Saturday, April 28, 2012

Miscellaneous

1. In an interesting article in the Mint, Suresh Gurumani has argued that private sector MFIs have demonstrated a scalable model that can also benefit the rural youth by providing gainful employment. He suggests that it is time for the government and the banks to step forward to use this model to further the objectives of financial inclusion.

2. The State of Bihar plans to set up two special courts to dispose of cases relating to defrauding of small investors by NBFCs.

3. The industry has differing views on the impact of the change in RBI regulations on NBFCs specializing in gold-loans - read here and here.

Finally, I am putting out a call for contributors to this blog. Anyone interested in contributing posts in the form of notes/ articles/ teasers in relation to the legal/ regulatory environment impacting NBFCs on a regular/ occasional basis, please drop me an mail - satyajit(dot)gupta(at)gmail(dot)com. Further details can be obtained through email.

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Wednesday, April 18, 2012

RBI Policy 2012 - 2013

The RBI unveiled its Monetary Policy Statement 2012 - 2013 on April 17, 2012. A few relevant proposals from the NBFC perspective are:

1. The Reserve Bank had constituted a Working Group (chaired by Mrs. Usha Thorat) to examine a range of emerging issues pertaining to the regulation of the NBFC sector in view of their growing importance and inter-connectedness with other segments of the financial system, which would have a bearing on financial stability. The report was placed on the Reserve Bank’s website in August 2011 for feedback from the public. The Policy Statement states that the RBI proposes to issue the draft guidelines on the regulatory framework for NBFCs by end-June 2012.

2. Core investment companies (CICs) have, as their primary activity, investment in equity shares of group entities for the sake of holding stake in these companies. As a holding company, a CIC may also need to invest in both financial and non-financial entities overseas. Accordingly, the RBI proposes to place the draft guidelines on overseas investment by CICs on the RBI website for public comments by end-April 2012.

3. The rapid expansion of NBFCs lending against gold has led to their increased dependence on public funds, including bank finance. To supplement the prudential measures already implemented for such NBFCs, the RBI has proposed that:

(a) banks should reduce their regulatory exposure ceiling in a single NBFC, having gold loans to the extent of 50 per cent or more of its total financial assets, from the existing 10 per cent to 7.5 per cent of bank’s capital funds. However, exposure ceiling may go up by 5 per cent, i.e., up to 12.5 per cent of bank’s capital funds if the additional exposure is on account of funds on-lent by NBFCs to the infrastructure sector; and

(b) banks should have an internal sub-limit on their aggregate exposure to all such NBFCs, having gold loans to the extent of 50 per cent or more of their total financial assets, taken together.

The RBI proposes to issue detailed guidelines in this regard separately. 

4. The RBI has also constituted a Working Group (chaired by Mr. K U B Rao) to study various aspects/ issues emerging from NBFCs lending against gold. 

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Friday, April 13, 2012

Revised FDI Policy: Clarification in relation to NBFCs

The Government of India (DIPP) has issued the revised Consolidated FDI Policy Circular 1 of 2012 that is effective from April 10, 2012. An accompanying press release lists the key changes.
The FDI Policy includes a clarification regarding the scope of ‘leasing’ for investment in non-banking finance companies (NBFCs). Note (ii) to Paragraph 6.2.24.2(1) of the FDI Policy states that "Leasing & Finance covers only financial leases and not operating leases." The press release also states that "...the activity of ‘leasing and finance’, which is one among the eighteen NBFC activities where induction of FDI is permitted, covers only ‘financial leases’ and not ‘operating leases’. This provision intends to clarify the coverage of the term ‘leasing and finance’, insofar as the NBFC sector is concerned." AS-19 defines a finance lease as a lease that transfers substantially all the risks and rewards incident to ownership of an asset.


The category of 'leasing and finance' is quite interesting and encompasses a wide variety of activities, including pure finance/ loan companies.

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Friday, April 6, 2012

Report of the Usha Thorat Committee


The Reserve Bank of India (RBI) released the Report of the Working Group on the Issues and Concerns in the NBFC Sector in August 2011. This Working Group, chaired by Mrs. Usha Thorat, former Deputy Governor of the RBI, was constituted to review the existing regulatory and supervisory framework of non-banking finance companies (NBFCs) with special focus on the risks in the sector. The Working Group was also expected to recommend appropriate regulatory and supervisory measures to address these risks. 

The key recommendations of the Working Group were:

1. The minimum net owned fund (NOF) requirement for all new NBFCs wanting to register with the Reserve Bank could be retained at the present Rs. 2 crores till the Reserve Bank of India Act is amended. The RBI should, however, insist on a minimum asset size of more than Rs. 50 crores for registering any new NBFC. Existing NBFCs below this limit may deregister or be asked to seek a fresh certificate of registration at the end of two years.

