RBI CIRCULAR ABOUT NBFC - THERE SEEMS A MISTAKE ND CONFLICT IN EXEMPTION FOR NBFC. Small companies should not be allowed to invite and accept deposits from public.

[C.A. DEV KUMAR KOTHARI]

The RBI has issued circular dated December 12, 2012 providing for changes in regulations about NBFC. It seems that there is a mistake in the exempted category of NBFCs with asset size below Rs. 25 crore. In this category words are added “whether accepting public funds or not”.

There seems a contradiction between purpose of exemption and the category of exempted NBFC in small segment.

The relevant portion from the circular and annexure there to are reproduced below with highlight.

Circular:

DNBS (PD) CC.No. /03.05.02/2012-13

December 12, 2012

All NBFCs (except primary dealers)

Dear Sir,

‘Review of NBFC Regulatory Framework – Recommendations of the Working Group on Issues and Concerns in the NBFC Sector – Entry Point Norms, Principal Business Criteria (PBC), Multiple and Captive NBFCs.

The Reserve Bank set up a Working Group (WG) under the chairmanship of Smt Usha Thorat, former Deputy Governor, RBI, to review the extant regulatory framework of NBFCs. The WG submitted the report on August, 2011 which was placed in public domain by the Reserve Bank for comments. The report along with the feedback was examined by the Reserve Bank and accordingly, it has been decided to amend the existing regulatory framework for NBFCs, wherever applicable.

2. The details of changes made to the existing regulatory framework on entry point norms, principal business definition and certain fresh prescriptions for multiple companies in a group as also captive companies are given in the Annex.

Yours sincerely,

(Uma Subramaniam)

Chief General Manager-in-Charge

From annexure:

3. Exempted NBFCs :

3.1 The following categories of NBFCs are exempted from registration with the Reserve Bank

i. NBFCs with asset size below Rs. 25 crore whether accepting public funds or not.

ii. NBFCs with asset size below Rs. 500 crore and not accepting public funds, directly or indirectly.

3.2 The provisions of Chapter IIIB of the RBI Act 1934, except Section 45N, will not apply in respect of the above exempted category of NBFCs. These NBFCs will have the option of surrendering the CoR on a voluntary basis.

3.3 The rationale for exemption is that as the above are essentially small non-deposit taking NBFCs and do not contribute to any major systemic risks or major disruptions in the market. Such a measure would not prevent small but potentially dynamic and innovative start-up companies from entering into the financial activity.

Analysis:

In the paragraph 3.3  while stating the  purposes or the rational for exemption it is stated that the above are essentiall small non-deposit taking NBFC- thus exemption is intended for NBFC not accepting deposits from public.

However, in exempted category (i) the words used are whether accepting public funds or not

Therefore, there is apparent conflict. The attention of concerned authorities is drawn by this article to recheck the circular and annexure and make necessary corrections to remove the above conflict.

NBFC accepting public deposits must be regulated:

NBFC having assets worth Rs.25 crore- must not be allowed to accept public deposits:

NBFC having assets worth Rs.25 crore can definitely be regarded as very small NBFC from the point of view of strict regulatory frame work for NBFC. However when question about NBFC (or any company for that matter) accepting public deposits comes, the size of such companies cannot be regarded as very small. In such cases either there should be no permission to obtain public deposits or there must be strict regulations to regulate public deposit administration of such companies.

If we look into history we can find many NBFC with assets of even 5-10 crores, who accepted public deposits, used to pay interest regularly and also declaring dividend. However, once regulations and restrictions on accepting public deposits were strictly enforced and those companies were not allowed to accept further deposits and were told to repay excess deposits, many of such companies had lot of problem and closed down or went into liquidation.

We can count many NBFC  who used to pay good dividend, regularly but had to close down when restrictions on extent of accepting deposits was made stringent. The reason for failure was that they could not continue roll of money by accepting new deposits and paying interest and dividend out of deposits. It was experienced that many of such companies used to pay interest and dividend out of capital (obtained by way of new deposits).

As it would not be possible to enforce regulations in a meaning full manner for such companies, it is desirable that companies having assets up to rupees 25 crore should not be allowed to accept deposits from public in any manner- directly or indirectly. They should also not be allowed to raise public money by way of issue of shares.

Provisions of S. 45N of RBI Act:

The provisions of section 45N of RBI Act which will continue to apply to exempted NBFC read as follows:

45N. Inspection.

¹[(1) The Bank may, at any time, cause an inspection to be made by one or more of its officers or employees or other persons (hereafter in this section referred to as the inspecting authority)-

(i) of any non-banking institution, including a financial institution, for the purpose of verifying the correctness or completeness of any statement, information or particulars furnished to the Bank or for the purpose of obtaining any information or particulars which the non-banking institution has failed to furnish on being called upon to do so; or

(ii) of any non-banking institution being a financial institution, if the Bank considers it necessary or expedient to inspect that institution.]

(2) It shall be the duty of every director or member of any committee or other body for the time being vested with the management of the affairs of the non-banking institution or other officer or employee thereof to produce to the inspecting authority all such books, accounts and other documents in his custody or power and to furnish that authority with any statements and information relating to the business of the institution as that authority may require of him, within such time as may be specified by that authority.

(3) The inspecting authority may examine on oath any director or member of any committee or body for the time being vested with the management of the affairs of the non-banking institution or other officer or employee thereof, in relation to its business and may administer an oath accordingly. taxmanagementindia.com
²[45NA.

Observations of author:

This provision is only about authority of RBI to inspect records etc. of NBFC and duties and responsibility of NBFC and its officers about allowing and helping in such inspection. It will be very difficult for RBI to provide suitable deterrent or ensure financial discipline by having inspection of such small companies. Therefore, there is need for complete restriction on acceptance of public money by any NBFC who do not want to follow strict regulations of RBI.

Note:

This article has been written on limited issue about small NBFC having assets up to Rs. 25 crore which should be exempted only if not accepting public deposits and an apparent conflict in circular. For other related changes in policy, readers may refer to circular in details.