JAIPUR NATIONAL UNIVERSITY

SEEDLING SCHOOL OF LAW & GOVERNANCE

(BANKING LAW)

Topic- Non banking financial companies

SUBMITTED TO; SUBMITTED BY;

MISS SALONI BAHL SHWETA SINGH

ASST. PROFESSOR, SSLG BALLB (8th SEM)

 DECLARATION

I, Shweta Singh student of BA-LLB 8th semester, hereby declare that project presented in this
is my own research work and has been carried out under the supervision and guidance of my
teacher Miss Saloni Bahl.

Date: 15th April, 2019

Name: Shweta Singh (BA-LLB 8th sem)

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 ACKNOWLEDGEMENT

I have taken efforts in this project. However, it would not have been possible without the kind
support and help of many individuals. I would like to extend my sincere thanks to all of them.

I am highly indebted to (Jaipur National University) for their guidance and constant
supervision as well as for providing necessary information regarding the project & also for
their support in completing the project.

I would like to express my gratitude towards my parents & member of (Jaipur National
University) for their kind co-operation and encouragement which helped us in completion of
this project.

I would like to express my special gratitude and thanks to industry persons for giving us such
attention and time.

My thanks and appreciations also go to Professor Miss. Saloni Bahl in developing the project
and willingly helped me out with her teaching abilities.

THANKING YOU

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 TABLE OF CONTENT

NON BANKING FINANCE COMPANIES.............................................................................5

DEFINITION.............................................................................................................................5

MEANING.................................................................................................................................6

CLASSIFICATION OF NBFCs................................................................................................7

 Hire purchase finance companies.....................................................................9

 Lease finance companies...................................................................................9
 Housing finance companies..............................................................................10
 Chit funds.........................................................................................................10
 The state housing finance societies..................................................................10
 Money lenders..................................................................................................10
 Residuary non banking companies...................................................................11
 Mutual benefit financial companies.................................................................11
 HUDCO............................................................................................................12

FUNCTIONS OF NBFCs........................................................................................................12

GROWTH OF NBFCs.............................................................................................................13

ROLE OF NBFCs..................................................................................................................,.13

SOURCES OF FUNDS...........................................................................................................15

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 NON BANKING FINANCIAL COMPANIES

Non Banking Financial Companies (NBFCs) are financial institutions which are not banks,
but they accept deposits and carry out functions similar to banks. NBFCs garnered the
attention of the Reserve Bank of India (‘RBI’) when several depositors lost their money,
during the failure of several banks in the late 1950s and early 1960s. In order to prevent the
large number of depositors, RBI initiated regulating them by introducing Chapter III B
in the Reserve Bank of India Act, 1934. In March 1996, there were around 41,000 NBFCs in
India and they were not recognised as a separate class. However, due to the failure of some of
the institutions the regulatory structure along with the reporting and supervision was
constricted by RBI. In the late 90s, sweeping changes were brought to protect the interest of
depositors and ensuring the desired functioning of NBFCs.

DEFINITION:

An NBFC is a company registered under the Companies Act, 1956 (‘Act, 1956’) or
Companies Act, 2013 (‘Act, 2013’) and is engaged in the business of financial institution.
Section 45I (f) of the RBIAct, 1934 defines
‘‘non-banking financial company’’ as –
(i) a financial institution which is a company;
(ii) 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;
(iii) 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 45I(c) of the RBI Act, 1934 defines the term financial institution as -
‘financial institution’ means any non-banking institution which carries on as its
business or part of its business any of the following activities, namely:–
(i) the financing, whether by way of making loans or advances or otherwise, of any activity
other than its own:
(ii) the acquisition of shares, stock, bonds, debentures or securities issued by a
Government or local authority or other marketable securities of a like nature:

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(iii) letting or delivering of any goods to a hirer under a hire-purchase agreement as
defined in clause (c) of section 2 of the Hire-Purchase Act, 1972:
(iv) the carrying on of any class of insurance business;
(v) managing, conducting or supervising, as foreman, agent or in any other capacity, of chits
or kuries as defined in any law which is for the time being in force in any State, or
any business, which is similar thereto;
(vi) collecting, for any purpose or under any scheme or arrangement by whatever
name called, monies in lumpsum or otherwise, by way of subscriptions or by sale of
units, or other instruments or in any other manner and awarding prizes or gifts,
whether in cash or kind, or disbursing monies in any other way, to persons from
whom monies are collected or to any other person, but does not include any institution,
which carries on as its principal business,–
(a) agricultural operations; or
(aa) industrial activity; or
(b) the purchase or sale of any goods (other than securities) or the
providing of any services; or
(c) the purchase, construction or sale of immovable property, so however, that no
portion of the income of the institution is derived from the financing of purchases,
constructions or sales of immovable property by other persons.

