RBI’s revised regulatory framework for Non Banking Finance Companies: An opportunity for entrepreneurs interested in lending and investments

RBI to issue fresh Certificates of Registration - freedom to grow till asset size reaches Rs 500 crores

RBI Watch                                                                                      NBFC Industry Structure 

RBI came out with the revised regulatory framework for Non Banking Finance Companies (NBFCs) in November last year.

Much of the focus in the press has been on the larger NBFCs and whether they have a level playing field with banks. For the summary of most of the issues, I can do no better than give the link to an interview that came out on December 7, 2014 with the Managing Director of Sundaram Finance, India’s venerable NBFC titled “We have beenhung out to dry”.

My focus is on the smaller NBFC, and how the new framework is a good opportunity for budding entrepreneurs to enter financial services.

What is an NBFC? In India a company that is in the financial services area but does not offer demand deposits (cash checking facilities) and is not part of the payments system is an NBFC. Some NBFCs such as insurance companies and stock brokers are specifically regulated by the Insurance Regulatory Development Authority and Securities and Exchange Board of India. Most of the others come within the ambit of the RBI as NBFCs.

The revised regulatory framework of the RBI raises the bar for an NBFC to be classified as Systemically Important to Rs 500 crores* from Rs 100 crores. This means that NBFCs have far more freedom to grow without the stringent RBI regulations on their activities, which come to bear only once the ceiling of Rs 500 crores of assets is crossed.

So, the small NBFCs will not be subject to RBI’s prudential regulations or conduct of business regulations, e.g. KYC (Know Your Customer), if they have not accessed public funds or do not have a customer interface. Such NBFCs will be exempt from maintaining CRAR (Capital to Risk Asset Ratio) of minimum 15%. Instead, small NBFCs will need to comply with a leverage ratio of 7, i.e. the ratio of total outside liabilities to net owned funds cannot exceed 7.  

There are some more exemptions. Small NBFCs will not need to comply with credit concentration norms (excessive credit exposure to specific sectors). Small NBFCs will also not need to comply with the more stringent NPA recognition norms introduced by RBI : NBFCs presently recognize exposures which are overdue for 6/12 months as Non-Performing Assets (NPAs); these are to be tightened to 3 months.

An entrepreneur or business group with a bright idea in lending and investing may well want to start a small NBFC. The NBFC company will need to be set up with minimum capital of Rs 2 crores. The company will then need to apply to the RBI for get approval - Certificate of Registration (COR) .

There is another route to getting into the NBFC business. Today there are in excess of 11,000 NBFCs! Most of them have little activity. This goes back to the 1980s and 1990S when there was light regulation of this sector, and lending and investing business in India exploded, especially in the absence of a reluctant banking sector to seize the opportunity. The revised regulatory framework of the RBI stipulates that all these NBFCs need to raise capital (net owned funds) from the current Rs 25 lakhs to 2 crores. An entrepreneur can buy into one of these NBFCs, and jump-start his/her NBFC business.

For certain specialised categories of NBFCs, the minimum capital requirements are higher: for both the factoring and microfinance business, the minimum capital requirement is Rs 5 crores ( 2 crores for a microfinance business in the North East of India), and for an infrastructure finance company the minimum capital required is Rs 300 crores.

 *Note this applies to non-deposit taking NBFCs – NBFCs in theory can like banks accept fixed deposits accounts from public, but RBI has not been giving permission to new NBFCs to raise deposits from the public.