1.NBFC FRAMEWORK 1. LEGAL FRAMEWORK 2. REGULATORY FRAMEWORK 3. AUDIT OF NBFC

2. LEGAL FRAMEWORK OF NBFC 3. What is NBFC ? From the text of sections 45-I (a), (c) & (f). Non banking financial Company means, which is engaged in- financing acquisition of shares, stocks, bonds, debentures or securities - letting or delivering of any goods to a hirer carrying on of any class of insurance business managing, conducting or supervising, as a foreman, agent or in any other capacity, of chits or kuries collecting for any purpose or under any scheme or arrangement, monies in lump sum or otherwise, by way of subscriptions or by sale of units or in any other manner and awarding prizes or gifts, whether in cash or kind or disbursing monies in any other way, to persons from whom monies are collected or to any other person. 4. But doesnt include- Which carries as its principal business Agricultural operations Industrial activity Purchase or sale of any goods (other than securities) or the providing of any services Purchase, construction or sale of immovable property, so, however, that no portion of income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons 5. Requirement of Registration and Net Owned Fund Section 45-IA of RBI Act, 1934 No NBFC shall commence or carry on the business of non- banking financial institution without- Obtaining a certificate of registration and Having net owned fund Notification No. DNBS. 132/CGM(VSNM)-99, DATED 20- 4-1999 Net owned fund to be 200 lakhs rupees for a NBFC which commences the business of a non-banking financial institution on or after 21st April, 1999 and 25 lakhs rupees for whose application for certificate of registration under section 45-IA is submitted to RBI on or before 20th April, 1999. 6. Commencement of Business by NBFC RBI2013-14/46DNBS(PD)CC No./344.03.02.001/2013-14 NBFC , which is in the Receipt of a COR from the Bank must necessarily commence NBFCs Business within six months of obtaining COR. If the Business is not commenced by the company within a period of six months , the COR shall stand withdrawn automatically. 7. Computation of Net Owned Fund (a) The aggregate of the paid-up equity capital and free reserves as disclosed in the latest balance sheet of the Company after deducting therefrom i . Accumulated balances of loss ii. Deferred revenue expenditure iii. Other intangible assets and (b) further reduced by the amounts representing (1) Investment of such company in shares of i. Its subsidiaries ii. Companies in same group iii. All other Non-Banking Financial Companies and (2) The book value of debentures, bonds, outstanding loans and advances (including hire purchase and lease finance) made to, and deposit with i. Subsidiaries of such company and ii. Companies in same group To the extent such amount exceeds ten percent of (a) above 8. Principal Business Criteria Press Release 99/1269 dated April 8, 1999 A company is treated as NBFC if its financial assets are more than 50% of its total assets ( net of intangible assets) and income from these financial assets is more than 50% of the gross income. Note :- RBI/2011-12/446 DNBS (PD) CC.No.259/.03.02.59/2011-12 Investments in fixed deposits can not be treated as financial assets and receipt of Interest Income from fixed deposits with bank can not be treated as Income from financial assets. 9. Exemption From The Provisions Of RBI Act, 1934 RBI/2013-14/38 DNBS.PD.CC.No.336/03.02.004/2013-1 Exemption has been provided to following :- i. Housing Finance Institutions ii. Merchant Banking Company iii. Micro Finance Companies iv. Mutual Benefit Companies v. Government Companies vi. Venture Capital Fund Companies vii. Insurance/Stock Exchange/Stock Broker/Sub-Broker viii.Others - Nidhi Companies, Chit Companies, Securitisation & Reconstruction Companies, Mortgage Guarantee Companies & Core Investment Companies 10. Exemption To Venture Capital Fund Provided VCF holding certificate of Registration of SEBI and not holding or accepting public deposit. 