What is a Non-Banking Financial Company?
A Non-Banking Financial Company (NBFC) is a company a) registered under the Companies Act, 1956, b) its principal business is lending, investments in various types of shares/stocks/bonds/debentures/securities, leasing, hire-purchase, insurance business, chit business, and c) its principal business is receiving deposits under any scheme or arrangement in one lump sum or in installments. However, a Non-Banking Financial Company does not include any institution whose principal business is agricultural activity, industrial activity, trading activity or sale/purchase/construction of immovable property. (Section 45 I (c) of the RBI Act, 1934) . One key aspect to be kept in view is that the financial activity of loans/advances as stated in 45 I (c) , should be for activity other than its own. In the absence of this provision, all companies would have been NBFCs.
What are systematically important NBFCs?
NBFCs whose asset size is of Rs.100 cr or more as per last audited balance sheet are considered as systemically important NBFCs. The rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability in our country.
Does the Reserve Bank regulate all financial companies?
No. Some financial businesses have specific regulators established by law to regulate and supervise them, such as, IRDA for insurance companies, Securities Exchange Board of India (SEBI) for Merchant Banking Companies, Venture Capital Companies, Stock Broking companies and mutual funds, National Housing Bank (NHB) for housing finance companies, Department of Companies Affairs (DCA) for Nidhi companies and State Governments for Chit Fund Companies. Companies which do financial business but are regulated by other regulators, are given specific exemption by the Reserve Bank from its regulatory requirements, such as, registration, maintenance of liquid assets, statutory reserves, etc. The Chart below gives the nature of activities and the concerned regulators.
What kind of specific financial companies are regulated by RBI?
The Reserve Bank of India regulates and supervises Non-Banking Financial Companies which are into the business of (i) lending (ii) acquisition of shares, stocks, bonds, etc., or (iii) financial leasing or hire purchase. The Reserve Bank also regulates companies whose principal business is to accept deposits. (Section 45I (c) of the RBI Act, 1934).
What are the powers of the Reserve Bank with regard to 'Non-Bank Financial Companies', that is, companies that meet the 50-50 Principal Business Criteria?
The Reserve Bank has been given the powers under the RBI Act 1934 to register, 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 can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by RBI under RBI Act. The penal action can also result in RBI cancelling the Certificate of Registration issued to the NBFC, or prohibiting them from accepting deposits and alienating their assets or filing a winding up petition.
Why are insurance companies, stock broking and merchant banking companies, Nidhis, housing finance companies and Chit Fund companies not regulated by the Reserve Bank of India?
These companies have been exempted from registration and other regulations of RBI in order to avoid dual regulation on them as they are regulated by other financial sector regulators.
Does the Reserve Bank have any statutory power vis a vis these exempted NBFCs?
It depends on the extent of exemption granted. Housing Finance Companies, for instance, are exempt from RBI regulations. Other entities like Chit Funds, Nidhi companies, Mutual Benefit companies, Insurance companies, Merchant Banking companies, Stock Broking companies, etc., are granted exemption from the requirements of registration, maintenance of liquid assets and statutory reserves. RBI though does not issue directions that could conflict with the directions issued by other financial regulators, viz., Housing Finance Companies are regulated by the National Housing Bank, Insurance Companies by IRDA, Stock broking, Merchant Banking Companies, Venture Capital Companies and companies that run Collective Investment Schemes and Mutual Funds are regulated by SEBI, Nidhi Companies are regulated by the Ministry of Corporate Affairs and Chit Fund Companies are under the regulatory ambit of the respective State Governments.
Does RBI regulate companies that carry on the financial activities as part of their business?
The Reserve Bank regulates and supervises companies which are engaged in financial activities as their principal business. Hence if there are companies engaged in agricultural operations, industrial activity, purchase and sale of goods, providing services or purchase, sale or construction of immovable property as their principal business and are doing some financial business in a small way, they will not be regulated by the Reserve Bank.
In respect of companies which do not fulfill the 50-50 criteria but are accepting deposits- do they come under RBI purview?
A company which does not have financial assets which is more than 50% of its total assets and does not derive at least 50% of its gross income from such assets is not an NBFC. Its principal business would be non-financial activity like agricultural operations, industrial activity, purchase or sale of goods or purchase/construction of immoveable property, and will be a non-banking non-financial company. Acceptance of deposits by a Non-Banking Non-Financial Company is governed by the Companies Acceptance of Deposits Rules, 1975. The Registrar of Companies in the State Governments administer the schemes.
What does conducting financial activity as "principal business" mean?
Financial activity as principal business is when a company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 percent of the gross income. A company which fulfils both these criteria will be registered as NBFC by RBI. The term 'principal business' is not defined by the Reserve Bank of India Act. The Reserve Bank has defined it so as to ensure that only companies predominantly engaged in financial activity get registered with it and are regulated and supervised by it and other trading, manufacturing or industrial companies are not brought under its regulatory jurisdiction. Interestingly, this test is popularly known as 50-50 test and is applied to determine whether or not a company is into financial business.
