and the cost of providing, as against the benefits, of

such disclosures.

ANALYSIS OF FINANCIAL STATEMENTS

“Financial statement analysis is designed to indicate the strength and

weaknesses of business undertaking through the establishment of certain

crucial relationship by regrouping and analysis of figures contained in

financial statements.13

“Financial Statement analysis is a judgmental process which aims

to estimate current and past financial positions and the results of the

operation of an enterprise, with the primary objective of determining

the best possible estimates and predictions about future conditions.”14

PURPOSE OF FINANCIAL STATEMENTS

"The objective of financial statements is to provide information about

the financial strength, performance and changes in financial position of an

13
. J.N. Myers, “Financial Statement Analysis” quoted by Dr. Ashok Sehgal & Dr. Deepak Sehgal in
“Advance Accounting” Fifth Edition, Taxmann Allied Services (p) Ltd., New Delhi, p. 449.
14
. Bernstein, “Financial Statement Analysis” quoted by Dr. Ashok Sehgal & Dr. Deepak Sehgal in
“Advance Accounting” Fifth Edition, Taxmann Allied Services (p) Ltd., New Delhi, p. 449.

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enterprise that is useful to a wide range of users in making economic

decisions." 15

Financial statements should be understandable, relevant, reliable and

comparable. Reported assets, liabilities and equity are directly related to an

organisation's financial position. Reported income and expenses are directly

related to an organisation's financial performance. Financial statements are

intended to be understandable by readers who have "a reasonable knowledge

of business and economic activities and accounting and who are willing to

study the information diligently." 16

USERS OF FINANCIAL STATEMENTS

(1). Financial statement users are broadly classified into two groups.

Internal users, primarily the managers of a company, are involved in

making operating and strategic decisions for the business. As

employees, they typically have complete access to a company’s

information system. Internally generated financial reports are,

therefore, specifically tailored to the unique information needs of an

internal decision maker, such as a CEO, CFO, or internal auditor.

External users are individuals not directly involved in the company’s

15
. "The Framework for the Preparation and Presentation of Financial Statements" International
Accounting Standards Board Accessed 24 June 2007.
16
. "The Framework for the Preparation and Presentation of Financial Statements" International
Accounting Standards Board Accessed 24 June 2007.

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 operations. These users must rely on information provided by

management as part of the financial reporting process. This book

stresses the analysis needs of external users of general-purpose

financial statements. Nevertheless, many analysis techniques

described here are usefully applied by internal users.

(2). There are many classes of external users of financial statements.

Creditors are bankers, bondholders, and other individuals who lend

money to business enterprises. Creditors look to financial statements

for evidence concerning the ability of the borrower to pay periodic

interest payments and repay the principal amount when the loan

matures.

(3). Equity investors include existing and potential shareholders of a

company. Existing shareholders need financial information in

deciding whether to continue holding the stock or sell it. Potential

shareholders need financial information to help in choosing among

competing alternative investments. Equity investors are generally

interested in assessing the future profitability and/or riskiness of a

company. Merger and acquisition analysts are interested in

determining the economic value and assessing the financial and

operating compatibility of potential merger candidates.

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 DIAGRAM : 1.3
USERS OF FINANCIAL STATEMENTS

Can they pay

me back?

Can the
Is there enough company afford
money to pay me Lenders
to pay me more?
on time?

Prospective
Suppliers employees
Owners’
Current
employees
Managers
Does this company
Am I getting a
have a future?
return on my
investment?

Attorneys
Customers and
litigants
Will they
be in
business Is the company
tomorrow? Am I running the worth suing?
company efficiently?

Source : James Bandler, “How To Use Financial Statements A Guide To Understanding

The Numbers”, McGraw-Hill, New York.

(4). Auditors use financial analysis techniques in determining areas

warranting special attention during their examination of a client’s

financial statements. A company’s board of directors, in their role as

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 appointees of shareholders, monitors management’s actions.

Regulatory agencies utilize financial statements in the exercise of

their supervisory functions, including the Securities and Exchange

Commission, which vigilantly oversees published financial statements

for compliance with federal securities laws certain price-regulated

industries, such as public utilities, submit financial reports to

regulators for rate-determination purposes. Other users include

employees (in evaluating the fairness of their wages and working

conditions), intermediaries (in offering investment advice), suppliers

(in determining the creditworthiness of customers), and customers (in

evaluating the staying power of their suppliers). All of these users rely

on the analysis of financial statements.

FINANCIAL LINKAGE BETWEEN BANKS AND NBFCs

Banks and NBFCs compete for some similar kinds of business on the

asset side. NBFCs offer products/services which include leasing and hire-

purchase, corporate loans, investment in non-convertible debentures, IPO

funding, margin funding, small ticket loans, venture capital, etc. However

NBFCs do not provide operating account facilities like savings and current

deposits, cash credits, overdrafts etc. NBFCs avail of bank finance for their

operations as advances or by way of banks’ subscription to debentures and

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commercial paper issued by them.