11. Exemption To Micro Finance Companies Provided they are engaged in micro finance activities, providing credit not exceeding Rs. 50,000 for a business enterprise and Rs. 1,25,000 for meeting the cost of a dwelling unit to any poor person for enabling him to raise his level of Income and standard of living and Licensed under section 25 of the Companies Act, 1956 And Not accepting public deposits 12. Exemption To Merchant Bankers Provided it is registered with SEBI and carrying on the business of merchant banker in accordance with SEBI Merchant Banking (Rules), 1992. Acquires securities only as a part of its merchant banking business Doesnt carry on any other financial activity referred to in section 45I(c) of RBI Act, 1934 Doesnt accept or hold Public deposits 13. Reserve Fund Section 45-IC Every non-banking financial company shall create a reserve fund and transfer therein a sum not less than twenty percent of its net profit every year as disclosed in the profit & loss account & before any dividend is declared. No appropriation of any sum from Reserve fund shall be made except for the purpose as may be specified and every such appropriation shall be reported within 21 days from the date of such withdrawal which for sufficient cause may be extended by Bank. 14. Registration of NBFC Application for a Certificate of Registration should be submitted to The General Manager/Deputy General Manager/ Department of Non-Banking Supervision, Reserve Bank of India, Regional Office. Documents required to be enclosed to the application form- 1. Identification Particulars 2. Statement on prudential norms 3. Information about the management 4. Certified copies of Certificate of Incorporation and Certificate of Commencement of Business. 5. A Board Resolution specifically approving the submission of the application and its contents. 6. A copy each of the Profit & Loss Account & Audited Balance Sheet for the last 3 years or for such shorter period as are available ( for Companies already in existence) 7. Certified copies of up-to-date Memorandum and Articles of Association of the Company. 8. Business plan of the Company for the next three years giving details of its (a) thrust of business; (b) market segment; and (c) projection of investments and income. 9. A company which is incorporated before January 9, 1997 and has net owned fund of less than 25 lakhs as on the date of application, may also furnish a time- bound program as how it proposes to attain the minimum net owned fund of Rs. 25 lakhs 15. Cancellation of Certificate of Registration & Appeal against thereof The Reserve Bank is empowered to cancel the certificate of registration issued to any NBFC for failure on the part of NBFC to fulfil conditions as laid down under section 45-IA of the RBI Act, 1934. A company, aggrieved by the Reserve Banks order of rejection of application or cancellation of certificate of registration may prefer an appeal to Central Government within a period of 30 days. 16. REGULATORY FRAMEWORK OF NBFC 17. Classification of NBFC Based on Nature of Business Based on Deposits RBI2013-14/46DNBS(PD)CC No./344.03.02.001/2013-14 Asset Finance Company Investment Company Loan Company Infrastructure Company Core Investment Companies-ND-SI Deposit Taking NBFC (NBFC-D) Non-Deposit Taking NBFC ( NBFC-ND) NBFC-ND having asset size 100 Cr. Or more as per latest audited Balance Sheet of the Company will be classified as systemically important non- deposit taking NBFC, in short NBFC-ND. 18. Applicability of Rules, Regulations & Directions NBFC-D NBFC-ND Non-Banking Financial Companies Acceptance of Public Deposits ( Reserve Bank) Directions, 1998 Non- Banking Financial ( Deposit Accepting or Holding) Companies Prudential Norms ( Reserve Bank) Directions, 2007 Non- Banking Financial Companies Auditors Report ( Reserve Bank) Directions, 2008 Reserve Bank of India ( Non- Banking Financial Companies) Returns Specifications, 1997 Non- Banking Financial Companies ( Deposit Accepting) ( Approval of Acquisition or Transfer of Control) Directions, 2009 Miscellaneous Non- Banking Companies ( Reserve Bank) Directions, 1977 Non- Banking Financial ( Non- Deposit Accepting or Holding) Companies Prudential Norms ((Reserve Bank) Directions 2007 Non- Banking Financial Companies Auditors Report (Reserve Bank) Directions, 2008 19. Returns to be filed by NBFC RBI/2013-14/37 DNBS.PD.CC.No.335/03.10.042/2013-14 By Deposit Taking NBFC By Non- Deposit Taking NBFC NBS-1 Quarterly Returns On Deposits NBS-2 Quarterly Return on Prudential Norms NBS-3 Quarterly Return on Liquid Assets NBS-4 