2. NBFCs not accessing public funds may be exempted from registration provided their assets are below Rs. 1000 crores.

3. Any transfer of shareholding, direct or indirect, of 25% and above, change in control, merger or acquisition of any registered NBFC should have prior approval of the RBI. [Currently, only change in control of deposit accepting NBFCs require prior approval of the RBI.]

4. The twin-criterion of assets and income for determining the principal business of an NBFC should be increased to 75% of the total asset and 75% of the total income, respectively. A time period of three years may be given to fulfill revised principal business criteria.

5. Tier I capital for Capital to Risk Weighted Assets Ratio (CRAR) purposes may be specified at 12% to be achieved in three years for all registered deposit taking and non-deposit taking NBFCs.

6. Liquidity ratio may be introduced for all registered NBFCs such that cash, bank balances and holdings of government securities fully cover the gaps, if any, between cumulative outflows and cumulative inflows for the first 30 days.

7. Asset classification and provisioning norms similar to banks to be brought in phased manner for NBFCs. Suitable income tax deduction akin to banks may be allowed for provisions made under the regulations. Accounting norms applicable to banks may be applied to NBFCs.

8. NBFCs may be subject to regulations similar to banks while lending to stock brokers and merchant banks and similar to stock brokers, as specified by the Securities and Exchange Board of India (SEBI), while undertaking margin financing.

9. Financial conglomerate approach may be adopted for supervision of larger NBFCs that have stock brokers and merchant bankers in the group.

10. Government owned entities that qualify as NBFCs may comply with the regulatory framework applicable to NBFCs at the earliest.

11. Board approved limits for bank’s exposure to real estate may be made applicable for the bank group as a whole, where there is an NBFC in the group. The risk weights for NBFCs that are not sponsored by banks or that do not have any bank as part of the group may be raised to 150% for capital market exposures and 125% for commercial real estate exposures. In case  of bank sponsored NBFCs, the risk weights for capital market exposures and commercial real estate may be the same as specified for banks.

12. NBFCs may be given the benefits under SARFAESI Act, 2002. [Currently, the benefits, e.g. enforcement of security interests utilizing the favourable provisions of the SARFAESI Act, are restricted to banks and certain financial institutions.]

13. Captive NBFCs, the business models of which focus mainly (90 per cent and above) on financing parent company’s products, may maintain Tier I capital at 12% from the time of registration. Supervisory risk assessment of such companies should take into account the risk of the parent company.

14. For the purpose of applicability of registration and supervision, the total assets of all NBFCs in a group should be taken together to determine the cut off limit of Rs. 100 crores.

15. All NBFCs with assets of Rs.1000 crores and above, whether listed or not, should be required to comply with Clause 49 of SEBI Listing Agreements including mandatory disclosures. [This will bring even unlisted NBFCs on par with public listed companies in terms of corporate governance norms, e.g. board independence, audit committee, periodic financial disclosures, etc.]

16. Disclosure for NBFCs with assets over Rs 100 crores may include provision coverage ratio, liquidity ratio, asset liability profile, extent of financing of parent company products, movement of non-performing assets (NPAs), off-balance sheet exposures, structured products and securitizations/ assignments.

17.  NBFCs with assets of Rs. 1000 crores and above should be inspected comprehensively on an annual basis with an annual stress test carried out to ascertain their vulnerability.

Comments had been invited on the report (to be submitted by end September 2011). There has been no further information available on this.

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NBFC regime continuous to be uncertain

My learned colleague Mr. Jayant Thakur has in his blog post analyzed the recent RBI circular I referred to earlier, which states that fixed deposits with banks do not count as financial assets for the purposes of NBFC regulations. Mr. Thakur's post goes on to examine the impact of this circular on existing NBFCs and other entities. I quote:


"this will create confusion to existing NBFCs already engaged in the business of finance. Bank Deposits are part of the portfolio of any NBFC. It may be recollected that the RBI had, vide its circular dated October 19, 2006, created a deeming condition regarding when a Company becomes an NBFC. It stated that, for a Company to qualify as an NBFC, at least 50% of its assets should be financial assets and 50% of its income should be from financial assets. If bank fixed deposits are excluded as financial assets for all companies, it may create problems for some NBFCs particularly in lean times and their auditors may have to qualify their reports.
And this circular may help out those companies who unwittingly became NBFCs on account when at a year end, they found that their assets consisted of financial assets including fixed deposits with banks being more than 50%. Since bank FDs are no more treated as financial assets, they may escape one or both of the conditions and thus escape the deeming provision which otherwise may have resulted in their requiring to apply for registration as NBFC."


