How to Set up a Non-Banking Financial Company (NBFC) in India?

Non-Bank Financial Companies (NBFCs) perform diverse financial functions such as receiving deposits, financing, leasing, and investing in securities, chit funds and lease purchase. NBFCs and banks have a lot in common except that NBFCs do not accept demand deposits except subject to the approval and not a part of the payment & settlement system like a bank. NBFCs work as vital resorts and are crucial support systems in an economy. In the words of the famous Economist, Alan Greenspan, Non-banking Financial Institutions contribute in empowering the economy as they deliver “multiple alternatives to transform an economy’s savings into capital investment which act as backup facilities should the primary form of intermediation fail”.

Today the NBFC sector in India accounts for 18 percent of the total formal credit flow that amounts to INR 118 trillion (about $158 billion). NBFCs pursued aggressive business growth through building distribution capabilities across new, untapped and under-penetrated geographies and customer segments. Moreover, NBFCs updated themselves with technological advances and integrated with the FinTech ecosystem in order to establish cost-effective, robust operations and risk management capabilities. By developing new channels of growth through venturing into partnerships with aggregators, e-commerce companies, FinTech and the MSME marketplace NBFC developed capabilities and stepped up its growth.

NBFCs have driven credit growth in unorganized sectors that were rejected by traditional resources such as banks. Several NBFCs have also amassed a niche, differentiated business models that are sector-, product- and geography-specific to harness existing enterprise with group capabilities. With their motto of prioritizing the customer before everything else, beginning from customizing products to match customer needs, enriching customer interactions to deepening customer relationships, NBFCs have emerged as the favoured lender in most market today.

An NBFC business cannot be engaged in the business of the sort whose primary functions include any of the following:

• Any Agricultural Activity
• Any Industrial Activity
• The purchase or sale of any goods excluding securities
• The sale or purchase or construction of any immovable property
• The provision of any services

The Categories of NBFCs

NBFCs are classified into deposit taking NBFC (‘NBFC-D’) or non-deposit taking NBFC (‘NBFC -ND’). The Reserve Bank of India classifies the NBFCs into seven categories based on their business:

• NBFC – Investment and Credit Company (NBFC-ICC)

Reserve Bank of India in a recent announcement combined the three categories of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs) and Investment Companies (ICs) into a new category called NBFC – Investment and Credit Company (NBFC-ICC). NBFC-ICC means any company which is a financial institution carrying on as its principal business, i.e. asset finance - the providing of finance whether by making loans or advances or otherwise for any activity other than its own and is carrying out the acquisition of securities; and is not any other category of NBFCs.

• NBFC- Infrastructure Finance Companies (NBFC-IFC)

Infrastructure Finance Company means a non-deposit taking NBFC that fulfils the criteria such as (a) 75 percent of its total assets in infrastructure loans, (b) Minimum Net Owned Funds of INR 300 crores (about $40 million), (c) Minimum credit rating of ‘A ‘ and (d) CRAR of 15%.

• Systematically Important Core Investment Companies (CIC-ND-SI)

CIC-ND-SI is an NBFC acting out the business of acquisition of shares and securities which satisfies the subsequent conditions such as (a) assets size should be INR 100 crores (about $13.33 million) or above; (b) holds not less than 90% of its Total Assets, (c) its investments in the equity shares in group companies constitutes not less than 60% of its Total Assets and (d) it does not trade in its investments in shares, debt or loans in group companies except through block sale for dilution or disinvestment.

• Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI)

Non-Banking Financial Company – Micro Finance Institution (NBFC-MFI) means a non-deposit taking NBFC that satisfies the conditions such as (a) Minimum Net Owned Funds (NOF) of INR 5 crore (about $6.7 hundred thousand)(For NBFC-MFIs registered in the North Eastern Region of the country, the minimum NOF requirement shall stand at INR 2 crore (about $2.7 hundred thousand) and (b) Not less than 85% of its net assets should be qualified asset.