Annual Return of critical parameters by rejected company holding deposits NBS-6 Monthly Return on Exposure to Capital Market by NBFC-D having Asset Size 100 Cr. Or more Audited Balance Sheet and Auditors Report For NBFC-ND-SI NBS-7 Quarterly Statement of Capital Funds, Risk Weighted ASSETS, Risk Asset Ratio etc. Monthly Return on Important Parameters ALM Returns : i. ALM-1 Statement of short term dynamic liquidity-Monthly ii. ALM-2 Statement of structural liquidity-Half-yearly iii. ALM-3 Statement of Interest Rate Sensitivity-Half-YEARLY iv. ALM-Yearly 20. Continued. By Deposit Taking NBFC By Non- Deposit Taking NBFC Continued.. Annual Certificate from auditors. NBFC With FDI - half yearly (ending March & September) Certificate from Auditors. With Regard to Overseas Investment- Quarterly Return For NBFC ( more than 50 Cr. But less than 100 Cr.) Quarterly Return on basic information Branch office Return 21. Applicability of Certain Directions, Regulations, Notifications on NBFC-ND-SI NBF ( Non- Deposit Accepting or Holding) Companies Prudential Norms ( Reserve Bank) Directions, 2007 Para-8 Asset Classification Standard Assets Sub-Standard Assets Doubtful Assets Loss Assets Para-9A Provision for Standard Assets . 25% of the outstanding shall be shown seperately as contingent provision against standard assets. Para-10 Disclosure in Balance Sheet For every NBFC- provisions made as per Para 9 & 9A For NBFC-ND-SI 1. CRAR 2. Exposure to Real estate Sector 3. Maturity Pattern of Asset & Liability 22. Continued Para 11- Constitution of Audit Committee By the NBFC having Assets of 50 cr. or more as per latest audited balance sheet of the company. consisting of not less than three members of Board of Directors. Note:-Audit Committee constituted under section 292A of companies Act, 1956 shall be the Audit Committee for this purpose with the samre powers, functions & duties as laid down under section 292A of Companies Act, 1956. Para 12- Accounting Year Preparation of Balance Sheet & Profit & loss account as on March 31 every year. For extension prior approval of RBI is necessary before approaching Registrar of Companies. Finalization of Balance Sheet within 3 month from the date to which it pertains. 23. Continued Para 13 Schedule to the Balance Sheet Particulars have been given in the Annex. Para 15 Submission of Certificate from Auditors Within one month from the finalization of Balance sheet and in any case not later than December 30th of that year. Such Certificate shall also indicate the Asset Income pattern of the Company Para 16 Requirement as to Capital Adequacy A minimum Capital Adequacy Ratio consisting of Tier I ( NOF) & Tier II Capital Not less than 15% of its aggregate Risk Weighted Assets on Balance Sheet and of Risk Adjusted Value of off-balance sheet items. Para 18 Concentration of Credit Lend to single borrower & single group of borrowers not exceeding 15% & 25% respectively of its owned fund. Invest in the shares of another company or single group of companies not exceeding 15% & 25% respectively of its owned fund. Lend & Invest both not exceeding 25% or 40% of its owned fund to a single party or to a single group of parties. Subject to certain provisions as provided in the directions. 24. Continued Para 19 Information with regard to change Information not later than one months from the occurrence of any change in: (a) The Complete postal address, telephone number/s & fax number/s of the Registered/corporate office; (b) The Names & residential addresses of the directors of the company; (c) The Names & official designation of its Principal officers; (d) The names & office address of the auditors of the company; (e) The specimen signatures of the officers authorized to sign on behalf of the company Para 20A NBFC Not To Be Partners In Partnership Firms RBI/2012-13/526 DNBS.PD/CC.No.328/03.02.002/2012-13 Partnership Firms include LLPs & AOP. Which had already contributed to the Capital of a LLPs /AOP are adviced to seek early retirement. 