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Whether Bank Deposits are financial assets - RBI circular creates problems for NBFCs and non-NBFCs


The circular dated 15th March 2012 of the Reserve Bank of India stating that bank deposits will not be treated as financial assets for NBFCs was highlighted in an earlier post by Mr. Satyajit Gupta who has explained its background and rationale. The author has raised a valid concern that the RBI may have about the trading in shell-NBFCs which are dormant and which keep their assets in bank deposits. Perhaps Reserve Bank of India has also the concern of the added burden of monitoring such dormant NBFCs.
However, there are some other worrisome implications of this circular that may create problems even to running NBFCs and even non-NBFCs. The following paragraphs highlight some problems arising out of these new requirements.
Essentially, one may recollect that, as Satyajit points out in his post, the Reserve Bank of India has now de-recognized bank deposits as financial assets. Income from bank fixed deposits is also de-recognized as income from financial assets. Thus, investing in bank fixed deposits will not be treated as carrying on the business of financial institution. The circular further states, quite harshly I think, that if a newly registered NBFC does not commence business of a financial institution – other than of course investing in bank fixed deposits – their certificate will be deemed to be automatically withdrawn.
The problem with making such a general rule is that, instead of applying only to newly registered NBFCs, it will apply to any NBFC and even a non-NBFC creating problems for some and perhaps unintended relief for others.
Thus, this will create confusion to existing NBFCs already engaged in the business of finance. Bank Deposits are part of the portfolio of any NBFC. It may be recollected that the RBI had, vide its circular dated October 19, 2006, created a deeming condition regarding when a Company becomes an NBFC. It stated that, for a Company to qualify as an NBFC, at least 50% of its assets should be financial assets and 50% of its income should be from financial assets. If bank fixed deposits are excluded as financial assets for all companies, it may create problems for some NBFCs particularly in lean times and their auditors may have to qualify their reports.
And this circular may help out those companies who unwittingly became NBFCs on account when at a yearend, they found that their assets consisted of financial assets including fixed deposits with banks being more than 50%. Since bank FDs are no more treated as financial assets, they may escape one or both of the conditions and thus escape the deeming provision which otherwise may have resulted in their requiring to apply for registration as NBFC.
RBI says that bank fixed deposits constitute near money and investing in such assets does not amount to carrying on of business of financial institution. However, one would think that this should actually support the argument that it should be included since an NBFC would keep the amount fixed deposits giving low taxable returns only if they need the monies quickly to deploy in its regular business.
Interestingly, only fixed deposits with banks have been excluded and not other liquid assets of similar nature. This may sound anomalous since NBFCs actually prefer in investing in other similarly liquid assets which yield more tax-efficient returns.
The six month limit to commence the business of NBFC may be an unduly strict requirement considering that this would mean that at least 50% of its assets and 50% of its income will need to be from financial assets within six months of grant of Certificate of Registration (CoR). An NBFC raising funds from various sources at one stroke and deploying them over a period of time may find this difficult to comply. The requirement that the CoR stands automatically withdrawn is particularly harsh as no notice is required to be given and there is no scope for any waiver or extension based on facts of each case.
This would also mean that that effectively the CoR has a validity period of six months only. It is not clear whether this would apply to NBFCs that have obtained CoR in the last six months. It is also not clear what would be the fate of those companies that have obtained registration earlier than six months but who are not in compliance with the condition that the business should have commenced within six months. If the intention is to apply this condition prospectively, this needs to be explicitly stated.
There is a valid concern that some NBFCs may be formed for selling. NBFCs have to undergo a fairly rigorous scrutiny for registration and sale of such “shell” NBFCs may defeat the point. However, a better solution to this may be to require that the buyers of such NBFCs be subjected to the same scrutiny rather than that such restrictions be placed on newly formed NBFCs and existing NBFCs.
The law relating to NBFCs has thus become just a little more complex, harsh and arbitrary. This is also in contrast with the report of the Working Group that liberally recommended that NBFCs having assets upto Rs. 1000 crores (Rs. 50 crores if they access public funds) should not require registration at all as compared to the present requirement of registering all companies engaged in the business of finance. Unlike this realistic and forward looking report, the circular of the Reserve Bank of India is backward looking and even otherwise creates more problems while only partly solving the targeted problem.

