Archive for month: February, 2019

-Loan and investment companies merged into one

By Anita Baid (finserv@vinodkothari.com)

In furtherance to the  Sixth Bi-monthly Monetary Policy Statement[1] for 2018-19 dated February 07, 2019[2] on ‘Harmonisation of NBFC Categories’, the Reserve Bank of India (RBI) released a notification on February 22, 2019[3] to harmonise three different categories of NBFCs into one, based on the principle of regulation by activity rather than regulation by entity.

With the water tight categories segregating asset finance companies, loan companies and investment companies having gone, what impact will the new scheme of regulations have on NBFCs?

Clearly, NBFCs will have more liberty in planning their asset allocation, with their business strategies in mind rather than regulation. Asset finance companies will, in particular, enjoy this new flexibility, as the earlier regime was fraught of difficulties of classification as to whether funding a taxi is like funding a productive/economic asset which will qualify for “productive/economic asset” category, and whether a car used for personal purpose will not. Neither will NBFCs have to maintain that productive/unproductive asset distinction, nor will they have to keep personal loans, LAP or loans against shares within limits on the fear of crossing the 60% bright line.

However, the new dispensation should not mean that companies will have blurred lines of asset allocation. In fact, strategy and asset focus would continue to define whether the NBFC in question goes for fin-tech enabled small business loans, or LAP, or equipment finance, or construction equipment lending.

Harmonisation of three categories into one

The evolution of the NBFC sector has resulted in several categories of NBFCs intended to focus on specific sector/ asset classes. At present there are twelve broad categories of NBFC, based on the nature of activity, namely,

Investment activities	Lending or similar activities	Other activities
Ø  Investment Company Ø  Core Investment Company Ø  Non-Operative Financial Holding Company	Ø  Loan Company Ø  Asset Finance Company Ø  Micro Finance Institution Ø  Infrastructure Finance Company Ø  Infrastructure Debt Fund Ø  Factor	Ø  Mortgage Guarantee Company Ø  Peer-to-Peer Lending Platform Ø  Account Aggregator

Out of around 10,190 NBFCs operating in India, more than 95 per cent (10,082) are non-deposit taking NBFCs. Too many categories only increase compliance cost for the entire non-banking sector and monitoring cost for the regulator. RBI has harmonised three different categories of NBFCs into one, based on the principle of regulation by activity rather than regulation by entity. Accordingly, the three categories of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs) and Investment Companies (ICs) have been merged into a new category called NBFC – Investment and Credit Company (NBFC-ICC).

Though it was expected to merge all the existing categories of NBFC, mentioned above, however, only the following three categories have been merged into one:

1. Asset Finance Company (AFC): An AFC is a company which is a financial institution carrying on as its principal business the financing of physical assets supporting productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipment, moving on own power and general purpose industrial machines.
2. Investment Company (IC): IC means any company which is a financial institution carrying on as its principal business the acquisition of securities.
3. Loan Company (LC): LC means any company which is a financial institution carrying on as its principal business the providing of finance whether by making loans or advances or otherwise for any activity other than its own but does not include an Asset Finance Company.

The merged category has been defined as follows:

“Investment and Credit Company – (NBFC-ICC)” means any company which is a financial institution carrying on as its principal business- asset finance, the providing of finance whether by making loans or advances or otherwise for any activity other than its own and the acquisition of securities; and is not any other category of NBFC as defined by the Bank in any of its Master Directions. 

The objective of this harmonisation is to allow greater operational flexibility to NBFCs. Post the aforesaid harmonisation, there shall be the same set of regulations for all the three categories of NBFCs even as they vary widely in their business focus and sources of funding. Further, the principal business criteria for AFC was calculated as aggregate of financing real/physical assets supporting economic activity and income arising therefrom is not less than 60% of its total assets and total income respectively, which has been reduced to the same level of 50%, pursuant to the harmonisation.

The classification of an NBFC as an AFC or LC or IC was done by the RBI at the time of issuance of the certificate of registration. Apart from satisfying the principality test, which has now been harmonised for all the three categories, there does not seem any other implementation issue in this regard.

