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Non-Banking Financial Company An Overview

Hemant Vijay Pandya FCS, LLB. Non-Banking Financial Company An Overview. PCS Annual Regional Conference, Indore. July 8, 2018. Historical Background of NBFCs in India. NBFCs as an industry has been there for several decades in the Indian financial system

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Non-Banking Financial Company An Overview

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  1. Hemant Vijay Pandya FCS, LLB Non-Banking Financial CompanyAn Overview PCS Annual Regional Conference, Indore July 8, 2018

  2. Historical Background of NBFCs in India • NBFCs as an industry has been there for several decades in the Indian financial system • With the growth in the number and size of NBFCs, various committees were formed in India to review the existing framework and address the shortcomings in the overall NBFC structure • Key Committees that played a role in shaping the NBFC regulatory system are as follows:

  3. Definition of NBFC • a financial institution which is a company; • a non-banking institution which is a company and which has as its principal business, the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; • such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify Section 45 I (f) of RBI Act, 1934 • Making loans and advances, • Acquisition of shares, stock, bonds, debentures, securities issued by Government or other marketable securities, etc, • Letting / delivering of goods to hirer under Hire Purchase Agreement, • Carrying on any class of insurance business. • Chit business or accepting public deposits under any Scheme / Arrangement. Section 45 I (c) of RBI Act, 1934 Financial Institution includes does not include • any institution whose principal business is that of agriculture activity, • industrial activity, purchase or sale of any goods (other than securities) • or providing any services and sale/purchase/construction of immovable property. 

  4. Requirement of registration as NBFC • No NBFC shallcommence or carry on business of non-banking financial institution without: • Obtaining Certificate of Registration from RBI; and • Having a Minimum Net Owned Fund of Rs. 200 Lakhs. • A company also needs to register as NBFC with RBI, if it fulfils the 50:50 test: • financial assets constitute more than 50 percent of the total assets and • income from financial assets constitute more than 50 percent of its gross income.

  5. Registration • Exemptions: • To avoid dual regulation, certain categories of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI • Venture Capital Fund/ Merchant Banking companies/ Stock broking companies registered with SEBI • Insurance Company holding a valid Certificate of Registration issued by IRDA • Nidhi companies as notified under Section 620A of the Companies Act, 1956 • Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982 • Housing Finance Companies regulated by National Housing Bank, • Stock Exchange or a Mutual Benefit company.

  6. NBFCs Types / Classifications • Classification on the basis of liability • NBFCs are broadly categorized into two categories as below: • NBFCs accepting public deposits (NBFCs – D); and • NBFCs not accepting/holding public deposits (NBFCs – ND) • Further, non-deposit taking NBFCs are categorized by their size into systemically important and non- systemically important as NBFC-ND-SI and NBFC-ND. • Determination of NBFC – ND – SI: • All NBFCs – ND whose asset size is Rs. 500 Crore and more as per the last audited balance sheet are considered as Systemically Important NBFC (NBFC-ND-SI).

  7. NBFCs Types / Classifications

  8. Multiple NBFCs in a Group • NBFCs that are part of a corporate group or are floated by a common set of promoters, shall not be viewed on a standalone basis. • The total assets of the NBFCs in a group including deposit taking NBFCs, if any, shall be aggregated to determine if such consolidation falls within the asset sizes of the two categories i.e. those with asset size of below Rs. 500 Crore and those with asset size of Rs. 500 crore and above. • Regulations as applicable to the two categories shall be applicable to each of the non-deposit taking NBFC within the group.

  9. Difference between NBFCs and Banks • NBFCs perform functions similar to that of banks but there are a few differences- • NBFCs cannot accept Demand Deposits; • NBFCs do not form part of the payment and settlement system and cannot issue Cheques drawn on itself; and • Deposit insurance facility of is not available for NBFC depositors, unlike in case of banks. • Innovative products offering. .