• NBFC- Non-Operative Financial Holding Company (NBFC-NOFHC)

It 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 ensure regulation of bank as well as all other financial services companies regulated by RBI or other financial sector regulators, to the degree permissible under the applicable regulatory prescriptions.

• Non-banking financial company - Peer to Peer Lending Platform (NBFC-P2P)

Non-banking financial company - Peer to Peer Lending Platform” (NBFC-P2P) means an institution which carries on the business of a Peer to Peer Lending Platform. NBFC-P2P shall have a net owned fund of not less than rupees twenty million.

• Housing Finance Company

Any company which is carrying on as its primary business the financing of acquisition or development of plots of land in connection therewith is called Housing Finance Company.

Procedure for the incorporation of an NBFC

The company require to submit the documents such as:

• Application Form
• Latest annual audited balance-sheet. However, in the case of a newly incorporated company, such particulars/information should be based on the balance-sheet as on a date falling within thirty days preceding the date of application
• Registration Certificates, Tax Certificates
• Board Resolutions
• Details of the Directors, Addresses, Director Identification Number etc.
• Background note on the activities of the company since inception and the reasons for applying for NBFC registration.
• Documents for investment in NBFC
• Details of Latest Shareholding Pattern and Net-worth of the company
• Details of Chief Executive Officer and Chairman
• Any other document required by Reserve Bank of India
• Copy of Fixed Deposit receipt & bankers’ certificate of no lien indicating balances in support of NOF.

The Reserve Bank of India shall examine the documents submitted by the company. It may ask for additional documents and clarifications from time to time. On its satisfaction, the Reserve Bank of India shall grant the license of NBFC to the company.

The Reserve Bank of India has issued detailed directions - Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 1998. The directions prescribe guidelines on capital adequacy, income recognition, asset classification and provisioning, exposure norms, disclosure requirements and restrictions on investments

Frequently Answered Questions regarding the establishment of an NBFC

a) Is it necessary that every NBFC should be registered with RBI?

No NBFC can commence or carry on the business of a non-banking financial institution as a primary business without obtaining a certificate of registration from the Reserve Bank of India and net owned funds of INR 200 lakh (about $27 million).

b) What is the meaning of ‘principal business’ in NBFCs?

The principal business means when a company’s financial assets constitute more than 50 percent of the total assets and income from financial assets constitute more than 50 percent of the gross income.

c) Is it necessary that promoters and directors have experience in the financial market before the registration of NBFCs?

The company requires to provide information on qualification and experience of promoters and directors in financial market before the registration of NBFCs.

d) What is the procedure for application to the Reserve Bank for Registration?

The company requires you to make an application to obtain the NBFC registration to the Reserve Bank of India with the required information. The Reserve Bank of India shall examine the documents submitted by the company. It may ask for additional documents and clarifications from time to time. On its satisfaction, the Reserve Bank of India shall grant the license of NBFC to the company.

e) Whether the foreign investment is allowed in NBFCs?

Under the Foreign Direct Investment Policy issued by the Department of Industrial Policy and Promotion, foreign direct investment in an NBFC (under other Financial Services) is permitted up to 100% under the automatic route.

f) What is the procedure for foreign investment in NBFCs?

NBFCs required to file form FC-GPR within 60 days of receipt of funds into the bank account. The Reserve Bank of India shall approve the FC-GPR form after reviewing the documents.

g) Whether NBFCs can receive a foreign loan (also known as External Commercial Borrowing)?

The NBFCs can receive a foreign loan for the purpose of capital expenditure, working capital or general-purpose, lending for capital expenditure, lending for working capital purposes or general corporate purposes and lending for repayment of Rupee loans availed domestically for capital expenditure & other purposes subject to the policy of External Commercial Borrowing of Reserve Bank of India.

h) Whether NBFCs require any approval for change in their ownership?

Any change in the shareholding of more than 26 percent of the NBFCs requires the approval from Reserve Bank of India.

i) Whether NBFCs require any approval for change in their Directorship or management?

