NON-BANKING FINANCIAL INSTITUTIONS, GROWTH OF

NON-BANKING FINANCIAL INSTITUTIONS, GROWTH OF India's financial system contains many institutions other than banks, including: corporations set up by legislatures; cooperative societies; companies and unincorporated bodies; governmentowned entities; nongovernment public limited and private limited companies; foreign companies; joint ventures among different types of owners; Hindu Undivided Families; clubs; unincorporated associations; and partnership firms. Many of the smaller entities are also engaged in financial services and nonfinancial activities.

Despite the unavailability of insurance for non-banking deposits, the higher rates of return, though marginal, have drawn large numbers of small savers to them. The gradual integration of domestic and external markets have also contributed significantly to the growth of this sector. With innovative market strategies, the non-banking financial institutions have mopped up public savings and command large resources.

Government-owned corporations and companies are governed by specific provisions in their respective statutes and state policies; cooperative societies function within a limited geographical area or particular business activity. The companies are permitted to operate in any part of the country, subject to compliance with the relevant regulations. Many of them are family-owned businesses, with financial support from a closely knit group of friends and relatives. With the liberalization and globalization of the economy, the role of private sector operators in the financial system has increased dramatically.

The small companies in towns and villages cater to the needs of local people, particularly for transport vehicles, and as such they supplement the role of banks. Entities engaged in leasing and purchase finance activities deserve special mention for their role in promoting capital investment in different sectors of the economy. They serve as the link between savers and users of money, mobilizing dormant savings into productive economic activities.

Linkages between Banks and Non-Banks

Non-bank and informal credit institutions are competitive as well as complementary to banks. The distinction between banks and non-banks has been blurred, since both engage in similar types of activities. Non-bank institutions supplement the role of banks in meeting the credit needs of traders and other businesses. Banks can perform the function of a wholesale credit institution; in recognition of this role, the ceiling on bank credit to non-banks was abolished. There is thus cohesion and working synergy between banks and non-banks, inasmuch as banks can function as wholesale credit providers, with the non-banks serving as their retail arm.

The government of India has permitted foreign direct investments in lease and finance, housing finance, and microcredit and rural credit activities. Any company incorporated under the Indian Companies Act of 1956 and engaged, as its principal business, in finance is identified as a non-bank financial company (NBFC). While the Reserve Bank of India (RBI) is vested with powers to supervise the deposit-taking activities of all NBFCs, various authorities, like the Securities Exchange Board of India (SEBI), the National Housing Bank, and the Insurance Regulatory and Development Authority, have been set up for closer regulation of the diverse functions of the companies such as capital market intermediaries, housing finance, and insurance.

The Reserve Bank of India Act, as amended in 1997, introduced comprehensive changes, vesting more powers with the RBI. The act now stipulates: a minimum entry point norm (Rs. 20 million); that all NBFCs obtain certificates of registration from the RBI; that the RBI may give directions to the NBFCs and their auditors and may file petitions and impose penalties against erring NBFCs; the maintenance of liquid assets as a percentage of deposit liabilities; the creation of a reserve fund and the transfer of at least 20 percent of their net profits to such reserve fund to strengthen their fund's base. Unincorporated entities engaged in financial business have been entirely banned from taking deposits from the public. Other entities engaged in nonfinancial activities have, however, been permitted to take deposits without any restriction or limitation. As such, the unincorporated bodies engaged in financial business have been marginalized.

A new RBI regulatory framework was devised in January 1998 to ensure that the NBFCs function on economically sound lines and strengthen the financial system of the country, while affording protection to depositors. A comprehensive supervisory and monitoring mechanism was put in place, encompassing ceilings on the quantum of public deposits (subject to the minimum investment grade credit ratings and capital adequacy ratios), interest rate on deposits, brokerage, period of deposits, methodology of accessing such deposits, maintenance of liquid assets as a percentage (currently 15%) of public deposits, and disclosure norms and requirement to furnish periodic returns. Investment patterns and the nature of securities in which the liabilities to depositors are to be invested has also been stipulated for non-banking companies. The prudential regulations on income recognition, accounting standards, asset classification, provisioning for doubtful debts, capital adequacy, exposure norms, and restrictions on investment in real estate and unquoted shares have been prescribed on lines similar to those applicable to commercial banks. The prudential standards relating to transparency in balance sheets and disclosure of the true and fair financial health of the company in the nature of income recognition norms, asset classification, and provisioning against nonperforming assets are also extended to non-banks.

The RBI has instituted a four-pronged supervisory mechanism over NBFCs. On-site examination is structured on the RBI's own CAMEL (capital, assets, management, earnings, liquidity) system. Off-site surveillance helps the RBI pick up warning signals, which can result in prompt supervisory intervention.

Status of Registration of NBFCs

The RBI received 37,318 applications from existing and new companies seeking grants of certificate registration under the new act to function as non-bank financial companies. All these applications were assessed, and by the end of August 2003, some 725 were registered for "public deposit"; 13,136 were registered as "nonpublic deposit" companies; and 23,434 were rejected for various reasons, including serious irregularities and violations of RBI regulations, weak financials, or poor track records of management.

With the prescription of prudential norms, sound guidelines, comprehensive regulations and supervision, and weeding out the weak as well as the unscrupulous players, the non-banks should regain their credibility. The share of institutional credit to the total resources available to non-banks accepting public deposits has risen steadily. The unauthorized acceptance of public deposits may soon become a recognizable offense. There are certain other measures that the government of India is considering, including tax parity for non-banks, extension of the facility of Debt Recovery Tribunals, and special recovery mechanisms to help them recover their dues from defaulting borrowers as speedily as do banks. Private sector companies have strong survival instincts and should emerge as strong and vibrant partners with public banks in India's fast-growing financial system.

Mohinder Kumar