The Companies which falls outside the purview of the definition -financial institution
those companies are known as non-banking non-financial companies. Also, the term
principal business has not been defined by RBI. However, there are various ruling which
emphasize on the various parameters viz. past history of the party, current and past
year's deployment of the capital, breakup of the income earned during the relevant and past
years,the nature of activities and the intent of the party. In order to identify a particular
company as an NBFC, RBI came with a principal business criteria.

MEANING:
According to the Reserve Bank (Amendment Act) 1997, "A Nonbanking finance company
(NBFC) means 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

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institution or class of such institutions as the Bank may with the previous approval of the
Central Government specify.
The definition excludes financial institutions besides institutions which carry on agricultural
operations as their principal business. Non-banking finance companies consists mainly of
finance companies which carry on hire purchase finance, housing finance, investment, loan,
equipment leasing or mutual benefit financial companies but do not include insurance
companies or stock exchanges or stock-broking companies. A residuary non-banking
company is a company which receives any deposit under any scheme or arrangement, by
whatever name called, in one lump sum or in instalments or in any other manner and which is
not,
a) an equipment leasing company
b)hire purchase company
c)housing finance company
d) an insurance company
e) an investment company,
f) a loan company
g) a mutual benefit financial company or
h) a miscellaneous nonbanking company.

Finally non-banking, non-financial company is defined as an industrial concern or a company

whose principal activity is agricultural operations or trading in goods and services or real
estate and which is not classified as a financial or a miscellaneous or a residuary non-banking
company.

CLASSIFICATION OF NBFCs:
The Reserve Bank has also made certain refinements in the norms for classification of
NBFCs into various sub-groups based on their principal activity as evidenced from the
asset/income pattern. Having regard to the special regulatory dispensation accorded to
equipment leasing and hire purchase finance companies, the criteria for classification of the
NBFCs has been tightened. Thus, an NBFC to be eligible for being classified as equipment
leasing company or a hire purchase finance company shall have not less than sixty per cent of
its assets and shall derive income from these activities taken together. All new NBFCs
incorporated after January 9, 1997 will provisionally classified for a period of one year and

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reviewed thereafter on the basis of their asset/income pattern as disclosed in their balance
sheet/profit and loss account and other related aspects. Existing NBFCs also those
unclassified will be classified on the basis of their principal activity as evidenced from their
financial statements into various categories such as Equipment Leasing Companies, Hire
Purchase Finance Companies, Loan Companies, Investment Companies, Miscellaneous Non-
banking companies or Residuary Non-banking companies as the case may be.
Only such of the NBFCs as have been specifically notified under section 620A of the
Companies Act, 1956 by the Government of India will be classified as Nidhi Companies.
NBFCs which have been incorporated with the intention to function as Nidhis will be
classified as Loan Companies and the directions as applicable to Loan Companies will be
made applicable to them till such notification. Equipment Leasing and Hire Purchase Finance
Companies The ceiling of public deposits as a multiple of net owned fund (NOF) in respect
of equipment leasing and hire purchase finance companies has been enhanced. Equipment
leasing and hire purchase finance having rating of minimum investment grade have also now
been allowed to access public deposits.
ith higher cash credit limits and gathering of resources through NCDs . The compulsion to
refund excess deposits may have nullifying effects during the interregnum as additional
resources raised in other forms will have to be utilized for refunding excess deposits. It has
therefore been represented by many NBFCs that the maximum ratios should be revised to
five times of net owned funds and a period of two or three years should be allowed for
refunding excess deposits or effecting the necessary adjustments. If the scope for securing
funds in the desired manner is made available the monetary authorities can have effective
supervision of the operations of the NBFCs concerned and prevent an increase in non-
performing assets and help also the small and medium borrowers to get their requirements
from NBFCs without undue delay at fairly reasonable interest rates.
Since NBFCs may have to play a more important role when economic growth gets
accelerated there will be need for larger volume of assistance against hire purchase and lease
contracts. There should thus be a pragmatic approach to outstanding issues, as stated above,
for securing a better coordination of the activities of banks financial institutions, NBFCs and
others.

