What is a Non-Banking Financial Company?
A Non-Banking Financial Company or commonly called NBFC is a company that is registered under the Companies Act and is engaged in wide-ranging financial services. These companies engage in the business of loans and advances, acquisition of shares, stocks, bonds, debentures, securities issued by Government or local authority or other marketable securities of similar nature like leasing, hire-purchase, insurance business or chit business.
How are NBFCs different from Banks?
NBFCs lend and make investments and function almost similar to the banks yet they are not banks; so let us understand what makes NBFCs different from banks.
These are a few factors that differentiate NBFCs from banks:
| Banks accept demand deposits that are repayable on demand. | NBFCs are not allowed to accept demand deposits. |
| Banks form an integral part of the payment and settlement system. | NBFCs do not form part of the payment and settlement system and therefore, cannot issue cheques drawn on itself. |
| Banks are allowed to deposit insurance facilities to the depositors of banks by Deposit Insurance and Credit Guarantee Corporation (DICGC). | No deposit insurance facility from Deposit Insurance and Credit Guarantee Corporation is given to the depositors of NBFCs. |
| Banks are mandatorily required to maintain reserve ratios like CRR or SLR. | NBFCs do not need to maintain reserve ratios. |
| Banks create credit. | NBFCs are not involved in the creation of credit. |
| Banks provide transaction services to their customers. | NBFCs do not provide transaction services to their customers. |
In spite of all the differences, NBFC sector in India has stood the test of time and has emerged as a major contributor to the Indian economy, leaving aside all skepticism leveled against it. So it important to have good NBFC compliances.
Rise & Rise of NBFCs
Initially, non-banking financial companies were looked upon with great skepticism and uncertain future but in recent years the NBFC sector in India has emerged as an imperative part of the Indian economy.
NBFCs have caught the country’s attention because they fill in the void left open by the banks and cater to the varied financial needs of an uncountable number of small firms as well as individuals.
In its journey forward NBFCs are helping in building an inclusive India by extending financial services to the economically weaker sections of the society and penetrating the rural areas; these people are generally ignored by the banks or are unable to meet credit requirements set by them.
NBFC sector in India is also critical for the growth of the Indian GDP as it is the primary source of finance for small and medium-sized businesses, generating jobs for many.
Another important reason for the success of NBFCs is that compared to the banks they face lower costs, higher margins, and fewer regulatory compliances which give them leverage.
Foreign Direct Investment & NBFCs
Foreign Direct Investment (FDI) in the NBFC Sector in India is permitted and in simple terms, it refers to an investment that is made by a foreign entity into an NBFC of India to have control over ownership.
FDI in India is regulated by the Foreign Exchange Management Act, 2000 and governed by the Reserve Bank of India.
In the NBFC Sector in India Foreign Direct Investment can be made through two different routes:
1) Government Route: FDIs under this need to be approved by the Reserve Bank of India.
2) Automatic Route: Foreign Direct Investments made through this route need no approval of the Authority
Brief History of FDI in the NBFC Sector in India
The government of India always adopted a conservative approach when it came to Foreign Direct Investments. FDI in India was traditionally looked upon as a complicated procedure and one in which investment trickled in slowly as the government faced a regulatory discomfort and was not in favor of allowing foreign direct investment above the minimum capitalization norms.
Gradually, liberalization took center stage and as the Indian economy opened up, the perspective of government also changed. In the meantime, foreign investors, that took notice of the expanding and booming economy of India, started showing keen interest in investing handsomely in various sectors, NBFC being one of them.
For the ease of business, changes were made in the norms with respect to FDI in the non-banking sector.
100% FDI in NBFCs
A notification by Reserve Bank of India on the 9th of September 2016 came out with an amendment Foreign Exchange Management (Transfer and Issue of Securities to Persons Resident outside India) Regulations, 2000.
According to this RBI notification, Foreign Direct Investment of up to 100% could now be made under the automatic route in select Non-Banking Financial companies.
