On July 25, the Reserve Bank of India set the NBFCs free "" well almost. It made regulatory changes of far-reaching consequences that left the NBFCs with a smile on their faces for the first time in three decades.
At last, they seemed to feel, their worth had been recognised and the RBI had conceded the fact that they mattered. Thus:
Ceiling on deposits for registered equipment-leasing and hire-purchase companies were removed;
NBFCs were allowed to set interest rates on deposits of one to five years "" something they had been fighting for for years;
n SLR requirements were cut from 15 to 12.5 per cent (and many feel these could go down even further in the months to come);
The overall ceiling on deposits for registered loans of investment companies was raised to twice the level of net-owned funds.
With this, a major battle appears to have ended between the authorities and the NBFCs. As the following saga shows, NBFCs have been around for a long time but attempts to regulate them started only in the 1960s. The first attempt was the Banking Laws (Miscellaneous Provisions) Act, 1963. Later, several committees were appointed to look into the functioning of these institutions and make recommendations for their healthy growth within a regulatory framework. The policy on regulating NBFCs has been based on these recommendations.
The Bhabatosh Datta Study Group (1971) recognised the dynamic role that NBFCs were capable of playing, supplementing bank activities, both in deposit-mobilisation and in lending.
But given the large number of NBFCs, reducing the number to be regulated would make the task much easier, the committee felt. Thus, it recommended that these entities should be encouraged to form themselves into corporate bodies.
For regulatory purposes, NBFCs could be classified into two groups "" approved and non-approved. The former being the corporatised units that satisfy certain additional criteria "" such as adequate amounts of capital, reserves, liquid assets and the like. And, while a minimum degree of control would be exercised over all NBFCs, the approved ones would have special privileges.
Thus, they would be eligible for refinance from the banking system, their lending operations would be covered under the Credit Guarantee Scheme, and deposit insurance would also be extended to the deposits of those institutions that conducted their business according to the requirements of the Deposit Insurance Corporation.
To encourage commercial banks to enter this field and to enable them to promote hire-purchase subsidiaries, it was recommended that the Banking Regulation Act be amended suitably. Another recommendation was that the interest rate ceiling on hire-purchase charges be a flat 10 per cent for new vehicles and 12 per cent for old. Similarly, it was felt that the role of investment trust companies and unit trusts ought to be enhanced in order to give these institutions an opportunity to create new financial assets for various classes of savers.
It was also recommended that genuine investment companies be given inter-corporate tax relief so long as they were prepared to assume the same obligations as the Unit Trust of India "" diversification of investments, distribution of a specified minimum portion of income and regulation. It was also suggested that no industrial or trading company be permitted to hold any share in investment companies and that the government consider appointing its nominees on the board of such companies so as to ensure independence of management.
As far as nidhis or mutual benefit funds were concerned, it was felt that those units that accepted demand deposits would be regulated in the same way as banks. Other nidhis would be licensed by the RBI on meeting norms relating to the minimum amount of paid-up capital and reserves, minimum level of liquidity ratio and the like. These institutions, too, would be classified into approved and non-approved categories.
Finance corporations, said the Datta group, needed to be regulated to protect depositors interests and to ensure that undesirable advances were not made. The group recommended that they be classified into approved and non-approved corporations and that only licensed corporations be allowed in this business. The following norms were prescribed: A liquidity ratio lower than for commercial banks and a ratio of owned funds to deposit liabilities; a ceiling on interest rates on deposits at a rate higher than that for commercial banks.
The James Raj Study Group (1975), which followed the Datta group, was formed to review the provisions of the RBI Act relating to NBFCs and to examine its adequacy given the recommendations of the Banking Commission.
The group recommended that NBFCs needed to be regulated not prohibited from accepting deposits. The regulatory framework had the same aims as before "" keeping the magnitude of NBFC deposits within reasonable limits, safeguarding depositors and ensuring that these companies served the objectives of monetary and credit policy.
Because the number of depositors was very large and the incidence of malpractice high, it was recommended that these companies be subject to the same type of controls as banks under the Banking Regulation Act, 1949. The RBI was named the appropriate authority to regulate these companies.
To ensure effective regulation, it was considered desirable to enact a separate, comprehensive legislation in place of Chapter 3B of the RBI Act. On prudential norms, the Raj Group recommended that a ceiling on deposit acceptance be prescribed on hire-purchase finance and loan companies at ten times their Net Owned Funds (NOF). Investment companies were already subject to a ceiling of 25 per cent of NOF which, it was recommended, be continued.
The group also recommended that the provision that allowed investment companies to borrow up to 15 per cent of NOF by way of unsecured loans guaranteed by directors, deposits from shareholders and the like, be withdrawn in a phased manner over a period of three years after which the companies could be allowed to accept deposits within a ceiling of 25 per cent of NOF.
A major recommendation was that all new NBFCs, apart from nidhis, would have a paid-up capital of not less than Rs 5 lakh (Rs 2 lakh for companies that carried out business at only one place with a population of less than 5 lakh).
Existing companies were to be regulated according to their net worth. All NBFCs were required to transfer to the reserve fund a sum equivalent to not less than 20 per cent of their annual profit, before declaring any dividend as long as the amount in reserve funds was less than the paid-up capital of the company. They also prescribed that all NBFCs should maintain liquid assets equivalent to not less than 10 per cent of their deposits.
All loans and advances by these companies to their directors and to firms in which they were interested as partners, managers or in any other capacity, would be prohibited, and that no NBFC, other than hire-purchase finance institutions (HPFIs) would be allowed to form any subsidiary, unless it was to carry on the same line of business as the holding company. The minimum period of deposit suggested was six months and the maximum, three years for hire-purchase, equipment-leasing, investment, loan and miscellaneous financial companies, and five years for housing finance companies.
The Chakravarty Committee (1985) was set up next to review the working of the monetary system. It felt that the regulation of NBFCs should curb that those activities that were not in conformity with credit policy but not those that genuinely helped trade and industry.
The non-corporate HPFIs sector, it said, needed to be encouraged to become companies and a system of licensing was needed to protect the interest of depositors.
The Vaghul committee (1987), which was appointed to examine the possibility of enlarging the scope of the money market, extended the scope of NBFC activity.
It recommended that NBFCs be encouraged to provide factoring services. Also, institutions and other entities like companies and trusts that could prove a resource surplus of at least Rs 5 crore per annum should be allowed to participate in the bill-discounting market.
The Narasimham Committee (1991) on the financial system also took a crack at the NBFCs. It said that minimum capital requirements should be stipulated for hire-purchase companies and leasing institutions in addition to the existing norms relating to gearing and liquidity ratios.
It also wanted prudential norms and guidelines on the conduct of business to be laid down for a system of off-site supervision based on periodic returns. Given the potential of merchant banks, it suggested that in the long-run they could be permitted access to the market for deposits and borrowed resources subject to maintenance of minimum capital and liquidity and within specifically-designed prudential norms. To encourage the growth of venture-capital business, it said that the guidelines needed to be amended to widen the scope of the eligibility criteria and give more flexibility to the operation of such companies. Also, well-managed NBFCs like hire-purchase and leasing companies and merchant banks should be allowed to operate in the money market within a specified regulatory framework.
The framework would include norms on capital adequacy, debt equity ratios, credit concentration ratios, income recognition, provision against doubtful debts, adherence to sound, accounting practices, uniform disclosure requirements and assets valuation. Further, eligibility criteria for their entry, growth and exit should be laid down. These institutions should be supervised by an agency to be set up for this purpose under the aegis of the RBI. With the latest announcements, made on July 24, it would appear that the RBI has implemented most of these recommendations.