Institutional Placement Program


(The following post is contributed by Yogesh Chande, an advocate practising in Mumbai)
The Institutional Placement Program (IPP) was approved by Securities and Exchange Board of India (SEBI) at its board meeting held on 3 January 2012. Subsequently, by a gazette notification dated 30 January 2012, the provision relating to IPP (Chapter VIII-A) was inserted in the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations).
IPP is one of the methods available to Indian listed companies for the purpose of complying with minimum public shareholding requirements[1] under the Securities Contracts Regulation (Rules), 1957 (SCRR), apart from the following methods prescribed under sub-clause (ii) of clause 40A of the equity listing agreement[2]:
(a)  issuance of shares to public through prospectus; or
(b)  offer for sale of shares held by promoters to public through prospectus; or
As regards pricing of the offering in case of an IPP, like in case of a public offering (initial or follow-on) under the ICDR Regulations, no pricing formula has been prescribed, except that under regulation 91F of the ICDR Regulations the eligible seller is obliged to announce a floor price or price band. The floor price or price band in case of an IPP is not linked to the historical market price of the equity shares or any other parameter, like in case of a “preferential allotment” under chapter VII of the ICDR Regulations[4], or like in case of a “qualified institutions placement” under chapter VIII of the ICDR Regulations[5]. It appears that the policy of the regulator has always been to regulate pricing norms in case of offerings where “retail shareholders” are not permitted to participate. SEBI has for the first time allowed free pricing regime for a “restricted public offer” like IPP.
Of all the modes prescribed under clause 40A of the equity listing agreement, IPP is the only mode available to an Indian listed company or its promoter[6] to comply with the minimum public shareholding requirement where a placement can be done only to “qualified institutional buyers”[7], without any pricing restriction, and without any participation by the “retail shareholders”. “Retail shareholders” are not permitted to invest in companies which (or its promoters) adopt the IPP. It is worth mentioning that, listed companies which are required to comply with the requirement of minimum level of public shareholding are typically those which are well managed fast growing companies (including MNCs) with good balance sheets and/or with consistent track record of paying dividends, in which the “retail shareholders” may also wish to participate but, may not be able to do so if the IPP is adopted for diluting the promoter shareholding in such companies.  
It is also interesting to note that one of the pre-requisites, both under chapter VII[8] (dealing with “preferential allotment”) and chapter VIII[9] (dealing with “qualified institutions placement”) of the ICDR Regulations, is that the listed issuer company should be in compliance with the requirement of minimum public shareholding. This is however not the case with regard to IPP. On the contrary, IPP is available only to those Indian listed companies which need to comply with the minimum public shareholding requirements under Securities Contracts (Regulation) Rules, 1957.
It is pertinent to note that, the “offer for sale by promoters through the secondary market” route is the fastest (settlement is completed on T+2 basis, where T is the date of closure of the offer), and more inexpensive than all the other routes prescribed under clause 40A (ii) of the equity listing agreement (including IPP), and where a “retail shareholder” is also permitted to bid. Hence, unless a company is in need of capital, there is no additional advantage (to the company) of IPP over “offer for sale by promoters through the secondary market” route, albeit the success of the offer will depend on the pricing of the shares being offered through both the routes.
- Yogesh Chande


[1] Listed companies where promoter shareholding is above 75%
[2] Amended on 8 February 2012
[3] This was also approved at the board meeting of SEBI held on 3 January 2012 and was made effective by a circular dated 1 February 2012
[4] Regulation 76
[5] Regulation 85
[6] “Eligible seller” in case of an IPP can be either the company or the promoter
[7] Defined in regulation 2(1)(zd)
[8] Regulation 72(1)(c)
[9] Regulation 82(c)

SEBI Regulates Algorithmic Trading


In order to keep up with advances in technology involving securities trading, SEBI has issued to the stock exchanges broad guidelines on algorithmic trading in the securities markets. The concept of algorithmic trading is defined as any “order that is generated using automated execution logic”. Such trading is effected by automated electronic platforms that analyze split-second information and act at speeds not capable of being generated through human intervention.
In order to mitigate any risks from such trading, SEBI’s guidelines require stock exchanges to put in place mechanisms – “arrangements, procedures and system capability” – to deal with the speed and volume of trading. Further, the stock exchanges are to “ensure that all “algorithmic orders are necessarily routed through broker servers located in India”. They also require stock exchanges to ensure that brokers providing the facility of algorithmic trading satisfy certain basic requirements and comply with initial conformance tests.

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.