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HIRE PURCHASE FINANCE COMPANIES:
The two terms hire purchase credit and instalment credit are used synonymously. The two
however, differ technically, in that in the case of the former the ownership of the good in
question is not transferred to the buyer till he clears all dues, while in the case of the latter,
once the loan contract is signed the ownership is immediately transferred to the buyer. We
shall also use the two terms interchangeably another term which is used in this context is
consumer credit. It is a concept with limited scope in comparison with the other two just
indicated because, strictly speaking, it covers credit for financing sales and purchases of
consumer goods and services only. Hire purchase credit may be consumer credit or
commercial credit.

LEASE FINANCE COMPANIES

A lease is a financing device which has developed rapidly during the 1960s and 1970s in the
U.S and in India just before the middle of the 1980s. It is a form of financing employed to
acquire the use of assets. Through lease, firms can acquire the economic use of assets for a
stated period of time without owning it. Every lease involves two parts the user of the asset
known as the lessee, and the owner of the asset known as the lessor.

There are two main types of leases: (a) operating lease and (b)fmancial or capital lease. The
operating lease is a short term lease which can be cancelled by giving proper notice at the
option of the lessee. Financial lessee is a non-cancelable contractual commitment on the part
of the lessee to make a series of payments to the lessor for the use of an asset. It may be
cancelled only if the lessor is reimbursed for any losses. The lease payment is a fixed
obligation which, if not met, will lead to financial insolvency of the lessee. The financial
lease may take the following forms:
(i) Sale and lease back. In this case the firm sells an asset it owns to another party
which leases it back to the former,
(ii) Direct lease. Here a company acquires the use of an asset directly from the
manufacturers,
(iii) Leveraged lease. In this case, three parties not the usual two are involved in the
arrangement. The three parties are the lesser, the lessee, and the lender.

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HOUSING FINANCE COMPANIES:
Housing is one of the basic necessities of man, and the capital required per dwelling is so
large that few individuals can raise it from their own savings. There is therefore a great need
and scope for the development of arrangements for supplying loans or finance for the purpose
of house construction. However, for some reason or other, the shelter sector of the Indian
financial system remained utterly underdeveloped till the end of the 1980s. The lack of
adequate institutional supply of credit for house building was stressed as an important gap in
the process of financial development in India. In the recent past, the authorities have initiated
certain steps to bridge this gap.

CHIT FUNDS
The Chit Fund is one of the financing agencies in India. It was very populat one time in
Tamilnadu and Kerala and has spread over to North India. Chit fiinds may also be known as
Kuri. They collect regular subscription from their members and distribute the same among
themselves. Chit funds are generally classified into Simple Chit, Prize Chit and Business
Chit.2

THE STATE HOUSING FINANCE SOCIETIES:

The State Housing Finance Societies (SHFSs) constitute another major source of funds in the
residential mortgage market. These societies advance loans to the affiliated Primary
Cooperative Housing Societies for construction of dwelling houses, purchase of land,
additions and improvements to existing houses, purchase of houses, and repayment of earlier
mortgage debt. The terms and conditions of loans vary somewhat from state to state; they
also vary with the location of these, the borrower's income group and the purpose of loan
within the state. The maximum amount of a loan varies between 65 to 80 per cent of the
value of the land and buildings, or some specified maximum amount, whichever is lower.

MONEY LENDERS:
The unorganized sector in the Indian Financial System consists of money-lenders, indigenous
banks, Nidhis, and chit funds. The Central Banking Enquiry Committee has classified
money-lenders into professional and non-professional money-lenders. Professional money-
lenders are those who have taken up money-lending as the sole profession. The professional
money-lenders are known as Mahajan or Sahukar. Non-professional moneylenders are those

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who have taken money-lending as one of their businesses, in addition to their main
business/profession. Non-professional moneylenders are merchants, traders, landlords who
carry on their profession but also lend out their surplus funds for profit.

