FDI in NBFC Sector Relaxed

Foreign direct investment (FDI) in non-banking finance companies (NBFCs) has been subject to minimum capitalisation norms. For example, any foreign investment of more than 75% in an NBFC requires a minimum capitalisation of US$ 50 million through foreign inward remittances.

As far as downstream investments are concerned, the Conslidated FDI Policy Circular provides that the relevant caps and conditionalities shall apply to downstream investments as well. However, there is a specific exception for 100% foreign-owned NBFCs where there is no restriction on establishing downstream subsidiaries without further capitalising each subsidiary with the minimum required foreign investment. However, this specific dispensation was not available to NBFCs where foreign investment is between 75% and 100%. By way of a Press Note No. 9 (2012) Series, the Government has now brought such NBFCs on par with 100% foreign-owned NBFCs, whereby they can also set up downstream subsidiaries without further capitalising each one of them with the requirement minimum amount.

A reportin the Business Standard sets out some of the advantages of this change:

The rule has made the business very capital intensive for companies that have FDI, as most of them prefer a subsidiary structure to carry out different types of businesses.

This was not the only problem. Norms say that a NBFC has to set up separate arm for different set of activity. It means a NBFC who is in the business of custodian service and then it decides to go into leasing and finance, it needs to set up a different arm.

Previous regulation meant such a NBFC, if having more than 75 per cent FDI but less than 100 per cent and a capital base of $50 million, it would need to bring another $50 million. Now this will not be required.

• Update (October 11, 2012): The above amendment has also been implemented by the Reserve Bank of India through a Circular.

Dormant NBFCs under RBI scanner

There are numerous NBFCs who have obtained registration from the RBI, parked their funds in fixed deposits with commercial banks but have not commenced NBFC activities for several years thereafter. In view of the recent difficulty in getting NBFC registrations as well as to get the benefit of lower net owned funds (NOF) requirements (in case the NBFC was registered pre-1999), acquiring such inactive/ dormant NBFCs had almost become the norm for entities wishing to enter the financial services' space in India.

The RBI has by way of a recent notification attempted to plug this loophole. The regulator has clarified that it issues a Certificate of Registration (CoR) for the specific purpose of conducting NBFI activities. Investments in fixed deposits cannot be treated as financial assets and receipt of interest income on fixed deposits with banks cannot be treated as income from financial assets as these are not covered under the activities mentioned in the definition of “financial Institution” in Section 45I(c) of the RBI Act 1934. Besides, bank deposits constitute near money and can be used only for temporary parking of idle funds, and/or in the above cases, till commencement of NBFI business. The RBI has directed that a NBFC which is in receipt of a CoR from the Bank must necessarily commence NBFC business within 6 months of obtaining CoR. If the business of NBFC is not commenced by the company within such a  period, the CoR will stand withdrawn automatically. Further, there can be no change in ownership of the NBFC prior to commencement of business and regularization of its CoR.

I am starting a blog tracking developments in laws/ regulations relating to NBFCs. Please follow and needless to mention, I am happy to receive comments/ feedback on practical experiences readers have had with the regulator.

RBI Report on NBFC Norms

Last week, a committee formed by the Reserve Bank of India (RBI) issued its report recommending changes to the manner in which non-banking finance companies (NBFCs) are regulated in India. A number of changes have been suggested to the operational norms governing NBFCs. These include capital adequacy requirements, liquidity ratio, asset classification and provisioning and the like, which are expected to strengthen the existing regime regulating NBFCs.


Apart from the general requirements, two recommendations are noteworthy. The first provides that the benefits of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) must be made available to NBFCs such that they are able to enforce their security interests utilising the favourable provisions of the Act. Currently, the benefit of the SARFAESI Act is available only to Indian banks and certain financial institutions. The second is that all NBFCs with assets of Rs. 1000 crores and above, whether listed or not, must comply with clause 49 of the listing agreement prescribed by SEBI for corporate governance and disclosure. This will bring even unlisted NBFCs on par with public listed companies in terms of corporate governance norms that will compel them to comply with requirements on board independence, audit committee, periodic financial disclosures, and the like. It is interesting to see an incorporation (by reference) of the SEBI corporate governance norms to the regime governing NBFCs (that includes unlisted ones as well).


Although the recommendations of the committee are far-reaching in nature, there is no clarity on whether and when they will be adopted and implemented. For instance, some of the changes will require amendment to legislation (e.g. SARFAESI Act and the RBI Act). However, the report represents and indication of the direction in which the regulatory regime governing NBFCs is likely to move in the near future.

The New Microfinance Institutions Bill

Over the last year or so, there has been a serious debate about the nature of regulation governing the microfinance sector. In view of the debacle in Andhra Pradesh, the Reserve Bank of India (RBI) had appointed a committee under the chairmanship of Mr. Malegam to review issues pertaining to the sector. The committee submitted its report in January this year.

In view of these events, the Government decided to relook at the Microfinance Bill previously presented in Parliament in 2007. Consequently, the Ministry of Finance has drafted the Micro Finance Institutions (Development and Regulation) Bill, 2011, which is published on its website for comments which are due August 7, 2011.