What is a Residuary Non-Banking Company (RNBC)? In what way is it different from other NBFCs?
Residuary Non-Banking Company is a class of NBFCs whose 'principal business' is to receive deposits, under any scheme or arrangement or in any other manner. These companies are not into investment, asset financing or lending. Functioning of these companies is different from that of NBFCs in terms of method of mobilization of deposits and requirement of deployment of depositors' funds. These companies, however, have now been directed by the Reserve Bank not to accept any deposits and to wind up their businesses as RNBCs.
We understand that there is no ceiling on raising of deposits by RNBCs, then how safe is deposit with them?
It is true that there is no ceiling on raising of deposits by RNBCs. However, every RNBC has to ensure that the amounts deposited with it are fully invested in approved investments. In other words, in order to secure the interests of depositor, such companies are required to invest 100 per cent of their deposit liability into highly liquid and secure instruments, namely, Central/State Government securities, fixed deposits with scheduled commercial banks (SCB), Certificate of deposits of SCB/FIs, units of Mutual Funds, etc.
Can RNBC forfeit deposit if deposit installments are not paid regularly or discontinued?
No. Residuary Non-Banking Company cannot forfeit any amount deposited by the depositor, or any interest, premium, bonus or other advantage accrued thereon.
What is the rate of interest that an RNBC must pay on deposits and what should be maturity period of deposits taken by them?
The minimum interest an RNBC should pay on deposits should be 5% (to be compounded annually) on the amount deposited in lump sum or at monthly or longer intervals; and 3.5% (to be compounded annually) on the amount deposited under daily deposit scheme. Interest here includes premium, bonus or any other advantage, that an RNBC promises to the depositor by way of return. An RNBC can accept deposits for a minimum period of 12 months and maximum period of 84 months from the date of receipt of such deposit. They cannot accept deposits repayable on demand. However, at present, the two RNBCs in existence (Peerless and Sahara India Financial Corporation Ltd) have been directed by the Reserve Bank to stop collecting deposits, repay the deposits to the depositor and wind up their RNBC business as their business model is inherently unviable.
What are deposits?
Deposits mean monies collected in any manner, other than that collected by way of share capital, contribution of capital by the partners of a partnership firm, security deposit, earnest money deposit, advance consideration for purchase of goods, services or construction, loans taken from banks, financial institutions and money lenders and subscription to chit funds. Monies collected in any manner other than these would be termed as deposits.
Which entities can legally accept deposits from public?
Banks, including co-operative banks, can accept deposits. Non-bank finance companies, which have been issued Certificate of Registration by RBI with a specific licence to accept deposits, are entitled to accept public deposit. In other words, not all NBFCs registered with the Reserve Bank are entitled to accept deposits but only those that hold a deposit accepting Certificate of Registration can accept deposits. They can, however, accept deposits, only to the extent permissible. Housing Finance Companies, which are again specifically authorized to collect deposits and companies authorized by Ministry of Corporate Affairs under the Companies Acceptance of Deposits Rules framed by Central Government under the Companies Act can also accept deposits also upto a certain limit. Cooperative Credit Societies can accept deposits from their members but not from the general public. The Reserve Bank regulates the deposit acceptance only of banks, cooperative banks and NBFCs.
It is not legally permissible for other entities to accept public deposits. Unincorporated bodies like individuals, partnership firms, and other association of individuals are prohibited from carrying on the business of acceptance of deposits as their principal business. Such unincorporated bodies are prohibited from even accepting deposits if they are carrying on financial business.
Can all NBFCs registered by RBI accept deposits? Does getting Certificate of registration from RBI mean the company can also raise deposits?
No. As stated above, registration with RBI does not automatically allow an NBFC to accept deposits. The Reserve Bank specifically authorizes an NBFC to accept deposits. This permission is given after verifying a registered NBFC's performance for three years. That an NBFC is permitted to raise deposits from public is specifically mentioned in its certificate of registration. In fact as a matter of public policy, Reserve Bank has decided that only banks should be allowed to accept public deposits and as such has since 1997 not issued any Certificate of Registration (CoR) for new NBFCs for acceptance of public deposits.
Why is the RBI so restrictive in allowing NBFCs to raise public deposits?
The Reserve Bank's overarching concern while supervising any financial entity is protection of depositors' interest. Depositors place deposit with any entity on trust unlike an investor who invests in the shares of a company with the intention of sharing the risk as well as return with the promoters. Protection of depositors' interest thus is supreme in financial regulation. Banks are the most regulated financial entities. The Deposit Insurance and Credit Guarantee Corporation pays insurance on deposits up to Rs.one lakh in case a bank failed.
Can a co-operative credit society accept deposits from the public?
No. Co-operative Credit Societies cannot accept deposits from general public. They can accept deposits only from their members within the limit specified in their bye laws.