RESIDUARY NON-BANKING COMPANIES:

Residuary non-banking companies (RNBCs) generally tap the public savings by operating
deposit schemes akin to recurring deposit schemes of the banks. Mobilisation of deposits is
effected from a large number of small and uninformed depositors by expressly promising
them that their money would be invested in banks and government securities. The collection
of deposits is done at the door steps of depositors through field staff who is paid a sizeable
commission. These companies get the fiands at low cost for longer terms, and deploy them at
relatively high yields. Many of these companies operate with meager capital. There are no
restrictions on the quantum of deposits they can raise.
They have certain adverse features; negative networth in some cases; not submitting periodic
returns to the regulatory authority; absence of designation of their banks by some of them;
and their mushroom growth. The aggregate deposits held by them as on 31 54 March 1990
were about Rs.900 crore, i.e. comparable to those of MNBCs 99 and greater than those of
MBFCs.

MUTUAL BENEFIT FINANCIAL COMPANIES :

Mutual benefit financial companies or nidhis, as they are known in India are public limited
joint stock companies operating mainly in South India, particularly in Tamilnadu. They are
old institutions, some of which have existed for 75 to 100 years. Out of 123 nidhis in 1995,
97 were in Tamilnadu of which 70 were in Chennai city alone. Some of them operate through
the network of branches. Most of them issue shares of denomination and no one except
promoters and directors can hold more than one share. They have a large membership
varying from 1000 to 200000, their share capital is very small. The sources of their funds are
share capital, deposits from their members, and deposits from the public. The deposits they
accept are fixed and recurring deposits. Unlike other NBFIs, nidhis also accept demand
deposits to some extent. They also borrow from banks. They may float special schemes for
widows, pensioners etc.

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HUDCO:
HUDCO is an important institution in this area. It was set up in April 1970 with the specific
purpose of providing loans for shelter. It has been financing housing projects located in the
areas where there is a keen demand not only for houses but also for commercial and industrial
sites. It has been providing mortgage loans to cooperative housing societies also. Its loans are
to the extent of 60 per cent of the cost of the houses, and the maturity period of its loans is
between 8 to 10 years. It may be noted that 55 per cent of HUDCO loans are earmarked for
economically weaker sections and low income group families besides 15 per cent of total
loans are earmarked for rural areas. Thus a major portion of HUDCO lending is at subsidized
rates of interest. Upto the end of March 1990 HUDCO had cumulatively sanctioned and
disbursed loans of Rs.4220 crore and Rs.2789 crore respectively.

FUNCTIONS OF NBFCs :
Deposits in the present context are accepted from the public by
(a)public and private limited non-banking, non-financial companies of « varying sizes
(b)public and private limited non-banking financial companies,
(c)govemment companies since 1980,
(d)branches of foreign companies,
(e)partnership firms and
(f)proprietary concerns.

Among these different groups of companies, the non-financial ones account for the largest
proportion of aggregate deposits. Within this group of companies, the private limited
companies and small companies rely more on deposits because of the difficulties they face in
raising funds on the stock market and from the financial institutions.

GROWTH OF NON BANK FINANCIAL SERVICES:

As the demand for financial services grows, countries will need to encourage the
development of non-bank financial intermediaries and securities markets in order to broaden
the range of services and to stimulate competition and efficiency. India has made
considerable progress towards more diversified financial systems. The role of banks in non-
bank financial services began to grow from the time of the amendment to the Banking

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Regulation Act in 1983. Many merchant banking divisions and mutual funds were set up by
the public sector banks since then. Banks began to increase their non-bank and nonfunded
business which are called financial services. More recently some more developments took
place to expand the scope for such services:
(l)keeping open Indian capital market to foreign financial institutions and overseas corporate
bodies to invest in India.
(2) FERA dilution to encourage both the inflow and outflow of funds and foreign investment
in India, some of which might flow into the stock and capital markets.
(3)Opening up mutual fund business and even banking to the private sector.