Thus, FDI norms in India were simplified and FDI in the non-banking sector was allowed under automatic route only in select 18 non-banking financial service activities and these too were subject to conformity with the minimum capitalization norms.
These were further divided into fund-based and non-fund-based activities.
The specific fund-based activities were:
- Merchant Banking
- Underwriting
- Portfolio Management Services
- Stock Broking
- Asset Management
- Venture Capital
- Custodial Services
- Factoring, Leasing
- Finance, Housing Finance
- Credit Card Business
- Micro Credit
- Rural Credit
The non-fund-based activities, that is, those which do not deal with credit or cash transactions, were:
- Forex Broking
- Financial Consultancy
- Credit Rating Agencies
- Money Changing Business
- Investment Advisory Services
FDI in the non-banking sector is permitted in these specified activities under the automatic route, subject to compliance with the minimum capitalization norms.
Capitalization Norms for Fund Based Activities:
- The minimum foreign capital requirement was USD 0.5 million.
- Out of this USD 0.5 million in foreign investment, 51 percent needed to be brought upfront.
- In case of acquisition of a stake of more than 51 percent, USD 5 million was the minimum foreign capital requirement and out of this, it was required to infuse 75 percent at once.
- For a stake of more than 75 percent, a minimum capital requirement of USD 50 million was required and which could be acquired via a joint venture only. Out of USD 50 million, USD 7.5 million had to be infused upfront.
Capitalization Norms for Non-Fund Based Activities:
- The minimum foreign capital requirement remains the same, I.e.-USD 0.5 million
- To be brought upfront
Changes made in the FDI Policy
Though RBI’s FEMA Notification No. 375/2016-RB dated 9 September 2016, RBI introduced key relaxations regarding FDI in the non-banking sector. Continuing with its liberalization policy to attract overseas investments the government allowed 100% foreign direct investment in 'other financial services’ carried out by non-banking finance companies. Going beyond the 18 specified activities, 100% FDI in the non-banking sector is now permitted through the automatic route.
This was a big-ticket change and in his 2016-17 budget speech, the then Finance Minister Arun Jaitley had hinted about this relaxation and said, "FDI will be allowed beyond the 18 specified NBFC activities in the automatic route in other activities which are regulated by financial sector regulators”.
Elaborating on 'Other financial services’ the FDI policy bifurcates it into two categories 'regulated’ and 'unregulated’. Regulated financial services are regulated by any financial sector regulator like RBI, SEBI, IRDA, Pension Fund Regulatory and Development Authority, National Housing Bank, etc. Whereas, unregulated services refer to those services which are not regulated by any financial sector regulator.
Important changes impacting Regulated Financial Services
Under the FDI notification two key relaxations were introduced with respect to regulated financial services:
1) first, FDI in India was opened up of all regulated financial services under the automatic route for up to 100%; and
2) second, minimum capitalization norms were removed.
Significant norms for Unregulated Financial Services
With respect to FDI in India in unregulated financial services, the extant policy prescribed:
- FDI in the non-banking sector in unregulated financial services 100% FDI was permitted but with prior government approval.
- And also mentioned that FDI in India in all such unregulated financial services will be subject to some specific conditions that will be decided by the government, like minimum capitalization norms.
The Ministry of Finance (MoF) through a press release dated 16 April 2018 in context of FDI in 'other financial services’ activities which are unregulated or partially regulated by any financial sector regulator, announced that:
a) For FDI in 'fund-based’ activities, the prescribed minimum capital requirement is $20 million.
b) Whereas for FDI in non-fund based activities the amount fixed was $2 million.
Effect of RBI Notification on FDI in NBFC Sector
The RBI notification regarding 100% FDI in the non-banking sector has impacted it and brought around these benefits:
- The Indian lending Businesses can now easily get investment from Foreign Banks and Venture Capitalists.
- The ease in norms will extend help in the growth and development of the NBFC sector in India.
- With 100% FDI in the non-banking sector these companies will be able to provide long-term loans to the infrastructure sector.
- This change in the FDI policy of India will help to spur the overall economic growth of India as it has opened the market for large investors.