  10. Factors contributing to the growth of NBFCs • Customised solutions/ Latent credit demand: • NBFCs offer customised loan structures with features such as interest moratorium and bullet repayment schedules, which are not offered by banks. • Stress on Public Sector Units: • Decision-making cycles in some public sector banks (PSBs) has elongated considerably, owing to risk aversion and fragile capital position. • Lower turnaround time: • NBFCs can disburse a large-ticket loan to a new customer in a short span of time compared to banks. • Strong client relationships: • Some NBFCs in this space have strong client relationships due to their presence in allied businesses, or because they are supported by well-established parent companies. • This aids them in both securing business and in risk assessment. • Wider Reach: • NBFCs have a wider distribution reach and sectors where traditional banks do not lend.

  11. Risks faced by NBFCs Credit Risk • The risk associated with the failure of the borrower to meet financial obligations to the lender in accordance with the agreed terms. Market Risk • It is the risk of losses arising from the movements in market price of various securities, which may impact our earnings and capital. Liquidity Risk • Risk arising due to unavailability of adequate funds at appropriate prices or tenure. Regulatory and Compliance Risk • The risk arising out of a change in laws and regulation governing a business. Reputation Risk • Current or prospective risk to business, earnings and capital arising from adverse perception of the organization on the part of customers, counterparties, shareholders, investors or regulators. Operational risk • Arise from inadequate or failed internal processes, people or systems, or from external events. Business and Continuity Risk • Incidents like fire, natural calamity, breakdown of infrastructure, acts of terrorism, etc can lead to disruption in the conduct of business.

  12. Key provisions governing NBFCs • NBFCs need to maintain a minimum capital ratio consisting of Tier I and Tier II capital not less than 15% of its aggregate risk weighted assets on balance sheet and of risk adjusted value of off balance sheet items. • Minimum Tier I capital requirement– 10% • Asset Classification Norms: All forms of credit (including receivables) are to be classified into four categories as follows: • Standard Asset: • An asset in respect of which, no default in repayment of principal or payment of interest is perceived and which does not disclose any problem or carry more than normal risk attached to the business. • Sub-Standard Asset: • An asset which has been classified as non-performing asset for a period not exceeding 12 months;

  13. Key provisions governing NBFCs (contd…..) • Doubtful Asset: • A term loan or lease asset or a hire purchase asset or any other asset which remains a sub-standard asset for a period exceeding 12 months • Non-Performing Asset (NPA): • An asset is classified as NPA when it has remained overdue for a period of three months or more. • Loss Asset: • An asset which has been identified as loss asset by a NBFC or its internal or external auditor or by the Bank during the inspection, to the extent it is not written off by the applicable NBFC; and • An asset which is adversely affected by a potential threat of non-recoverability due to either erosion in the value of security or non-availability of security or due to any fraudulent act or omission on the part of the borrower • Additional information to be disclosed in Schedule to the Balance Sheet (detailed classification of loans and advances, public deposits, investments, related party disclosures, NPA details, etc)

  14. Key provisions governing NBFCs (contd…..) • Loan against NBFCs own shares is prohibited: • No NBFC shall lend against its own shares or debentures. • Loan against security of shares: • Maintain Loan to Value (LTV) ratio of 50 percent for loans granted against the collateral of shares of Group 1 Securities, as issued by SEBI. • In case of shortfall in maintenance of 50 % LTV due to movement in share prices, same to be made good within 7 working days. • Concentration of credit/investment: • NBFC can, • lend to • any single borrower upto fifteen per cent of its owned fund; and • any single group of borrowers upto twenty five per cent of its owned fund; • invest in • the shares of another company upto fifteen per cent of its owned fund; and • the shares of a single group of companies uptotwenty five per cent of its owned fund; • lend and invest (loans/investments taken together) upto • twenty five per cent of its owned fund to a single party; and • forty per cent of its owned fund to a single group of parties.

