What is an NBFC?
Finance is the most crucial segment for building a strong and sound economy. Banks (both public and private sector) have long been the primary suppliers of finance for the Indian economy. Additionally, numerous co-operative societies and co-operative banks have played crucial supporting roles in the supply of finance. There are other marginal forms of funding like Nidhi companies, Chit funds, Self-help groups, and licensed moneylenders who are integrated in the formal economy to a lesser degree. Direct market credit in the form of issuance of debt securities remains the domain of only a handful of big corporates.
Apart from these entities and sources, NBFC is another sophisticated and well-regulated form of entity involved in the financial market. Reserve Bank of India is the sectoral regulator who registers the NBFCs through grant of certificate of registration and lays down several governing norms for NBFCs through its powers under the Chapter IIIB of the Reserve Bank of India Act, 1934.
Uses of NBFCs
The dynamism of NBFCs is increasing rapidly in the Indian economy. They have become a tool for operating many innovative businesses. As little as a decade ago, the NBFCs were largely a privilege reserved for the well-established corporate groups in key cities.
However, since the past decade, the composition as well geographical location of the entrepreneurs who are taking the NBFC route is changing. We are now witnessing many first-generation entrepreneurs with tech-based ideas (like digital lending) opting for the NBFC route. Further, many established and licensed moneylenders from small towns (who are now not eligible to lend under the Banning of Unregulated Deposit Schemes Act, 2019) are opting to incorporate a company and registering it as an NBFC.
Another observed use is where the manufacturers or resellers are opting to incorporate NBFCs to make available the option of availing credit for purchase of their products under the same roof. Even the companies that are established with the sole purpose of making investments in other entities are opting to become NBFCs.
Types of NBFC
Financing takes various shapes and forms. The type of transaction that may be entered into by a particular entity depends upon the norms set by the regulators (typically, RBI). Depending upon the business, the following types of NBFCs can be registered:
- Infrastructure finance company (which deploys a minimum of 75% of the total assets in infrastructure loans).
- Peer to peer lending (where the NBFC provides the online platform for lending money between its participants).
- Micro Finance Institution (NBFC-MFI) A non-deposit taking NBFC having not less than 85% of its assets in the nature of qualifying assets (micro-finance loans given for the generation of income).
- Investment and Credit Companies NBFCs which are allowed to grant loans and make investments. This is the most common type of NBFC.
It is to be noted that these companies are primarily engaged in the businesses mentioned above and require specific registrations which are subject to different obligations. There are different guidelines for different types of finances as well. E.g. where loans are granted against gold, different regulations are applicable.
Deciding the sub-type
Depending upon the funding obtained, there are different sub-types as well. Based upon deposits taken, there are deposit-taking and non-deposit taking NBFCs. RBI has already stopped granting licenses for deposit-taking NBFCs. Presently, two types of NBFCs can be incorporated:
- Type I – NBFC-ND not accepting public funds/ not intending to accept public funds in the future and not having customer interface/ not intending to have customer interface in the future
- Type II – NBFC-ND accepting public funds/ intending to accept public funds in the future and/or having customer interface/intending to have customer interface in the future.
Customer interface basically means having interaction with your customer. Examples of companies having such interface are lending companies or leasing companies. Examples of companies not having such interface are where the sole objective is to invest in the securities of other companies.
Benefits of incorporation of an NBFC
There are certain advantages of choosing an NBFC as a business vehicle. The main advantages are:
- NBFCs can lend to any person, as their loans do not amount to a ‘deposit’ under any legislation.
- The provisions of Section 186 of the Companies Act, 2013 (Regarding loans and investment by the Companies) do not apply except for restrictions regarding layers of subsidiary companies.
NBFCs and Banks differ in the main aspect that NBFCs cannot accept demand deposits or issue cheques upon themselves. All other activities can be carried on in NBFCs.
Whether a company ‘becomes’ NBFC due to its investment income?
As the NBFCs are basically financing any activity other than their own, it is often the case that companies may invest in other group companies or extend loans bearing interest. Such incidental income does not result in the Company being treated as an NBFC.
RBI has prescribed a 50:50 test which checks if ‘financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income’. Only if these tests return positive that the Company is required to be registered as an NBFC.
For every company which is covered under the Companies (Auditor’s Report) Order, 2020, this test is checked by the Statutory Auditor every year.
Registration as an NBFC
The first step of registration is to incorporate a company. After incorporation, the Company shall comply with various parameters like Net Owned Funds, having minimum infrastructure, drafting business plans and policies. After such compliances are made, the application for grant of certificate of registration is required to be made.
Post-registration compliances
After incorporation, ideally, a time of about 15-30 days shall be allocated for laying down a variety of systems (including designing internal checks, employee trainings, and setting other internal controls) for ensuring compliances of norms mandated by RBI.
- Team Efficax