Sources of Finance Functions and Investment Policies of NBFIs in India RBI Guidelines on NBFCs Products offered by different NBFCs in India Features of these Financial Products

1. NBFC
Module 3

2. Syllabus
• Sources of Finance
• Functions and Investment Policies of NBFIs in India
• RBI Guidelines on NBFCs
• Products offered by different NBFCs in India
• Features of these Financial Products

3. Sources of Finance

5. Sources of Fund
On The Basis Of Time Or Period
• Long Term and
• Short Term .
On The Basis Of Ownership
• Owned Fund .
• Borrowed Fund
On The Basis Of Source Of Generation
• Internal Fund
• External Fund

6. Sources of Fund or Finance
• Issue of shares
• Debenture
• Bond
• Loan and Overdraft
• Leasing and Hire Purchase
• Mortgage loan
• Retained Earnings
• Trade Credit
• Sale of Stock and Fixed Assets
• Debt Collection
• Factoring
• Public Deposit
• Commercial Bank
• Commercial Paper

7. Issue of Shares- What is a Share?
• A part or portion of a larger amount which is divided among a number of
people, or to which a number of people contribute.
• A unit of ownership that represents an equal proportion of a
company's capital. It entitles its holder (the shareholder) to an
equal claim on the company's profits and an equal obligation for the
company's debts and losses.
• In general a share is a part of the ownership of a company. A person who
buys a portion of a company’s capital becomes a shareholder in that
company’s assets and as such receives a share of the company’s profits in
the form of an annual dividend. Lucky or astute investors may also reap a
capital gain as the market value of the shares increases.

8. Types of Shares
• Mainly Two Types of Shares
– Equity Shares
– Preference Shares

9. • Equity shares are the main source of finance of a firm.
• It is issued to the general public.
• Equity shareholders do not enjoy any preferential rights with
regard to repayment of capital and dividend.
• They are entitled to residual income of the company, but
they enjoy the right to control the affairs of the business and
all the shareholders collectively are the owners of the
company.
EQUITY SHARES

10. • Equity shares are suitable for investors who are willing to assume risk
for higher returns
• Payment of dividend to the equity shareholders in not compulsory
• Equity capital serves as permanent capital as it is to be repaid only at
the time of liquidation of a company
• Equity capital provides credit worthiness to the company and
confidence to prospective loan providers
MERITS

11. LIMITATIONS
• Investors who wants steady income may not prefer equity
shares as equity shares get fluctuating returns
• The cost of equity shares is generally more as compared to
the cost of ravishing funds through other sources
• Issue of additional equity shares dilutes the voting power and
earnings of existing equity shareholders
• More formalities and procedural delays are involved while
raising funds through issue of equity share.

12. PREFERENCE SHARES
• Type of share which enjoy preference in all cases
• Preference shares allow an investor to own a stake at the issuing
company with a condition that whenever the company decides to pay
dividends, the holders of the preference shares will be the first to be
paid.
• This shares, often with no voting rights, which receive their dividend
before all other shares and are repaid first at face value if the company
goes into liquidation

13. Merits
• Preference shares provide reasonably steady income in the form of
fixed rate of return and safety of investment.
• Preference shares are useful for those investors who want fixed rate of
return with comparatively low risk.
• It does not affect the control of equity shareholders over the
management as preference shareholders don’t have voting rights.

14. LIMITATIONS
• Preference shares are not suitable for those investors who are willing to take
risk and are interested in higher returns .
• Preference capital dilutes the claims of equity shareholders over assets of
the company.
• The rate of dividend on preference shares is generally higher than the rate of
interest on debentures.

15. Equity Shares V/S Preference Shares

17. • A debenture is a type of debt instrument
• That is not secured by physical asset or collateral.
• Debentures are backed only by the general credit worthiness and
reputation of the issuer.
• Both corporations and governments frequently issue this type of
bond to secure capital.
• Like other types of bonds, debentures are documented in
an indenture.
DEBENTURES

18. • If a company needs funds for extension and development
purpose without increasing its share capital,
• it can borrow from the general public by issuing certificates for a
fixed period of time and at a fixed rate of interest.
• Such a loan certificate is called a debenture.
• Debentures are offered to the public for subscription in the same
way as for issue of equity shares.
• Debenture is issued under the common seal of the company
acknowledging the receipt of money.