The uncertainty created around the certificate of registration is also undesirable. Mr. Thakur has referred to the Usha Thorat Committee report which has made various liberal and realistic recommendations, which has not seen the light of day - I will write on this report soon. In contrast to the same, these measures seem quite retrograde in nature. Comments from readers welcome.

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Monday, April 2, 2012

RBI revises fair practices code

NBFCs in the lending business are required to adhere to certain fair practices, i.e. certain general principles on adequate disclosures on the terms and conditions of a loan and also adopt a non-coercive recovery method. These are prescribed by RBI and amended from time to time to deal with market trends. Recently with the creation of a new category of NBFC-MFIs and rapid growth in lending against gold, the RBI has amended the fair practices code. 


A few highlights of the fair practices code is set out below:


1. NBFCs shall mention the penal interest charged for late repayment in bold in the loan agreement.


2. NBFCs shall ensure that the staff are adequately trained to deal with the customers in an appropriate manner, and not rudely.


3. NBFC-MFIs should ensure that recovery of loans should not be through coercion.


4. Suitable internal control systems should be implemented by all NBFCs.


5. NBFCs lending against gold must ensure that assaying is done properly, gold jewellery is properly stored and appropriately insured. An auction procedure must be established for cases where the loans are not repaid.


NBFCs are required to upload the fair practices code on their website and display the same prominently at their office/s. Non-compliance with the terms of these regulations may invite penalties from the RBI, however it will be interesting to see how many NBFCs actually adhere to the fair practices code drawn up.

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Sunday, April 1, 2012

RBI tightens regulations for 'golden' NBFCs

Jab ghar mein padha hai sona, tab kahein ka rona!

This catchy jingle was the talk of town recently and was part of the ad campaign for one of the NBFCs which lend against gold. With Indians being known to have a good saving habit and gold being a favourite for Indians of all classes, lending against gold has really taken off recently. Keeping in mind the risks to the banking system and retail investors, the Reserve Bank of India has tightened regulations pertaining to NBFCs which lend against gold by amending the rules for such NBFCs.

By way of amending notifications, the banking regulator has directed that the prudential norms applicable to companies having half their assets in gold be amended such that (a) they achieve a Tier-I capital (capital by way of equity or equity-like instruments) of 12% by April 2014, (b) these companies cannot lend more than 60% of the value of gold jewellery, (c) these NBFCs are also expected to disclose the percentage of the loans against the assets held by them, in their balance sheets, and (d) NBFCs are also prohibited from lending against gold coins and/ or bullion.

News reports indicate that the loan to value (LTV) ratios in the sector are currently above 60%. Companies have started recalling loans to adhere to the LTV ratio. CRISIL, which monitors most of the companies in the sector, believes that the RBI guidelines will have an overall positive impact on the sector over the long term as these will reduce regulatory uncertainties that the sector has witnessed in the recent past and enhance stakeholders’ confidence. The LTV cap is likely to result in significantly lower growth rates as borrowers will have to bring in additional jewellery to get the same same loan amount. In addition, this development could result in business volumes shifting to the unorganized sector, which will continue to extend loans at higher LTV ratios. The currently high profitability of gold loan companies may also moderate as these companies are likely to reduce pricing to protect their market share and prevent a shift to the unorganized segment.

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Dormant NBFCs under RBI scanner



There are numerous NBFCs who have obtained registration from the RBI, parked their funds in fixed deposits with commercial banks but have not commenced NBFC activities for several years thereafter. In view of the recent difficulty in getting NBFC registrations as well as to get the benefit of lower net owned funds (NOF) requirements (in case the NBFC was registered pre-1999), acquiring such inactive/ dormant NBFCs had almost become the norm for entities wishing to enter the financial services' space in India.

The RBI has by way of a recent notification attempted to plug this loophole. The regulator has clarified that it issues a Certificate of Registration (CoR) for the specific purpose of conducting NBFI activities. Investments in fixed deposits cannot be treated as financial assets and receipt of interest income on fixed deposits with banks cannot be treated as income from financial assets as these are not covered under the activities mentioned in the definition of “financial Institution” in Section 45I(c) of the RBI Act 1934. Besides, bank deposits constitute near money and can be used only for temporary parking of idle funds, and/or in the above cases, till commencement of NBFI business. The RBI has directed that a NBFC which is in receipt of a CoR from the Bank must necessarily commence NBFC business within 6 months of obtaining CoR. If the business of NBFC is not commenced by the company within such a  period, the CoR will stand withdrawn automatically. Further, there can be no change in ownership of the NBFC prior to commencement of business and regularization of its CoR.

This blog will track developments in laws/ regulations relating to NBFCs. Please follow and needless to mention, I am happy to receive comments/ feedback on practical experiences readers have had with the regulator.

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