Already a number of private sector companies/firms are engaged in financial services, such as
investment financing, hire purchase, mortgage financing and housing finance etc. private
sector was permitted to set up mutual funds, banks and 58 financial institutions, financial
deregulation, fi-eeing of interest rates on debentures, banks lending rates and their practices
etc.
ROLE OF NBFCs:
The growth in the economy in the last two decades has been propelled by the service sector
and the Table provides the real growth rate (at 1993-94 prices) of Service Sector activities
between 1993-94 and 2002-03. All have grown above the national income rate of 5.89 per
cent. Hotels and restaurants have grown 10.5 per cent, trade at 7.9 per cent and non-railway
transport 7.6 per cent. The service sector activities are substantially financed by non-banking
financial companies (NBFCs) which constitute engines of credit growth.
The share of the construction industry in gross value addition in 2003 was Rs. 138443 crores.
Lending by commercial banks for housing activities in 2003 amounted to Rs.36587 crores or
around 35 per cent of the aggregate 64 borrowing needed (75 per cent of value addition) by
this industry. Thus nearly 65 per cent of the private construction activity is financed by the
nonbanking sector. The P&P (proprietorship and partnership) sector has a large presence,
more than 60 per cent in this industry.
The truck financing activity is the most innovative and efficient symbol of the NBFC sector.
Second-hand truck financing has created a fascinating backbone for the transport industry by
focusing on the small man and this has been one of the major contributions of the NBFC
sector to the economy. One can, therefore, say that the role of NBFCs in the credit delivery
system in both manufacturing and service sectors is significant per se and compared to the

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commercial banks also. But, unfortunately, the planners, instead of nurturing and enhancing
their credit delivery mechanisms, are focusing more on control and regulation. The failure of
some NBFCs has shifted the focus to their liability side while the asset or lending side is
more important for an emerging market like India. In a large country like India seeing
substantial growth in service activities where the share of P&P firms is significant, it is
important that the role played by NBFCs in credit provision is recognized.
They have extensive network and credibility among their constituents, both borrowers and 65
lenders. Their ability to access public deposits is the meeting point for their customers, since
both are usually un-incorporated entitles. A developing country like India needs multiple
institutions catering to different segments and capable of accessing funds from the public, the
market or from institutions. A prudent lender is one who borrows efficiently. It is actually
two sides of a coin.
The RBI has now strengthened its machinery of registration and supervision and extended
prudential norms to NBFCs. Denying access to deposits would seem a case of throwing a
baby out with the bathwater. On the contrary, the RBI may apply its mind in strengthening
the fiinctioning of NBFCs if necessary facilitating better access to the capital market. The
RBI's Report on Trend and Progress of Banking in India 2004 mentions that banks should
extend wholesale financial assistance to non-governmental organizations/microfinance
intermediaries and work as innovative models for securitization of MFIs receivable
portfolios. Such micro-credit institutions can take the form of NBFCs funded by individuals
or a group of banks, but not permitted to take public deposits.
There are some persistent problems for NBFCs apart from deposittaking. These relate to
flexible handling of their capital issues both SEBI for relaxations with sympathy, especially
since they are rated and supervised. These specific relaxations are more a matter of
confidence-building. The requests made by NBFCs deserve sympathetic treatment by both
the securities market regulator and the central bank. In short, NBFCs are vitally needed to
give the Indian economy a much needed boost by enabling easier access to credit. As it is,
public and private sector banks are finding it difficult to extend their reach for various
reasons.

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SOURCES OF FUNDS:
The main sources of funds for NBFCs have been their paid up capital, borrowings from banks
and financial institutions, issue of bonds and debentures, inter corporate loans, deposits from
shareholders and directors and public deposits.

Some of the larger NBFCs have accessed multilateral funds. These companies have been
working within the stipulated frame work on borrowings as a multiple of net owned funds.
Although the overall ceilings were not found inadequate, these companies have sometimes
faced difficulties in raising resources from banks/financial institutions more so at a
reasonable rate of interest. As a result, they looked for other sources even at higher costs. The
contribution of public issues, debenture/bonds, intercorporate loans and public deposits has
shown a progressive rise in the overall pool of funds.
Recognising the importance of the NBFC sector and the need to integrate it with the
mainstream of the financial system, the Working Group on Finance Companies appointed by
the RBI set the agenda for reforms. Pending amendments to the RBI Act, a series of policy
measures were initiated to monitor the activities of large NBFCs having net owned funds of
Rs.50 lakhs and above on a broader spectrum of regulation simultaneously offering them
incentives for their compliance with the regulatory framework.

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