20. • It is preferred by investors who want fixed income at lesser risk
• Debentures are fixed charge funds and do not particulars in profits of
the company.
• The issue of debentures is suitable in the situation when the sales and
earnings are relatively stable.
Merit

21. LIMITATIONS
• As fixed charge instruments debentures put a permanent burden on
the earnings of a company.
• In case of redeemable debentures, the company has to make
provisions for repayment on the specified date, even during periods of
financial difficulty.
• Each company has certain borrowing capacity.

26. • A commercial bank is a financial institution that provides
various financial service, such as accepting deposits and
issuing loans.
• Commercial bank customers can take advantage of a range
of investment products that commercial banks offer
like savings accounts and certificates of deposit.
• The loans a commercial bank issues can vary from business
loans and auto loans to mortgages.
COMMERCIAL BANKS

27. • Banks provide timely assistance to business by providing funds as and when
needed by it.
• Secrecy of business can be maintained as the information supplied to the
bank by the borrowers is kept confidential
• Formalities such as issue of prospectus and underwriting are not required for
raising loans from a bank.
• Loan from a bank is a flexible source of finance as the loan according to
business needs and can be repaid in advance when funds are not needed.
MERITS

28. LIMITATIONS
• Funds are generally available for short periods and its extension or
renewal is uncertain and difficult
• Bankers make detailed investigation of the company affairs financial
structure etc and may also ask for security of assets and personal
sureties .
• In some cases difficult terms and conditions are imposed by banks for
the grant of loan.

29. A financial institution (FI) is a company engaged in the
business of dealing with monetary transactions, such as
deposits, loans, investments and currency exchange.
Virtually everyone living in a developed economy has an
ongoing or at least periodic need for the services
of financial institutions.
FINANCIAL INSTITUTIONS

30. • Financial institutions provide long term finance which are not provided
by commercial banks.
• Besides providing funds many of these institutions provide financial
managerial and technical advice and consultancy to business firms.
• As repayment of loan can be made in easy instalments, it does not
prove to be much of a burden on the business.
MERITS

31. LIMITATIONS
• Financial institutions follow rigid criteria for grant of loans.
• Too many formalities make the procedure time consuming and
expensive.
• Certain restrictions such as restriction on dividend payment are
imposed on the powers of the borrowing company by the financial
institutions.

32. Profits generated by a company that are not distributed to stockholders
(shareholders) as dividends but are either reinvested in the business or
kept as a reserve for specific objectives (such as to pay off a debt or
purchase a capital asset).
• Free off cost source
RETAINED EARNINGS

33. • Retained earnings is a permanent source of funds available to an
organization.
• It does not involve any explicit cost in the form of interest, dividend or
floatation cost.
• As the funds are generated internally, there is a greater degree of
operational freedom and flexibility.
Merits

34. LIMITATIONS
• Excessive plaguing back may cause dissatisfaction amongst the
shareholders as they would get lower dividends.
• It is an uncertain source of funds as the profits of business are
fluctuating;
• The opportunity cost associated with these funds is not recognized by
many firms.

35. Trade Credit
• Trade credit is the credit extended to you by suppliers who let you buy
now and pay later.
• Any time you take delivery of materials, equipment or other valuables
without paying cash on the spot, you're using trade credit.

36. Merit
• Trade credit is a convenient and continuous source of funds;
• Trade credit may be readily available in case the credit worthiness of
the customers is known to the seller;
• Trade credit needs to promote the sales of an organaisation
• If an organisation wants to increase its inventory level in order to
meet expected rise in the sales volume in the near feature.