Further, the term non-banking financial company has also been defined in the Master Directions for deposit taking NBFCs[4] as follows:

“non-banking financial company” means only the non-banking institution which is an investment and credit company or a mutual benefit financial company or a factor registered with the Bank under section 3 of Factoring Regulation Act (2011);

According, the broad head of NBFC now consists of only three categories:

1. NBFC-ICC
2. Mutual Benefit Financial Company (MBFC)
3. NBFC-Factor

Here, MBFC means any company which is a financial institution notified by the Central Government under section 620A of the Companies Act, 1956 (Act 1 of 1956) and NBFC Factor means a nonbanking financial company as defined in clause (f) of section 45-I of the RBI Act, 1934 which has its principal business as defined in paragraph 40 of these directions and has been granted a certificate of registration under sub-section (1) of section 3 of the Factoring Regulation Act, 2011.

This definition is however restricted to only deposit taking NBFCs and does not extend to non-deposit taking NBFCs. Also, the said definition of NBFC does not include micro finance institutions, Infrastructure Finance Company and Infrastructure Debt Fund as an NBFC.

All related Master Directions for non-systemically important non-deposit taking, systemically important non-deposit taking company, deposit taking company, standalone primary dealers and residuary non-banking companies have been updated accordingly.

Cap on investment limit

The RBI has capped investment limit of deposit taking NBFC-ICC in unquoted shares of another company which is not a subsidiary company or a company in the same group of the NBFC to 20% of its owned fund. The text of the relevant regulation is reproduced herein below:

40. Restrictions on investments in land and building and Unquoted shares

(1) No ICC, which is accepting public deposit, shall, invest in

a) land or building, except for its own use, an amount exceeding ten per cent of its owned fund;

b) unquoted shares of another company, which is not a subsidiary company or a company in the same group of the non-banking financial company, an amount exceeding twenty per cent of its owned fund.

Provided that the land or building or unquoted shares acquired in satisfaction of its debts shall be disposed off by the non-banking financial company within a period of three years or within such period as extended by the Bank, from the date of such acquisition if the investment in these assets together with such assets already held by the non-banking financial company exceeds the above ceiling;

Explanation. – While calculating the ceiling on investment in unquoted shares, investments in such shares of all companies shall be aggregated. Provided further that the ceiling on the investment in unquoted shares shall not be applicable to an investment and credit company in respect of investment in the equity capital of an insurance company upto the extent specifically permitted, in writing, by the Bank.

It is to be noted that investments done by non-deposit taking NBFCs having an asset size of more than 500 crores are already regulated by the concentration norms.

Ratings based risk weight

Along with the aforesaid harmonisation, differential regulations relating to a bank’s exposure to the three categories of NBFCs viz. AFCs, LCs and ICs also stand harmonised.[5]

Currently, the benefit of risk weighting based on ratings is applicable only in case of asset finance companies as per Master Circular-Basel III Capital Regulations dated July 1, 2015. That is to say, in case of all other NBFCs, such as loan companies, the risk weights are 100% irrespective of the rating of the borrower NBFCs.

Under extant guidelines on Basel III Capital Regulations, exposures/claims of banks on rated as well as unrated NBFC-ND-SIs, other than AFCs, Non-Banking Financial Companies – Infrastructure Finance Companies (NBFCs-IFC) and Non-Banking Financial Companies – Infrastructure Development Fund (NBFCs-IDF), have to be uniformly risk-weighted at 100%. With a view to facilitating flow of credit to well-rated NBFCs, a separate RBI circular stipulates that exposures to all NBFCs, excluding Core Investment Companies (CICs), will be risk weighted as per the ratings assigned by the rating agencies registered with SEBI and accredited by the RBI, in a manner similar to that of corporates. Exposures to CICs will continue to be fully risk-weighted.

Conclusion

The harmonisation intends to ensure better administration and uniformity of norms. It is also connected with another proposal to provide risk weight by the banks on the lending to NBFCs based on the credit rating. Further, this comes as a major relief to AFCs who were always facing deicidal issue whether the asset class qualifies as financing real/physical assets for productive / economic activity.

The new regulatory ambit of Investment and Credit Companies will have a huge number of NBFCs, as most NBFCs were investment companies as per RBI parlance.

Notably, the Companies Act, 2013 (sec 186) continues to distinguish, from the viewpoint of exemption from lending/investment limits, between companies principally engaged in the business of lending, and those engaged in the business of investments.

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[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=46237

[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=46235

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11483&Mode=0

[4] Master Direction – Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016

[5] Our detailed article can be read here- http://vinodkothari.com/2019/02/rbi-bi-monthly-credit-policy-nbfcs-moved-to-a-ratings-based-risk-weight-regime/