Referring to NBFIs, Alan Greenspan (1999) had stated: “…enhance the resilience of the financial system to economic shocks by providing it with an effective ‘spare tyre’ in times of need…”
1.1) In the period following the last amendment of the RBI Act in 1997, the non-banking financial sector has evolved considerably in terms of operations, variety of market products and instruments, technological sophistication, etc. Over recent years the NBFCs have assumed increasing significance and have added considerable depth to the overall financial sector. The regulatory responses on the part of RBI have also kept pace with the evolution of this sector. In particular, regulation has adequately addressed the issue of depositor protection, a major concern of RBI. There has been a gradual, regulation induced reduction in the number of deposit taking NBFCs, including Residuary Non-Banking Finance Companies (RNBCs), from 1,429 in March 1998, to 311 in March 2010. The deposits held by these companies (including RNBFCs) decreased from Rs. 23,770 crore, comprising 52.3 percent of their total assets, to Rs. 17,273 crore, comprising 15.7 percent of their total assets.
1.2) But there’s a general belief that there is no difference between the activities undertaken by these companies with that of the banks and that there isn’t any need for such companies as they carry a systemic risk to the Indian Financial System while some believe that they pose a huge threat to the Indian Banking System. The truth as always lies somewhere in between. Our study focuses on the relevance of NBFC’s and whether they pose a threat to the Indian Banking Sector. 2) Defining NBFC’s:
2.1) A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company). 2.2) In terms of Section 45-IA of the RBI Act, 1934, no Non-banking Financial company can commence or carry on business of a non-banking financial institution without a) obtaining a certificate of registration from the Bank and b) without having a Net Owned Funds of Rs. 25 lakhs (Rs two crore since April 1999)
2.3) Basic Distinction with Banks:
NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below: i. NBFC cannot accept demand deposits;
ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself; iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
3) Classification of NBFC’s:
The NBFCs are broadly being classified into two categories based on whether they accept public deposits, viz., (i) NBFC-Deposit taking (NBFC-D) and
(ii) NBFCs-Non-Deposit taking (NBFC-ND).
Besides, there are only two residuary non-banking finance companies (RNBCs)7 which are also deposit taking companies of different character. Among the NBFCs-ND, companies with asset size of Rs. 100 crore and more have been categorized as systemically important (NBFC-ND-SI). Further, since 2006, both of deposit taking and non-deposit taking NBFCs were reclassified based on...