Non-Banking Finance Company (NBFC) and Foreign Loans
Foreign loans through FDI in India in the non-banking finance sector are governed by these 3 entities:
- Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulation, 2000
- Foreign Exchange Management Act, 1999
- Regulations passed by RBI
Non-Banking Finance Company (NBFC) and Foreign Loans
The loan which is borrowed from foreign institutions is termed as 'External Commercial Borrowings’ (ECB) and these can be obtained from foreign financial institutions or foreign banks without much difficulty. Moreover, the norms specify that these ECBs can also be obtained from a shareholder but on a condition that such a shareholder should not be the resident of India and owns a minimum of 25% of the total shares of the borrower company.
The guidelines passed by RBI lays down that ECBs can be obtained in some specific sectors of NBFCs but only after the necessary conditions are fulfilled. Thus, for obtaining foreign loans in non-banking financial companies it is mandatory to comply with the procedure laid down by RBI.
External Commercial Borrowings
The most important FDI in India is External commercial borrowings (ECB). These are basically loans that are availed by eligible Indian resident entities from non-resident lenders confined to permitted and non-permitted end-use, minimum maturity, maximum all-in-cost ceiling.
Eligible Borrowers
Entities that are allowed to raise Foreign Direct Investment in India are eligible to borrow External Commercial Borrowings. Such as:
- Port Trust
- Units in SEZ
- SIDBI
- EXIM Bank of India
- Registered Entities engaged in microfinance activities
Recognized Lender
To be considered a recognized lender, an entity should be a resident of a FATF or IOSCO compliant country.
Additionally, Multilateral and Regional Financial Institutions where India is a member country shall also be as recognized lenders;
Individuals as lenders can only be permitted if they are foreign equity holders or for subscription to bonds/debentures listed abroad;
- Overseas branches or subsidiaries of Indian banks are permitted as recognized lenders only for FCY ECB (except FCCBs and FCEBs).
- Overseas branches or subsidiaries of Indian banks can participate as arrangers, underwriters, market makers or traders for Rupee denominated Bonds issued overseas, but are subject to applicable prudential norms.
- However, Indian banks will not be allowed issuances of underwriting by foreign branches or subsidiaries of Indian banks.
Limit and Leverage Under the Automatic Route
- According to the policy governing FDI in India under the aforesaid framework, all eligible borrowers can raise ECB up to USD 750 million or equivalent per financial year.
- Additionally, under the automatic route ECB liability-equity ratio for ECB raised from direct foreign equity holders cannot exceed 7:1; but this clause is not applicable if the outstanding amount of all ECB is within the limit of USD 5 million.
End-use of ECB
The non-banking finance companies are entitled to take a loan only for the following purposes:
- Working capital
- Repayment of rupee loan for capital expenditure
- Repayment of rupee loan for other than capital expenditure
Minimum Average Maturity Period (MAMP) for NBFC
Under the Foreign Exchange Management Regulation, there are various rules and regulations provided that deal with regulating External Commercial Borrowing. There are some rules specifically for the period of maturity.
Under the ECB Framework borrowings are subject to some reporting requirements along with any other specific reporting required under the framework:
| S. No. | Particulars | MAMP |
|---|---|---|
| 1. | For the purpose of working capital or for general corporate purpose | 10 years |
| 2. | On lending for repayment of Rupee loans availed domestically for capital expenditure | 7 years |
| 3. | On lending for repayment of Rupee loans availed domestically for purposes other than capital expenditure. | 10 years |
Procedure for External Commercial Borrowing by NBFCs in India
- The first requirement, for any draw-down in respect of an ECB, is to obtain the Loan Registration Number (LRN) from the Reserve Bank of India.
- To obtain the LRN the borrowers need to submit duly certified Form ECB in duplicate to the designated AD Category I bank.
- LRN can also be generated through an authorized dealer by submitting all the supporting documents.
- These dealers take 7 days of time to get the Loan Registration Number generated.
- Once the Loan Registration Number is generated, the amount of loan can be credited in the bank account.