37. LIMITATIONS
• Availability of easy and flexible trade credit facilities may induce a firm
to indulge in overtrading which may add to the risk of the firm.
• Only limited amount of funds can be generated through trade credit
• It is generally a costly source of funds as compared to most other
sources of raising money.

38. Factoring
• Factoring is a type of finance in which a business would sell its
accounts receivable (invoices) to a third party to meet its short-term
liquidity needs.
• Under the transaction between both parties, the factor would pay the
amount due on the invoices minus its commission or fees.

39. Merits
• Obtaining funds through factoring is cheaper than financing through
other means such as bank credit
• With cash flow accelerated by factoring the clients is able to meet his/
her liabilities promptly as and when these arise.
• Factoring as a source of funds is flexible and ensures a definite pattern
of cash inflows from credit debt that a firm might otherwise be unable
to obtain.

40. LIMITATIONS
• This source is expensive when the invoices are numerous and smaller
in amount
• The advance finance provided by the factor firm is generally available
at a higher interest cost than the usual rate of interest.
• The factor is a third party to the customer who may not feel
comfortable who may not feel comfortable while dealing with it.

41. • Lease financing is one of the important sources of medium- and long-
term financing
• The owner of an asset gives another person, the right to use that asset
against periodical payments.
• The owner of the asset is known as lessor and the user is called
lessee.
LEASE FINANCING

42. Merits
• It enables the lessee to acquire the asset with a lower investment.
• Simple documentation makes it easier to finance assets.
• Lease rentals paid by the lessee are deductible for computing taxable
profits.
• It provides finance without diluting the ownership or control of
business.

43. LIMITATIONS
• A lease arrangement may impose certain restrictions on the use of
assets.
• The normal business operations may be affected in case the lease is
not renewed.
• It may result in higher payout obligation in case the equipment is not
found useful and the lessee opts for premature termination of the lease
agreement and .

44. Public Deposits
• Public deposits refer to the unsecured deposits invited by companies from the public
mainly to finance working capital needs.
• A company wishing to invite public deposits makes an advertisement in the newspapers.
• Any member of the public can fill up the prescribed form and deposit the money with the
company.
• The company in return issues a deposit receipt.
• This receipt is an acknowledgement of debt by the company.
• The terms and conditions of the deposit are printed on the back of the receipt.
• The rate of interest on public deposits depends on the period of deposit and reputation
of the company.

45. Merits
• The procedure of obtaining deposits is simple and does not contain
restrictive conditions as are generally there in a loan agreements.
• Public deposits do not usually create any charge on the assets of the
company. The assets can be used as security for raising loans from
other sources.

46. LIMITATIONS
• New companies generally find it difficult to raise funds through public
deposits
• It is an unreliable source of the finance as the public may not respond
when the company needs money
• Collection of public deposits may prove difficult, particularly when the
size of deposits required is large.

47. COMMERCIAL PAPER
• Commercial Paper or CP is defined as a short-term, unsecured money
market instrument, issued as a promissory note by big corporations
having excellent credit ratings.
• As the instrument is not backed by collateral, only large firms with
considerable financial strength are authorised to issue the instrument.

48. MERITS
• A commercial paper is sold on an unsecured basis and does not contain
any restrictive conditions
• As it is a freely transferable instrument it has high liquidity
• It provides more funds compared to other source
• A commercial paper provides a continuous source of funds.
• Companies can park their excess funds in commercial paper thereby
earning some good retunes on the same.

49. LIMITATIONS
• Only financially sound and highly rated firms can raise money though
commercial papers
• The size of money that can be raised though commercial paper is
limited to the excess liquidity available with the suppliers of funds at a
particular time.
• Commercial paper is an impersonal method of financing.

50. Functions of NBFC

51. Functions of NBFC
 Brokers of loanable funds.
 Mobilization of savings.
 Channelization of funds into investment,
 Stabilize the capital market,
 Provide liquidity.

