Back with more!

I am posting after almost 6 months - in the meantime, I have moved law firms and have a new set of responsibilities. My NBFC focus at work has decreased a little but I continue to monitor the sector.

Amongst interesting developments, there is the RBI 'moratorium' on registering new NBFCs instituted through the First Bi-monthly Monetary Policy Statement, 2014-15. This was in view of the fact that the law relating to NBFCs is due for a complete overhaul which remains pending.

The RBI has now issued a notification relating to mergers and acquisitions involving NBFCs. This now makes mergers and acquisitions relating to NBFCs (whether deposit accepting or not) subject to prior approval of the RBI. The policy rationale behind this approach is to ensure that the acquirer / resulting entity following the merger/ acquisition is a “fit and proper person” that has the necessary qualifications to carry on the business of the NBFCs, and such that a transaction is not prejudicial to public interest or the interest of depositors. Interestingly, the RBI notification defines “control” as having the same meaning assigned to it in the SEBI Takeover Regulations. Therefore, any type of control over management and policy decisions of the company, whether through acquisition of shares or through other means such as shareholder agreements could fall within the purview of the RBI approval requirement. Hence, even acquisitions of minority stakes in NBFCs may be subject to scrutiny if they are accompanied by significant rights granted to acquirers/ investors through  protective provisions such as board nominations, quorum rights, veto rights and the like that may be contained in shareholders’ (or similar) agreements or in the articles of association of companies. In other words, the approval requirement may be triggered not just for outright acquisitions or takeovers but also investments that are accompanied by significant protective rights to the investors.

Proposed changes to NBFC Regs

Pursuant to the Usha Thorat Committee report, the RBI has proposed wide-ranging amendments to the NBFC regulations. In order to adopt a consultative approach, the RBI has placed on its website, the draft guidelines to address issues and concerns in the NBFC sector. 

The draft revised guidelines relate to entry point norms, principal business criteria, prudential regulations, liquidity requirements for NBFCs and corporate governance. While accepting some of the suggestions, the RBI has proposed additional time to bring the new regulatory framework into existence. My colleague, Mr. Jayant Thakur has commented on the proposed changes elsewhere.

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.

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.