Any change in the management of the NBFC which would result in a change in more than 30 percent of the directors requires approval from Reserve Bank of India.

j) NBFCs are charging high-interest rates from their borrowers. Is there any ceiling on the interest rate charged by the NBFCs to their borrowers?

Reserve Bank of India has deregulated interest rates to be charged to borrowers by financial institutions.

k) Whether Reserve Bank of India can penalize the NBFCs in case unable to meet the criteria of 50-50 principal business criteria?

The Reserve Bank of India can lay down policy, issue directions, inspect, regulate, supervise and exercise surveillance over NBFCs that meet the 50-50 criteria of principal business. The Reserve Bank of India can penalize NBFCs for violating the provision.

FDI changes in NBFC’s

It is essential that every NBFCs should be registered with the Reserve Bank of India before commencing the business. Further, such NBFC should be a company registered under the Companies Act, 2013 and should have a minimum net owned fund of INR 200 lakh (about $27 million). Under the Foreign Direct Investment Policy issued by the Department of Industrial Policy and Promotion, foreign direct investment in an NBFC (under other Financial Services) is permitted up to 100% under the automatic route. The company requires you to make an application to obtain the NBFC registration to the Reserve Bank of India.

Sources of funding for NBFCs

In the recent years, NBFCs have surfaced as one of the significant net receivers of funds from the rest of the financial system. The funding structure of NBFCs has progressed from short-term borrowings to long-term borrowings. The sources for its funding can be explained within the points below:

• The Department of Investment and Promotion Board eased the foreign direct investment policy in which NBFCs are permitted to receive the foreign investment up to 100% under the automatic route. This has opened the gateway for large foreign NBFCs to partner and invest in domestic NBFCs.
• The Reserve Bank of India also eased the policy of External Commercial Borrowing in January 2019 which allows NBFCs (other than Micro Finance) to raise the international debt from the international market. The new External Commercial Borrowing Policy invites many international financial institutes to provide long term finance to NBFCs in India at low favourable rate of borrowing cost with a range of 3.5 to 4.5 percent plus LIBOR. The sector witnessed an interest from Multinational funds which are focussed in lending to MSMEs marketplace.
• Domestic financial institutions like Public Sector Banks, National Bank for Agriculture and Rural Development (NABARD), Small Industries Development Bank of India (SIDBI), Asian Development Bank (ADB) have also come forward to finance NBFCs.
• NBFCs raise the funds in short-term by issuance of commercial papers (an unsecured money market instrument issued in the form of a promissory note). However, NBFCs are exploring more stable and long-term sources of capital, commercial papers are expected to be replaced by other forms of borrowings such as non-convertible debentures (NCDs). In addition, in the medium to long term, more stable sources of financing like bonds, external commercial borrowings and retail NCDs are likely to become more prominent.
• The NBFCs have also started developing strategic investment partnerships with international aggregators, e-commerce companies, FinTech companies which are willing to enter Indian marketplace. NBFCs are optimising the operational cost to improve the return on equity (ROE) and free up capital for investments in growth areas. The government should extend additional funding sources to NBFCs to reduce over-dependence on banks and address the current liquidity crunch.

Conclusion

NBFCs have been experiencing liquidity challenges due to the domestic economic slowdown particularly in the automotive, infrastructure and real estate sectors, and also because there is an increase in the operating cost of the same, such as sales & marketing, servicing and collection cost by NBFCs, and lastly due to the competitive lending rates in the market.

For a solution for these issues, it is necessary that such NBFC’s establish strong governance and risk management practices to gain the trust of the stakeholders resulting in the reduction of the borrowing cost which will in turn increase the return of investment and ensure their sustainability in the industry.

Further, NBFCs can upgrade on their bottom line by minimizing operational cost through leveraging technology and automation initiatives. Finally, by focussing on the needs of the customers and developing value creating partnerships with key market players can lead to the evolution of NBFC industry.