52. Regulations of NBFC

54. RBI REGULATIONS
• A company incorporated under the Companies Act, 1956 and desirous
of commencing business of non-banking financial institution as defined
under Section 45 I(a) of the RBI Act, 1934 should comply with the
following:
– i. it should be a company registered under Section 3 of the
companies Act, 1956
– ii. It should have a minimum net owned fund of 200 lakh. (The
minimum net owned fund (NOF) required for specialized NBFCs
like NBFC-MFIs, NBFC-Factors, CICs is indicated separately in the
FAQs on specialized NBFCs)

55. Does the Reserve Bank regulate all
financial companies?
• No.
• Housing Finance Companies, Merchant Banking Companies, Stock
Exchanges, Companies engaged in the business of stock-broking/sub-
broking, Venture Capital Fund Companies, Nidhi Companies,
Insurance companies and Chit Fund Companies are NBFCs but they
have been exempted from the requirement of registration under
Section 45-IA of the RBI Act, 1934 subject to certain conditions.

57. What are the requirements for registration with RBI?
• In terms of Section 45-IA of the RBI Act, 1934, it is
mandatory that every NBFC should be registered with RBI to
commence or carry on any business of non-banking financial
institution.
• To obviate dual regulation, certain categories of NBFCs
which are regulated by other regulators are exempted
from the requirement of registration with RBI viz.
– Eg. Venture Capital Fund / Merchant Banking companies /
Stock broking companies registered with SEBI.

58. Contd..
• Should have a minimum net owned fund of Rs 25 lakh raised
to Rs 200 lakh WEF April 21, 1999.
• NBFC have to maintain 10 and 15 per cent of their deposits in
liquid assets effectively from January 1 and April 1,1998,
respectively.
• All NBFCs are not entitled to accept public deposits. Only
those NBFCs holding a valid Certificate of Registration with
authorization to accept Public Deposits can accept/hold public
deposits.

59. Contd…
• They have to create reserve fund and transfer not less than 20% of
their net deposits to it every year.
• The NBFCs are allowed to accept/renew public deposits for a minimum
period of 12 months and maximum period of 60 months.
• They cannot accept deposits repayable on demand.
• NBFCs cannot offer interest rates higher than the ceiling rate
prescribed by RBI from time to time.

60. Regulations applicable on non-deposit accepting NBFCs with asset
size of less than 500 crore?
The regulation on non-deposit accepting NBFCs with asset size of less than 500
crore would be as under:
(i) They shall not be subjected to any regulation either prudential or conduct of
business regulations viz., Fair Practices Code (FPC), KYC, etc., if they have not
accessed any public funds and do not have a customer interface.
(ii) Those having customer interface will be subjected only to conduct of business
regulations including FPC, KYC etc., if they are not accessing public funds.
(iii) Those accepting public funds will be subjected to limited prudential regulations
but not conduct of business regulations if they have no customer interface.
(iv) Where both public funds are accepted and customer interface exist, such
companies will be subjected both to limited prudential regulations and conduct of
business regulations.

61. Regulation of NBFCs
• While NBFCs have been rendering many useful services, several advances,
unhealthy features of their working also have been observed.
• At present all NBFCs except HFCs are regulated by the RBI.
• With enactment of RBI (Amendment) act 1997, all of them with net owned funds of
ì.25Lakhs and above have to register with the RBI now.
• The BFS with the help of department of supervision of the RBI began supervising
NBFCs from July 1995.
• HFCs are regulated by NHB. The major regulatory provisions are:-
(i) The minimum net worth funds of 25 Lakh and the NBFC should achieve the
minimum net worth norm in 3 years or extended 3years more at the discretion of
RBI.
(ii) NBFCs have to maintain 10%and15% of their deposits in liquid assets.
(iii) They have to create reserve fund and transfer not less than 20% of their net
deposits to it every year.