Since both the banks and NBFCs are seen to be competing for

increasingly similar types of some business, especially on the assets side,

and since their regulatory and cost-incentive structures are not identical it is

necessary to establish certain checks and balances to ensure that the banks’

depositors are not indirectly exposed to the risks of a different cost-incentive

structure. Hence, following restrictions have been placed on the activities of

NBFCs which banks may finance:

i) Bills discounted / rediscounted by NBFCs, except for rediscounting of

bills discounted by NBFCs arising from the sale of –

a) Commercial vehicles (including light commercial vehicles); and

b) Two-wheeler and three-wheeler vehicles, subject to certain conditions;

i) Investments of NBFCs both of current and long term nature, in any

company/entity by way of shares, debentures, etc. with certain exemptions;

ii) Unsecured loans/inter-corporate deposits by NBFCs to/in any company.

iii) All types of loans/advances by NBFCs to their subsidiaries, group

companies/entities.

iv) Finance to NBFCs for further lending to individuals for subscribing to

Initial Public Offerings (IPOs).

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v) Bridge loans of any nature, or interim finance against capital/debenture

issues and/or in the form of loans of a bridging nature pending raising of

long-term funds from the market by way of capital, deposits, etc. to all

categories of Non-Banking Financial Companies, i.e. equipment leasing and

hire-purchase finance companies, loan and investment companies, Residuary

Non-Banking Companies (RNBCs).

vi) Should not enter into lease agreements departmentally with equipment

leasing companies as well as other Non-Banking Financial Companies

engaged in equipment leasing.

17
MAJOR DIFFERENCES BETWEEN BANKS & NBFCS

NBFCs are doing functions akin to that of banks; however there are a

few differences, namely, A NBFC cannot accept demand deposits (demand

deposits are funds deposited at a depository institution that are payable on

demand immediately or within a very short period like your current or

savings accounts).

 It is not a part of the payment and settlement system and as such

cannot issue cheque to its customers.

 Deposit insurance facility of DICGC is not available for NBFC

depositors unlike in case of banks.

17
. http://www.apnapaisa.com/tag/non-banking-financial-companies/

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 TABLE : 1.3
BANKING VERSUS NON-BANKING COMPANIES
REGULATORY ARBITRAGE IN INDIA
Banks NBFCs
Functional restrictions
Carrying on checking Permitted Not permitted
accounts, remittance
functions and typical
retail banking
Acceptance of term Permitted, subject to term Permitted subject to
deposits restrictions (short term limitations, but the term
deposits are accepted by of deposit is at least 1
banks) year.
Trusteeship function, Permitted No express bar is there
nominee
Other functional Banking Regulation Act a. For domestic
limitations expressly bars any NBFCs, no bar
business other than that On non-financial
permitted by the Act [Sec business, except
6 (1)] that on crossing
of a certain
barrier (50%
of income or assets),
the NBFC will lose
its character as an
NBFC
b. For NBFCs having
international
funding under
automatic route, any
activity included
within the 19
permitted activities
is possible. Any
other activity is
possible only with
the express FIPB
approval

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Leasing and hire Banks are allowed to a No limit
purchase limit of 10% of their
assets
Operating lease Treated as a non-financial Permitted, though
business, not permitted treated as non-financial
business
Securitisation Permitted subject to Permitted subject to
capital norms and other capital norms and other
limitations limitations
Licensing restrictions
Need for a license, Any new bank needs a It is comparatively
license. Licensing norms much easier to get
are tightly controlled and registration as an
generally, it is perceived NBFC. Besides, there
to be quite difficult to get are some 30000 NBFCs
a license for a bank currently registered,
many of which may be
available for sale.
Ownership structure/ change in ownership
Indian ownership Not more than 10% of While prior intimation
capital in a bank may be of a takeover is required
acquired without the in case of NBFCs, there
approval of the RBI is no need for express
permission for a change
in voting control. There
is no limit as to the
percentage holding
permitted in case of
NBFCs
Foreign ownership Upto 74% capital in 100% capital may be
banking companies may held by foreign owners
be acquired for foreign subject to minimum
owners. capitalisation
requirements under FDI
norms

Capital adequacy requirements and provisioning

Basle norms Present capital regulations Prudential Regulations
are based on Basle I. Basle which lay down capital

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 II is proposed to be adequacy have been
implemented effective substituted in Feb 2007,
2007. Capital requirement but they are based on
generally 9% of risk- Basle I and not Basle II.
weighted assets Capital requirement
generally 10% of risk-
weighted assets.
Credit control and sectoral asset restrictions
SLR/CRR norms Substantial part of assets Only 15% of the
of banks is blocked due to deposit liabilities of
statutory liquidity ratio NBFCs is to be held in
(SLR) and cash reserve certain permitted
ratio (CRR). These are securities.
periodically changed to
control the expansion of
M3 in the economy.
Sectoral exposures Periodic regulations place Very scanty limitations
limits on the extent to have been placed on
which banks may invest in assets of NBFCs.
capital market and other Investment in real estate
specific segments. There and unquoted equity
are certain segments in shares is controlled.
which banks need to Capital market
allocate minimum exposure is only
percentage of required to be reported.
their assets
Source : Vinod Kothari, “New Directions For Non-Banking Finance Companies”, sited
from http://www.india-financing.com, on 12-09-2008.

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