  15. Corporate Governance (CG) Applicable to every non-deposit NBFC with asset size of Rs.500 Crore and above (NBFC-ND SI) and all deposit accepting NBFC-D Committees to be formed • Audit Committee • Nomination Committee • Risk Management Committee Fit and Proper Criteria • Put in place a Policy at the time of appointment for directors • Declaration and Undertaking from Directors • Deed of Covenant • Change of Directors-furnish quarterly statement to RBI Disclosure and Transparency • Risk Management System/ Risk Management Policy • Conformity with Corporate Governance Standards • Disclosures in Annual Financial Statements Not Applicable to Systematically Important Core Investment Company Rotation of Partners in Statutory Auditors Firm • Rotate the partner/s of the CA firm conducting the audit, every 3 years. • Partner so rotated shall be eligible to conduct audit after 3 years. Framing of Internal Guidelines • Frame internal guidelines on CG with approval of BOD • Internal guidelines shall be published on the website

  16. Policies to be adopted by a NBFC

  17. Broad working of an NBFC (Loan Company) • Credit Committee • Audit Committee • Asset Liability Management Committee • Risk Management Committee • Borrowing Committee

  18. Broad working of NBFCs (Loan Company) (Contd..) Compliance & Legal Controllers Risk Team Business Team

  19. Role of Business Team Back ground check by Relationship Managers Call for Group Information (History) of the Client Analysis and Data Collection Analysis of group cash flows, credit worthiness, demand-supply study in the market Viability of the Project Viability is based on the stage of the project, title deeds, location, selling price etc. Proposals are discussed in the Credit Committee Based on the analysis If project is found to be good, it is then taken to the Credit Committee for approval Approved or Rejected based on the viability

  20. Role of Risk Team Preliminary Risk Assessment Borrowers Credit Risk Assessment is carried out along with its group. Assessment of Profitability and Solvency • Sectoral Stress Conditions • Delays in project execution and cost overrun of key projects • Impact of fall in sales price/ increase in raw material prices Assessment of Collateral • Ability of collateral to preserve value under various conditions • Assessment of inventory and price movements in collateral micro-market (in the case of real estate collateral) a risk report is made on the proposed borrower group and circulated to the Credit Committee. Continuous Monitoring Post Disbursement • Sectoral reports from rating agencies to reassess Solvency, Liquidity and Collateral Risk • Monthly and Quarterly Reports from borrower including updated group debt data, status of key projects etc.

  21. Role of Controllers Accounts, Audit and Budget Preparation of Accounts, Financial Statements, Management Information System, Budget and variance analysis, Treasury Management. Regulatory Compliances Filing of returns with RBI Direct Tax and Indirect Tax compliances Bank Borrowings Determination of requirement of Funds for disbursements and borrowings Determination of requirement of Funds Commercial Papers Inter-Corporate Deposits Identification of Sources for the origination funds Identification of Sources of funds and negotiating with the Non-Convertible Debentures – No DRR if Private Placement

  22. Role of Compliance and Legal Legal • Vetting of the term sheets and various agreements executed by a Company. • Liasoning with external lawyers • CERSAI Filing Maintenance of minutes • Maintenance of minutes of Committee and Board meeting Quarterly/Annual Compliance • Statement on Change in Directorship-Quarterly • LAS Reporting-Quarterly • Resolution to be passed by BOD confirming that it is not accepting any public deposit-Annually • Corporate Governance declaration from the Directors-Annually Event Based • Appointment of Directors – Declaration and Undertaking from Directors, Deed of Covenant and Annexure III • Vetting of Agreements for Bank Borrowings • Issuing NCDs and its related compliances

  23. Tie ups/Diversification of area of business by NBFCs • NBFCs cannot be a partner in partnership firms including Limited Liability Partnerships. • NBFCs can undertake insurance business on fee basis after obtaining requisite permission from Insurance Regulatory and Development Authority to act as Composite Corporate Agent and on following the guidelines issued by RBI. • They can also distribute Mutual Fund products subject to following of guidelines on distribution of MF products issued by the Reserve Bank of India (RBI) and complying with SEBI guidelines including Code of Conduct, for distribution of Mutual Fund Products. • NBFCs can issue cobranded credit cards with schedule commercial banks with prior approval of the RBI and after complying with the guidelines on Issue of cobranded credit cards.

