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Full-throttle Reform of NBFC Regulation creates several potential issues
Submitted by admin on Wed, 08/31/2011 - 00:38
By Vinod Kothari,
Microfinance Focus, August 30, 2011: The report of the Working Group (WG) headed by Smt. Usha Thorat has done a wonderful job and put together a remarkable report which, if accepted, would make NBFC regulation sensible in the country. It is not for the first time that an attempt for a complete overhaul of the regulatory regime has been attempted. In 2003, the Finance Committee of the Parliament had made recommendations on a Financial Companies Regulation Bill1 which has since never been acted upon. The Parliamentary Committee had also made sweeping suggestions – including the point that investment companies should be completely excluded from the regulatory ambit of NBFCs.
In fact, India is one of the few countries which are regulating investment companies and financial companies under the same regulatory regime, whereas the nature and business of investment companies may be totally different. It is for this reason that we have a mass of more than 12000 NBFCs registered and being regulated by the RBI. At the point when NBFC registration regime was first implemented, there were well over 37000 companies registered as NBFCs, since, going by the way the definition is laid down, even a husband-and-wife company investing self-owned funds into stock markets will be said to be an NBFC, where the RBI must step in to protect the shareholders from the shareholders.
De-registration based on size:
The WG has not gone into the question of what an NBFC is, and what business would make a company an NBFC. However, the WG has recommended de-registration of all non-depository companies with asset size of Rs 50 crores or below. This would prima facie be a great relief for smaller investment companies. But then, there are fall-out problems. For instance, the Motor Vehicles authorities in several Southern states have come up with rules that registration of a motor vehicle with endorsement of a hypothecation in the name of an NBFC will not be allowed, unless the NBFC is RBI-registered. So, as RBI de-registers NBFCs of less than Rs 50 crores in assets, smaller companies would practically be forced out of vehicles finance business.
There is a welcome measure introduced – to regulate NBFCs with asset size of less than Rs 1000 crores only if they have “public funds”, including funds from banking channels.
There is yet another significant change proposed – changing the definition of “principal” business for NBFC registration. We have commented on several occasions earlier that the administrative definition of the RBI capturing 50% of income and assets for NBFC definition is at best an issue of administrative convenience, and cannot be applied mechanically. The WG suggests that this threshold should be moved up to 75%, which is quite a welcome step. If 50% were the criteria, an entity formed as NBFC may effectively carry substantial amount of non-financial business, and still retain NBFC classification.
It is notable that the Dodd Frank Act in the USA has put a threshold limit of 85% for a company to be regarded as non-bank financial company.
Pre-empting Basle III
The WG brings in a new concept of liquidity ratio – which is a part of Basel III recommendations. Basel III is still a few years away for banks in the world, but the WG has already introduced a liquidity ratio based on 30 days’ cashflows. In principle, the stipulation is prudentially important, as it helps to maintain better asset liability management.
There is quite an important point that the WG makes – tax deduction for provisions made by NBFCs. Currently, NBFCs make provisions for NPAs as required by RBI directions, but they do not get any tax deduction for the same. A Supreme Court ruling had also declined such tax benefits. The WG suggests parity between banks and NBFCs in terms of tax deductibility – something that would require amendment of the Income-tax law.
Corporate governance has become the buzzword these days, and the WG report is also full of references to application of corporate governance and disclosure norms to NBFCs whether they are listed or not. This measure is also welcome.
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