A New Order

The thrust on financial sector supervision has been fairly pervasive--with one major exception. A problem that defied solution till recently, was the regulation of the non banking finance companies(NBFC)sector. Bringing a sharply polarised and unorganised sector, where barely 10,845 companies (out of a total of 40,000 companies) submitted annual returns, was no easy task either for the Reserve Bank of India (RBI) or the Department of Company Affairs (DCA).

The problem was compounded because of two other crucial factors. One was that only 750 finance companies were registered with the RBI. The other deterrent was that before the ordinance was passed in January this year, the RBI purview extended mostly to the deposit taking activity of finance companies.Regulation in such a scenario could only end up being half-baked. This state of affairs could not be allowed to continue; regulating a sector that was fast emerging as a para banking industry was long overdue.

 

The situation could change drastically now, if expectations do come true. On January 9,1997, the Khanna Committee, an eleven member committee set up by the RBI, publicised the contents of its report spelling out a regulatory framework for the heterogenous NBFC sector. The Khanna Committee report, coupled with the RBI ordinance that followed soon afterwards, has triggered off some expectation in concerned circles about the wide sweep of powers now given to the RBI with which to control NBFCs.

At first sight, the RBIs powers--which will come into effect on April 1 this year--seem formidable. The ordinance vests the RBI with powers to force unregistered NBFCs to close shop and wind up companies defaulting on payment of fixed deposits (see box on Khanna Committee recommendations and provisions of ordinance). In fact, seen in conjunction with the Khanna Committee recommendations

( there is a high possibility that some more of the Committees recommendations may be incorporated in the ordinance), the powers seem all encompassing. But a month down the line, there is a great deal of speculation about how effective the reforms will be in regulating NBFCs. And if they do turn out to be effective, how long will it take for this to happen?

Time yet for take-off

Most major players in the sector feel that the first issue that needs to be tackled on a war footing is the RBIs regulatory role. R Shankar Raman, senior vice president, L&T Finance, perceives this to be a long term proposition because the central bank itself has to go in for tremendous organisational restructuring to be able to implement the recommendations of the Khanna Committee. On line database management--which takes time to be set up-- would be one of the key requirements. ``It is a bundle of good intentions, but how soon the RBI can equip itself to implement the reforms is the moot question,'' says Shankar Raman.

There is no doubt that the powers of the central bank have been considerably widened. As against RBIs limited scope of regulation earlier, the new ordinance gives it the powers to control almost every aspect of an NBFCs operations.

Paradoxically though, the broad sweep of the powers itself is raising doubts about how long it will be before the Khanna Committee recommendations are finally implemented.

One major factor that will determine a timeframe for the whole exercise of regulation is the number of finance companies that will actually need to be monitored. With entry point barriers being retained at a net owned fund (NOF) level of Rs 50 lakh, it will still be a mammoth task for RBI to monitor these companies. It is anybodys guess as to how many more companies will be added to RBI supervision as all companies with an NOF above Rs 50 lakh now need to compulsorily register. Says Atul Nishar, chairman, Apple Finance: If Rs 100 crore is required for setting up a bank, Rs 100 crore for an insurance firm, Rs 10 crore for a mutual fund, then why not set Rs 5 crore as an entry point limit for an NBFC?

So, would the entry point for new entrants now be raised? That was a possibility, since the RBI now has powers under the new ordinance to stipulate an entry point limit between Rs 50 lakh and Rs 2 crore. However, the feeling amongst the larger players is that the RBI may not like to raise the threshold limit immediately--and the answer may have to do more with political compulsions than economic rationale. A little-known fact is that in states like Bihar, Uttar Pradesh and in many southern states, politicians own many NBFCs with very low levels of net owned funds! In case the RBI is unable to use this elimination mechanism effectively, it would definitely take the sting out of regulation. A better option would have been setting a higher mandatory threshhold, as suggested by Nishar.

Another unwarranted laxity is the provision of the new RBI ordinance (amending the RBI Act 1934), which states that companies with a current NOF lower than Rs 50 lakh have been given a time period of six years to increase their net-owned funds to Rs 50 lakh. Finance company heads feel that for the entry point to have any sanctity, granting such a long time period to achieve this limit does not make sense at all, given the time value of money. Furthermore,it is imperative for all finance companies to have a substantial start-up NOF today. This is mainly because further accretion to net worth, after the start off, is not very high, says S K Shah, general manager, Crisil.

The lacuna

An issue that will continue to plague RBI regulation over NBFCs is the dual control over the sector. To a large extent, the success of monitoring unincorporated bodies will depend on the co-ordination between the RBI and the registrar of companies (ROC) and the rapport they are able to build with the state government. This is because, while the new ordinance prohibits an unincorporated body from collecting deposits, it is only the state government which will be in a position to track down the individual partnership or firm. It will be absolutely impossible for the RBI to monitor so many small firms. Some state governments, like the Tamil Nadu state government, have already taken steps to govern unincorporated bodies. A special court has been set up to look into these mushrooming bodies. But given the political affiliations of NBFCs, not all state governments are likely to be as co-operative as this, though. How effective can the RBIs powers be, in such a case?

Some recent developments have been overlooked,too. The ordinance has not addressed the problem of regulation of some categories of finance companies that are not technically categorised as NBFCs. The Khanna Committee has recommended the need `to identify an appropriate authority for looking into the activities of animal husbandry companies, plantation companies and those manufacturing companies which have, for the last few years, been active in accepting public deposits. No regulatory authority has been identified for these companies operating in grey areas. At present, these companies come neither under the Department of Company Affairs nor the RBI.

R Shankar Raman feels that some of the disclosure norms for these companies can be on par with other NBFCs. Non performing assets and capital adequacy norms should be applied to manufacturing companies doing finance business and accepting public deposits, considering the fact that such companies are active mobilisers in the fixed deposit markets. In order to bring animal husbandry and plantation companies under regulation, one can re-define deposits and bring their deposits under the RBI framework,too,'' says V S Srinivasan, vice chairman, Twentieth Century Finance, and one of the members of the Khanna Committee.

The RBI ordinance recommends the creation of a reserves fund which requires an NBFC to plough back 20 per cent of its net profit every year to the fund. Coupled with the other recommendation (this has not yet been incorporated ) of increasing capital adequacy over the current 8 per cent within the next two to three years, it seems to indicate that there is an attempt to bring the NBFC sector at par with the banking sector. R.N. Bose, president, Mukand Holdings and Finance, stated that with these regulations coming into place, there will be an immediate need for NBFCs to become more professional. ``The cowboy approach to staffing will have to be given up,'' he said.

But Bose is sceptical about the possibility of a really meaningful scrutiny by the RBI.``The committee recommends appraisal of the senior level management of finance companies. But are companies equipped to handle such scrutiny by RBI? questions Bose. ``Do the smaller companies have even a five page manual on their activities which RBI can see? he asks.

`Perhaps it is better for these companies that RBI take some time in actually carrying out their rating systems! By this time, they could prepare themselves for the scrutiny, says the head of a small finance company.

The Committees recommendations also place an increased responsibility on auditors now. The recommendations state that not only should all statutory returns be certified by auditors, but that they should also put down their comments on how compliant the NBFC in question has also been. How effective can this be? Not very, under the current circumstances. Since there are a number of family run businesses currently, there is a fear whether auditors exercising these powers will really be retained. This could place auditors in a cleft stick, as failure to comply with RBI directions will make them liable to punishment which may extend to Rs 5000. More than the monetary imposition, its the black spot that will rankle. The perception is that because of these reasons, the power of the auditors would exist only on paper, till such time the as the sector becomes more professional.