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07 Aug 2019

Budget Proposal to Boost Non-Banking Financial Companies

The looming crisis concerning Non-Banking Financial Companies (NBFC) necessitated some quick action on the part of the government to stabilize the shaking consumer confidence on the shadow banking sector. Although scholars are still confident of the sector’s performance as a whole but delayed disbursement caused by liquidity crunch was seen as a cause of concern that required quick redressal to attain balance.  

The liquidity crunch is not a recent development, it started affecting NBFCs, especially micro-finance institutions, in the aftermath of demonetization as these institutions basically catered to the financial needs of the lower section of the society which had to bear the major brunt of the currency deficit. The situation further worsened with increasing bank NPAs and the recent payment defaults by leading infrastructure finance companies. Non-Banking Finance Company-Microfinance Institutions (NBFC-MFIs) hold the largest share of portfolio in micro-credit with the total loan outstanding of ₹68,868 crore, which is 36.8 per cent of total micro-credit universe.i 

In a bid to lower the NBFC liquidity crisis, the Central Government in its Budget 2019-20 announced that, “NBFCs are playing an extremely important role in sustaining consumption demand as well as capital formation in small and medium industrial segment. NBFCs that are fundamentally sound should continue to get funding from banks and mutual funds without being unduly risk averse. For purchase of high-rated pooled assets of financially sound NBFCs, amounting to a total of Rupees one lakh crore during the current financial year, Government will provide one time six months’ partial credit guarantee to Public Sector Banks for first loss of up to 10%.ii Thereby the Union Budget has enhanced the liquidity to financially sound NBFCs.  

The NBFC situation had worsened because of increased dependence on easy money by the banks which declined after the Infrastructure Leasing and Financial Services Ltd debacle and the fact that these entities are loosely regulated. The Central Government therefore proposed to increase RBI’s oversight on these entities through the following changes to the NBFCss regulations in its Finance (No.2) Bill, 2019(“Bill 2019”)iii 

Net Owned Fund: 

At present no NBFC can commence or carry on the business of a non-banking financial institution without obtaining a certificate of registration and having the net owned fund of twenty-five lakh rupees or such other amount, not exceeding two hundred lakh rupees, as the RBI may, by notification in the Official Gazette, specify.  

The Bill 2019 proposed to increase the upper limit to a hundred crore rupeesFurther, the RBI may notify different amounts of net owned fund for certain categories of NBFCs. This change will enable RBI to notify a higher minimum net-owned fund requirement for an NBFC. 

Debenture Redemption Reserve: 

Ms. Nirmala Sitharaman, the Finance Minister, in her budget speech mentioned that NBFCs which do public placement of debt have to maintain a Debenture Redemption Reserve (DRR) and in addition, a special reserve is also required to be maintained as per the RBI. The Budget 2019-20 relaxed the mandate of having DRR by NBFCs for raising the funds in public issues. However, the reference of the same is not provided in the Bill 2019. 

Change in Board of Directors: 

Further, the Bill, 2019 has granted the power to RBI to remove the directors of NBFCs where it is satisfied that the affairs of the NBFCs are in a manner detrimental to the public interest. However, the RBI is required to grant an opportunity to the director to represent himself before an order is passed against him. Further, the RBI has the power to appoint a new director in place of the director removed.  

Supersede the Board: 

RBI is authorised to supersede the Board of Directors of an NBFC, not exceeding five years, to prevent the affairs of an NBFC being conducted in a manner detrimental to public interest or the interest of the depositors or creditors or interest of the NBFC (other than Government Company) or for securing the proper management of such NBFC or for financial stability, if it is necessary so to do. 

Removal of Auditor: 

RBI is empowered to remove or debar an auditor from exercising the duties as auditor of any of the RBI regulated entities for a maximum period of three years, at a time,  in case the auditor fails to comply with any direction given or order made by the RBI. 

Currently, ICAI Council has power to debar its members from audits with or without directions from any authority. However, with this change, RBI is also vested with the power to debar auditors.  

Scheme for Amalgamation and/or Reconstruction: 

RBI may frame scheme for amalgamation and/or reconstruction of NBFCs with any other NBFCs and/or splitting of the NBFCs into different units or institutions and vesting viable and non-viable businesses in separate units or institutions to establish Bridge Institutions. 

“Bridge Institutions” mean temporary institutional arrangement made under the scheme, to preserve the continuity of the activities of NBFCs that are critical to the functioning of the financial system. 

Once RBI frames the scheme it is understood that the Companies will have to adopt the NCLT Process to obtain necessary orders.  

Information of Group Companies: 

RBI is empowered to seek statements and information relating to the business or affairs of any group company of NBFCs where it considers necessary or expedient to obtain. Further, the bank may cause an inspection or audit of any Group Company. 

Group Company” shall mean an arrangement involving two or more entities related to each other through any of the following relationships, namely: – 

(i) subsidiary– parent (as may be notified by the RBI in accordance with Accounting Standards); 

(ii) joint venture (as may be notified by the RBI in accordance with Accounting Standards); 

(iii) associate (as may be notified by the RBI in accordance with Accounting Standards); 

(iv) promoter-promotee (under the Securities and Exchange Board of India Act, 1992 or the rules or regulations made thereunder for listed companies); 

(v) related party; 

(vi) common brand name (that is usage of a registered brand name of an entity by another entity for business purposes); and 

(vii) investment in equity shares of twenty per cent. and above in the entity. 


Penalties/Fine: 

The penalties/fine for non-compliance under various provisions has also been increased as follows: 


SL No Description of the Penalties  Existing Amount of Penalty/Fine  Proposed revision of the Penalty/Fine amount 
1 If any person fails to produce any documents or any books.   Fine of Rs. 2000/- for each offence and Rs. 100/- per day where failure is continuous.  Fine of Rs. 100000/- for each offence and Rs. 5000/- per day where failure is continuous. 
2 Non-Compliance of Section 45IA (1) of the RBI Act, 1934.  Maximum fine of Rs. 500000/- along with imprisonment.   Maximum fine of Rs. 2500000/- along with imprisonment. 
3 Failure by the Auditor to comply with any direction given or order made by the RBI.  Maximum Fine of Rs. 5000/-   Maximum Fine of Rs. 1000000/- 
4 Person who fails to comply with any direction given or order made by the RBI.  Fine of Rs. 50/- per day during which non-compliance continues.  Fine of Rs. 5000/- per day during which non-compliance continues. 
5 Any person guilty of non-compliance with the provisions of NBFCs.  Fine upto Rs. 2000/- and Rs. 100/- per day during which non-compliance continues.  Fine upto Rs. 100000/- and Rs. 10000/- per day during which non-compliance continues. 

 

Conclusion: 

With high risk entities such as small and medium enterprises (SMEs), real estate developers and auto manufacturers majorly relying on NBFCs for their funding requirements, it is crucial that they are effectively managed to reduce the chances of them slipping into a major crisis. The proposed changes to the NBFC’s regulations are endeavoured to provide liquidity as well as increasing their commitment as reliable lendersSound implementation of these measures is vital to bring back the NBFC sector to a solid ground. 

 

Image Credits: Ishant Mishra

https://unsplash.com/photos/xgt5DPiDKfY

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