62. Contd…
(iv) The RBI directs them on issues of disclosures, prudential norms, credit,
investments etc.
(v) Nomination facility is available to depositors of these companies.
(vi) Unincorporated bodies engaged in financial activity cannot accept deposits
from the public from April, 1997.
(vii) They have to achieve a minimum capital adequacy norm of 8% by March,
1996.
(viii) They have to obtain a minimum credit rating from any one of 3 credit rating
agencies.
(ix) A ceiling of 15% interest on deposits has been prescribed for MBFCs or
Nidhis.
(x) The interest rate ceiling on deposits as also the ceiling on quantum of deposits
for NBFCs (other than Nidhis) have removed

63. Investment Policies of NBFIs in India

64. Investment Policies of NBFIs in India
• An investment policy is any government regulation or law that
encourages or discourages foreign investment in the local economy
• A document that formalizes an institution's goals, objectives, and
guidelines for asset management, investment advisory contracting,
fees, and utilization of consultants and other outside professionals.

65. Contd..
• Over the years since liberalization of the Indian economy in 1991, India
witnessed a significant interest of foreign investors in the Indian NBFC
sector.
• NBFCs are governed under the policies and guidelines as issued from time
to time by the Reserve Bank of India.
• FDI in NBFCs has been allowed up to 100% since 1997 subject to the
minimum capitalization norms as issued by the Government.

66. Foreign investment is allowed in the following
activities:
• Merchant Banking
• Under Writing
• Portfolio Management Services
• Investment Advisory Services
• Financial Consultancy
• Stock Broking
• Asset Management
• Venture Capital
• Custodian Services
• Factoring
• Credit Rating Agency
• Leasing & Finance
• Housing Finance
• Forex Broking
• Credit Card Business
• Money Changing Business
• Micro Credit and Rural Credit.

67. Law governing the foreign
investments in NBFC
• Foreign exchange provisions are regulated by the FEMA, 2000 and
NBFCs operations are regulated by the Reserve Bank of India within
the framework of the RBI Regulation Act 1934, 100% FDI is allowed in
NBFCs subject to the minimum capitalization norms as issued by the
Government.

68. • As per Press Note 7 of 2008 issued by the DIPP the minimum
capitalisation of foreign holding requirements for NBFC's are as follows:
1. US$ 0.5 million in case the shareholding percentage is below 51%
2. US$ 5 million in case the shareholding percentage is between 51% & 75% &
3. US$ 20 million in case the shareholding percentage is between 75% & 100%

69. Foreign Investments Subject To Minimum Capitalization
Norms
• The US $0.5 million for foreign capital up to 51% to be brought up front.
• The US $5 million for foreign capital more than 51% and up to 75% to be brought up front.
• 50 million for foreign capital more than 75% out of which $7.5 million to be brought up front and
the balance in 24 months.
• The NBFCs having foreign investment more than 75% and up to 100%, and with a minimum
capitalization of $50 million, can set up step down subsidiaries for specific NBFC activities,
without any restriction on the number of operating subsidiaries and without bringing additional
capital.
• Joint Venture operating NBFCs that have 75% or less than 75% foreign investment can also
set up subsidiaries for undertaking other NBFC activities, subject to the subsidiaries also
complying with the applicable minimum capitalization norm mentioned above.
• Non- Fund based activities: The US $0.5 million to be brought upfront for all permitted non-
fund based NBFCs irrespective of the level of foreign investment.

70. • Subject to certain conditions
• For such company it would not be permissible to set up any subsidiary
for any other activity, nor can participate in the equity of an NBFC
holding company. Above mentioned capitalization norms apply to each
downstream subsidiary engaging in NBFC activities except where its
parent entity already has more than 75% foreign investment.

71. Contd…
• However, on 10th August 2016, the Government of India approved further
changes to the FDI requirements pertaining to NBFC's.
• 100% FDI through the automatic route is now permitted in "Other Financial
Services" as well, provided such services are regulated by any financial
sector regulator.
• Minimum capitalisation norms as mandated under FDI policy have been
eliminated as most of the regulators have already fixed minimum
capitalisation norms.

72. • These recent changes of doing away with the minimum
capitalization norms is a boon since this will spur economic
growth by increasing FDI in the NBFC sector.
• NBFCs have had a major impact on the growth of SMEs and
businesses in rural areas.
• This is primarily based on strong local knowledge and
consumer relations.
• Increasing FDI will be beneficial for these businesses due to
the relatively easier and faster sanction of loans with
favourable interest rates.

