Non-Banking Financial Companies (NBFCs) in India: Functioning & Reforms

Preface

Non-banking financial companies (NBFCs) comprise a heterogeneous lot of privately-owned, small-sized financial intermediaries which provide a variety of services including equipment leasing, hire purchase, loans, investments and chit fund activities. These companies play an important role in providing credit to the unorganised sector and to the small borrowers at the local level. Hire purchase finance is by far the largest activity of NBFCs.

Although NBFCs in India have existed for a long time, they shot into prominence in the second half of the 1980s and in the first-half of the 1990s, as deposits raised by them grew rapidly. NBFCs were historically subjected to a relatively lower degree of regulation vis-à-vis banks. Prior to reforms in this sector, operations of NBFCs were characterized by several distinctive features, viz. no entry barriers, limited fixed assets and no holding of inventories-all of which led to a proliferation of NBFCs.

Though heterogeneous, NBFCs can be broadly classified into three categories: (a) asset finance companies (such as equipment leasing and hire purchase), (b) loan companies and (c) investment companies.

A separate category of NBFCs, called the residuary non- banking companies (RNBCs), also exists as it has not been categorised into any one of the above referred three categories.

Besides, there are miscellaneous non-banking companies (chit funds), mutual benefit financial companies (Nidhis and unnotified Nidhis) and housing finance companies.

Primarily engaged in the area of retail banking, they face competition from banks and financial institutions. With the increasing services sector activity in India, the NBFCs have been playing a critical role in providing credit. NBFCs have extensive networks with some of them accepting public deposits.

In terms of regulation and supervision, there are two broad categories of Non-banking Financial Companies (NBFCs), viz. Non-banking Financial Companies-Deposit Taking (NBFCs D) and Non-banking Financial Companies-Non-deposit Taking (NBFCs-ND). While NBFCs-D have been regulated by the RBI from 1963, an amendment to the RBI Act in 1997 empowered the RBI to regulate and supervise all categories of NBFCS more comprehensively. NBFCs-ND, until recently, were subject to minimal regulation as they were non-deposit taking. Recognising, however, the growing importance of this segment and their linkages to banks and other financial institutions, capital adequacy and exposure norms were made applicable to NBFCs-ND with assets above Rs. 100 crore from April 1, 2007.

The role of NBFCs in transferring the funds from lenders to borrowers has been well-recognized. The main advantages of these companies are as under:

Customer orientation and prompt provision of services. 

Concentration in the main financial centres.

Attractive rates of return offered.

Lower transactions costs of operations.

Quick decision-making ability.

Simplified sanction procedures.

Flexibility and timeliness in meeting the credit needs of specified sectors (like equipment leasing and hire purchase).

On account of these advantages, NBFCs have in recent years grown sizeably both in terms of their numbers as well as the volume of business transactions.

There are indications that the reform process has not as yet resulted in any noticeable improvement in the operational efficiency of NBFCs. In fact profitability position has showed some signs of deterioration in recent years. Similarly, operations of NBFCs have witnessed significant changes especially on the liability side. With the tightening of regulations, many of the NBFCs with insufficient capital base have been weeded out. This combined with the tightening of regulations for raising deposits has resulted in reduction in size of this sector.

As NBFCs provide important services in certain niche areas of the financial sector, improvement in the efficiency of these entities is of crucial importance. The RBI has continued to pursue with various State Governments the case for enacting legislation for protection of interest of depositors in financial establishments. Creating public awareness about activities and risk-profile of NBFCs is yet another important area, which needs to be focussed upon. Improvement in corporate governance practices and financial disclosures by NBFCs also need to be focused upon in future.

I take this opportunity to record my deep sense of gratitude and indebtedness to following distinguished scholars for their help and encouragement: Dr. Uttam Kumar Datta, Professor, Department of Commerce, Burdwan University, Burdwan; Dr. J.B. Sarkar, Formerly Reader, Department of Commerce, Burdwan University, Burdwan; Professor Amit Kumar Mullick, Honourable Vice-Chancellor, Burdwan University; Professor Ujjal Kumar Mullick; Professor Debashish Sur, Reader and Head, Department of Commerce, Burdwan University, Burdwan.

Thanks are also due to my friends Saif, Kiran and Suman for assisting me at every stage of the completion of this work. Finally, I express my gratitude to my parents, wife Syeda Reshma Begum and daughter Raitah Zain, without whose co- operation, good wishes and affection this work would not have seen the light of the day.

Burdwan May 2010

Jafor Ali Akhan