- Monthly reporting of actual transactions is mandatory and for this the borrowers need to file the returns with Reserve Bank of India through AD Bank through form ECB-2.
- The duly filled Form ECB-2 must reach the Department of Statistics and Information Management (DSIM) within the time span of seven working days from the close of the month to which it adheres to.
Late Submission Fee (LSF) for Delay in Reporting
If there is a delay in reporting of the drawdown of ECB proceeds before obtaining LRN or in filing returns and subsequent submission of Form ECB-2 then they can regularize the particular delay by payment of late submission fees in the following way:
| Sr. No. | Type of Return/Form | Period of delay | Applicable LSF |
|---|---|---|---|
| 1. | Form ECB 2 | Up to 30 calendar days from the due date of submission | INR 5,000 |
| 2. | Form ECB 2/Form ECB | Up to three years from the due date of submission/date of drawdown | INR 50,000 per year |
| 3. | Form ECB 2/Form ECB | Beyond three years from the due date of submission/date of drawdown | INR 100,000 per year |
Such borrowers can pay the LSF through its AD bank, by way of demand draft in favor of "Reserve Bank of India” or any other mode specified by the Reserve Bank. The requisite return(s) must accompany all such payments.
Conclusion
Allowing 100% FDI in the NBFC sector in India has been a game-changer as it has opened up foreign investment channels and helped the sector to grow at a faster pace than ever before.
FDI in the non-banking sector has helped it in its exponential growth and has made this sector a great contributor to the economic growth of India as its contribution is higher than any other sector.
The Non-Banking finance sector has witnessed improved capital inflow due to FDI in India and therefore, the NBFCs are not only able to cater to the daily needs of the business but are also investing in large projects.
The most noteworthy impact of FDI in India has been that it has helped in removing the domestic monopolies that the large investors enjoyed, and it has provided a level playing field to the NBFCs in a highly competitive market.
It would not be wrong to say that FDI in the non-banking sector has become the backbone for the Non-Banking Finance companies and supported them in successfully achieving their vision and objectives.
Way Forward
On the one hand, there are no two ways about the incomparable benefits of 100% FDI in the non-banking sector but on the other, it is also true that there are certain ambiguities in the said policy that are pulling down this sector.
Owing to this, Private equity (PE) and venture capital (VC) funds have written to the Reserve Bank of India as they are demanding clarity on its licensing policy for non-banking finance companies (NBFCs).
RBI in the recent past has returned a large number of NBFC applications pointing out that the parent entity of the proposed NBFC entity was not regulated or listed in the headquartered jurisdiction. At the same time the central bank has also rejected license applications of NBFCs that received funding from Mauritius, arguing that the country is included in the Foreign Action Task Force (FATF) grey list.
Alleging that the RBI is not able to carry out satisfactory due diligence for grant of registration by the Indian Private Equity and Venture Capital Association (IVCA) has forwarded a representation. IVCA has pointed out that the steps taken by the RBI would negatively impact the already cash-strapped NBFC Sector in India as blocking these investors will potentially hamper the flow of foreign funds and have a cascading effect.
The letter sent by IVCA categorically points out this pain area, "The position taken by RBI is expected to deprive NBFCs of offshore capital as well as leave them dependent on funds from the domestic market. It will also aggravate the continual liquidity woes of NBFCs and discourage the emergence of innovative NBFC models that PE and VC investors support".
The contradictory stand of RBI in different cases has left the industry demanding a clear cut regulation that will bring 100% clarity on all matters related to FDI in India. In wake of such a situation, the government should direct RBI to effectively plug in all the loopholes and ensure smooth flow of FDI in the non-banking sector.
The pivotal role that NBFCs play in the economic growth of the country is undisputed as it has come as the biggest economic driver. NBFCs are helping the government to achieve its dream of holistic development by reaching the weakest section of the society and geographically too, have penetrated the rural, backward areas.
Thus, the government must take cognizance of the disablers and barriers in FDI in the non-banking sector and mend it at the earliest so that the country’s economic growth progresses without a hitch.
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