73. Contd..
• However, a major issue facing the NBFC sector is the
multiplicity of regulators.
• Both RBI and SEBI exercise regulatory control over NBFC's.
• Whilst the regulators try to avoid encroaching upon the
others domain, there is consistent tussle between the
regulators as to which activity would fall under which
regulator's domain.
• A clarity and consistency in this regard would be very
welcome.

74. CHANGES MADE IN FDI POLICY
• In RBI notification dated 9 September 2016 following key relaxations have been
introduced:
• In NBFC 100% FDI through the automatic route is now permitted in “Other Financial
Services” beyond the 18 specified activities.
• Provided that the activities are regulated by financial sector regulators such as RBI,
SEBI, Pension Fund Regulatory Authority of India (IRDA) etc.
• Under FDI Policy, additional capitalization norms linked to foreign ownership has
been removed, and thereby the capitalization norms have been aligned with those
prescribed by the relevant regulators regulating these activities. Under FDI Policy,
minimum capitalization norms have been eliminated as most of the regulators have
already fixed minimum capitalization norms.
• Unregulated NBFCs which are not regulated by any financial sector regulators will
require prior government approval.
• Due to the relatively easier and faster sanction of loans with favorable interest rates,
increasing FDI will be beneficial for the business. This move of the government is
expected to provide a much-needed boost to this sector.

76. ROLE OF NBFC

77. ROLE OF NBFC
• Development of sectors like transpiration, infrastructure
• Employment generation
• Help and increase wealth creation
• Economic development
• To finance economic weaker section
• Huge contribution to state exchequer
• Rural development
• Financial inclusion

80. Advantages of NBFC

81. Some of the major benefits of NBFCs are:
• Lenient conditions for getting a loan in comparison to traditional banks
• Approve smaller loan sizes
• Borrower evaluation based on known history of the business
• Single product and dedicated business

82. List of major products offered by NBFCs in
India
• Funding for small commercial
vehicles
• Business loan against property
• Funding of infrastructure assets
• Retail financing
• Loan against shares
• Funding of plant and machinery
• Project finance
• Unsecured personal loans
• Trade finance
• Venture finance
• Home loan
• Personal loan
• Vehicle loan
• Gold loan
• Property loan
• Business loan
• Education loan

83. FEATURES AND BENEFITS -
Funding for small commercial vehicles
• Loans from Rs.1 lakh onwards
• Fast track approvals
• Flexible finance schemes for new and used vehicles
• Minimum documentation
• Easy repayment options
• Maximum funding at ex-showroom price
• Attractive schemes to suit your needs
• Faster sanction and disbursement of loan
• Personalised customer service
• Simple documentation process

84. FEATURES AND BENEFITS-
BUSINESS LOAN AGAINST
PROPERTY
• Loan available against residential and commercial property
• Loan Tenor up to 180 months
• Loan Amount – Starting from Rs. 5 Lakh up to Rs. 2 crore
• Best income assessment for loan

85. FEATURES AND BENEFITS- GOLD
LOAN
• Loan available against jewelry ornaments of 20 ct and above
• Loan Tenor of 12 Months
• Flexible interest payment of 30, 90 & 180 days
• Loan Amount – starts from Rs.3000
• Instant Cash Disbursement
• Safe & Secure Storage System
• Flexible schemes to suit your financial requirements

86. What is Retail Banking
• Retail banking, also known as consumer banking, is the typical mass-
market banking in which individual customers use local branches of
larger commercial banks.
• Services offered include savings and checking accounts, mortgages,
personal loans, debit/credit cards and certificates of deposit (CDs).
• In retail banking, the focus is on the individual consumer.

87. Syllabus
• Sources of Finance
• Functions and Investment Policies of NBFIs in India
• RBI Guidelines on NBFCs
• Products offered by different NBFCs in India
• Features of these Financial Products