Under the new Bill, the RBI is designated as the umbrella authority that will regulate microfinance institutions. The Bill details the powers exercisable by RBI over the various types of institutions currently carrying on microfinance activity (which include non-banking finance companies and cooperatives). More importantly, the draft legislation seeks to do away with the fragmentation that currently exists in regulating the sector. For example, RBI’s role is expected to supersede regulatory powers exercised by various state governments, such as Andhra Pradesh that swiftly promulgated an ordinance last year that significant curtailed the ability of microfinance institutions to carry out their activities in that state. However, states can be expected to challenge the possible usurpation of powers by Parliament (and there are already signs of that occurring), which in turn lead to interesting constitutional questions involving the division of legislative powers between the centre and the states.

As for regulation of the sector itself, the scope of the Bill largely covers the role of RBI in overseeing the sector in terms of its supervisory powers over various institutions carrying on microfinance activity. All institutions will be required to register with the RBI. In that sense, it does not cover the whole gamut of issues considered by the Malegam committee. Moreover, as noted in this critique, the Bill’s predominant focus on organizational aspects of microfinance institutions overshadows the required regulation on the relationship between the institutions and their customers, who are represented by the needy sections of society. The Bill perhaps lacks in its silence on the latter aspect.

Although the Bill is an important step in generating greater discourse on the topic, it is bound to generate issues or objections from various interest groups, with the likelihood that its passage in any form or its implementation could be met with delays.

More Hurdles for LLPs

As we have previously noted on this Blog, the popularity of limited liability partnerships (LLPs) has not met with expectations since introduction of that business vehicle in April 2009. While the Government has taken certain steps to boost the utility of LLPs, such as by considering the possibility of foreign investment into LLPs discussed in this paper issued by the Department of Industrial Policy & Promotion, more recent steps taken and views adopted by the regulatory may amount to a retrograde step.

First, as the Economic Times reports, it is currently not possible for various corporate groups to restructure their holding companies so as to convert them into LLPs. The reasoning is as follows:

But, corporates planning to convert their holding companies into LLPs have been told by the registrar of companies (ROC) to get a no-objection certificate (NOC) from RBI; and the central bank is unwilling to give one. "There is a concern that the moment a company becomes LLP, it will be out of the RBI radar. These companies are core investment companies and under new rules they will be monitored, like non-banking finance companies (NBFCs), by the regulator," said an RBI official.
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Currently, the definition of NBFC under the RBI Act does not specifically cover LLPs. Only companies registered under the Companies Act can form NBFCs. "We have told RBI that the law has to be changed to enable recognition of LLPs as core investment companies under the NBFC format," said an official in the registrar of LLPs in Delhi. An RBI spokesperson confirmed that the central bank is in discussion with the ministry of corporate affairs on the subject.

The LLP structure was introduced primarily keeping in mind operating companies, and not holding and investment companies.

Although there is no restriction under the LLP Act as to the activities that an LLP can carry out, the lack of acceptance of the new business vehicle under other legislation such as the RBI Act has given rise to such ambiguities, thereby curtailing the utility of the LLP and its benefits.

Second, although FDI into LLPs is being actively considered, it has been reported that there is no momentum to permit LLPs to raise overseas debt in the form of external commercial borrowings:

The finance ministry and the Reserve Bank of India have opposed changes in the external commercial borrowings (ECB) policy to allow overseas borrowings by LLPs, while responding to a discussion paper on this form of business put out by the department of industrial policy and planning (DIPP), the policymaking body on foreign investment.

The ECB regime should be identical to the one applicable for partnerships, the finance ministry said in response to the paper. The finance ministry is of the view that while FDI can be allowed in this form of business entities, but not overseas debt, said a government official privy to the discussions.
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The current policy allows companies to raise ECBs, but sole proprietorship firms and partnerships are prohibited from accessing such debt. Though, LLPs combine features of the corporate form of business and partnerships, they are closer to partnerships. …

RBI: Regulatory Framework on Core Investment Companies

An earlier post had discussed a Reserve Bank of India (RBI) proposal on regulation of Core Investment Companies; and had discussed the draft guidelines which the RBI had proposed. The RBI has now released the ‘Regulatory Framework for Core Investment Companies’. A Core Investment Company (CIC) is defined as being an NBFC carrying on the business of acquisition of shares and securities which satisfies the following conditions:

i. it holds not less than 90% of its Total Assets (total assets also being defined in a separate clause) in the form of investment in equity shares, preference shares, debt or loans in group companies.

ii. its investments in the equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies constitutes not less than 60% of its Total Assets.

iii. it does not trade in its investments in shares, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment.

iv. it does not carry on any other financial activity referred to in Section 45I(c) and 45I(f) of the Reserve Bank of India Act, 1934 except investment in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of group companies or guarantees issued on behalf of group companies.

Among other things, all CICs with an asset size of less than Rs.100 crores would be exempted from the requirements of registration with RBI. For this purpose all CICs belonging to a Group will be aggregated. CICs with an asset size of Rs 100 crores or more will be considered as Systemically Important Core Investment Companies (CICs-ND-SI) and would be required to obtain Certificate of Registration (COR) from RBI under Section 45-IA of the Reserve Bank of India Act, 1934. Minimum Capital Ratios and Leverage Ratios have been prescribed for CICs-ND-SI. The notification (dated August 12, 2010) is available here.