  24. Key Regulatory Framework introduced • Information Technology Framework: • IT Strategy Committee is to be formed: • To approve IT strategy and policy documents; • To ensure IT investments represent a balance of risks and benefits and that budgets are acceptable; • To monitor the method that management uses to determine the IT resources needed to achieve strategic goals; • To institute effective governance mechanism and risk management process for all IT outsourced operations • Various Policies to be adopted: • Information Security (IS) Policy • Cyber Security Policy • Cyber Crisis Management Plan (CCMP) • IT Policy

  25. Key Regulatory Framework introduced (Contd…) • Business Continuity Plan: • BCP shall be designed to minimise the operational, financial, legal, reputational and other material consequences arising from any disaster • BCP may have features like Business Impact Analysis and Recovery strategy/Contingency Plan • The test should be based on ‘worst case scenarios’ • The results along with the gap analysis should be placed before the Chief Information Officer and the Board • IT Enabled Management Information System (MIS): • NBFCs may have the following as part of an effective system generated MIS: • dashboard for the Top Management summarising financial position vis-à-vis targets • System enabled identification and classification of SMA and NPA as well as generation of MIS reports • MIS should facilitate pricing of products, especially large ticket loans • MIS should capture regulatory requirements and their compliance • Financial Reports including operating and non-operating revenues and expenses, cost benefit analysis of segments/verticals, cost of funds, etc • Fraud analysis, Incident reporting their impact and steps taken for non-recurrence of such events in the future

  26. Key Regulatory Framework introduced (Contd…) • Outsourcing Policy: • NBFC intending to outsource any of its financial activities are required to put in place a comprehensive outsourcing policy, approved by its Board, inter alia, containing criteria for selection of such activities as well as service providers, delegation of authority depending on risks and materiality and systems to monitor and review the operations of these activities. • The terms and conditions governing the contract between the NBFC and the service provider shall be carefully defined in written agreements and vetted by NBFC's legal counsel . RBI to have access of records of vendors. • NBFCs need to ensure that the service provider periodically tests the Business Continuity and Recovery Plan and may also consider occasional joint testing and recovery exercises with its service provider. • In a group structure, NBFCs may have back-office and service arrangements/ agreements with group entities.

  27. Key Regulatory Framework introduced (Contd…) • High Risk NBFCs: • The Financial Intelligence Unit (FIU) has put 9,491 non-banking finance companies under the high-risk category because of non-compliance with Prevention of Money Laundering Act, 2002 • FIU has put out the list of NBFCs categorised as ‘High Risk Financial Institutions’ for non-compliance with PMLA and PML Rules non-registration of Principal Officer (PO) as on January 31, 2018.  • Powers under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act): • Systemically important NBFCs have been categorized as ‘secured lenders’ under the SARFAESI Act. As such, these NBFCs may now enforce security interests on assets charged to them, without having to resort to either judicial or arbitral authorities.

  28. Key Regulatory Framework introduced (Contd…) • Foreign Direct Investment: • Upto 100% Foreign Direct Investment is allowed for NBFCs • Overseas Investment by NBFCs: • The aggregate overseas investment shall not exceed 100% of the NoF. • Overseas investment shall not involve multi layered, cross jurisdictional structures and at most only a single intermediate holding entity shall be permitted. • Acquisition / Transfer of control of NBFCs: • Prior approval of RBI required for • Any takeover or acquisition of applicable NBFC, which may or may not result in change of management • Any change in shareholding which would result in acquisition / transfer of shareholding of 26 percentor more of paid up equity capital.

  29. Role of RBI in the functioning of NBFCs • Regulatory • Ensure that NBFCs  serve the financial system efficiently. • Protect the interest of depositors. • Entry norms for NBFCs and prohibition of deposit acceptance by unincorporated bodies engaged in financial business. • Compulsory registration, maintenance of liquid assets and creation of reserve fund. • Power to issue directions for NBFCs. • Supervisory • On-site Inspection • Off-site Surveillance System • Market intelligence • Exception reports of statutory auditors of NBFCs

  30. Opportunities for Company Secretaries • In employment: • Growing Sector • Day to Day changes in Regulations • Robust Compliance System required. (One of the 3 lines of defence) • In Whole time practice: • Half Yearly Certificates have to be submitted to Banks, in case of Bank Borrowings • CERSAI Registration • Debenture Trustee requirements- Debenture Trust Deed

  31. Your views/feedback are always welcome at: Hemant Vijay Pandya 9619094999 or on my email: hemant_vpandya@yahoo.com

  32. Thank You

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