25. Continued RBI2013-14/42 DNBS(PD)CC No./340.03.02.042/2013-14 FPC-Fair Practice Code The Board of Directors of NBFC should lay down the appropriate grievance redressal mechanism within the organization to resolve disputes. All NBFC have to display the the following information at their branches/ places where business is transacted: 1. The name and contact details of grievance redressal officer 2. If complaint/dispute is not redressed within a period of one month, appeal may be preferred to the office-in-charge of Regional office of DNBS of RBI. 3. FPC be put in place by all NBFC with the approval of Boards within one months from the date of issue of circular. 4. NBFC will have the freedom of drafting the FPC, But in no way sacrificing the spirit underlying the above guidelines. 5. The same shall be put on their web-site, if any. 26. Accounting for Taxes on Income-AS 22 RBI/2012-13/33 DNBS (PD). CC.No.290/03.02.001/2012-13 As creation of DTA ( Deferred Tax Asset) would give rise to certain issues impacting the balance sheet of the Company, It is clarified that the Regulatory treatment to be given is as under :- DTA will be treated as an intangible asset and should be deducted from Tier I capital. 27. Core Investment Company RBI /2012-13/30 DNBS (PD) CC No. 291 / 03.02.001/ 2012-13 July 2, 2012 The Bank had announced in the Annual Policy 2010- 2011 that companies which have their assets predominantly as investments in shares for holding stake in group companies but not for trading, and also do not carry on any other financial activity, i.e., Core Investment Companies, (CICs), justifiably deserve a differential treatment in the regulatory prescription applicable to Non-Banking Financial Companies which are non deposit taking and systemically important to this extent . 28. What is CIC ??? A non-banking financial company carrying on the business of acquisition of shares and securities and which satisfies the following conditions as on the date of last audited balance sheet :- i. It holds not less than 90% of its assets in the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in group companies; ii. Its investments in equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue) in group companies constitutes not less than 60% of its net assets as mentioned in clause ( i) above; iii. It doesnt trade in its investments in shares, bonds, debentures, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment; iv. It doesnt carry on any other financial activity referred to in section 45-I(c ) & 45-I(f) of Reserve Bank of India Act, 1934 except 29. Continued (a) Investment in i. Bank deposits ii. Money market instrument, including money market mutual funds iii. Government securities, & iv. Bonds or debentures issued by group companies and v. Issuing guarantee on behalf of group companies. 30. When CIC to be considered not carrying on the business of acquisition of shares and securities??? Core Investment Companies (CICs) were not considered as carrying on the business of acquisition of shares and securities in the following circumstances, namely, (I ) not less than 90% of their assets were in investments in shares for the purpose of holding stake in the investee companies; (ii) they were not trading in these shares except for block sale (to dilute or divest holding); (iii) they were not carrying on any other financial activities; and (iv) they were not holding / accepting public deposits. As such, companies fulfilling the above criteria were not required to obtain Certificate of Registration (COR) from RBI under Section 45 IA of the RBI Act 1934. it is very difficult to determine whether a company has invested in the shares of another company for the purpose of holding stake or for the purpose of trade. It was therefore decided that investing in shares of other companies, even for the purpose of holding stake should also be regarded as carrying on the business of acquisition of shares in terms of Section 45I(c) (ii) of RBI Act. 31. Companies in the Group Para 3(1)(b) of N/No. DNBS.(PD)219/CGM(US)-2011 dated Jan. 5, 2011 Companies in the group means an arrangement involving two or more entities related to each other through any of the following relationship, viz., Subsidiary-parent (defined in terms of AS 21), Joint Venture ( defined in terms of AS 27), Associate ( defined in terms of AS 23), Promoters Promotee (as provided in the SEBI ( Acquisition of shares & takeover) Regulations 1997) for listed companies, a related party ( defined in terms of AS 18)Common brand name and investment in equity shares of 20% & above 32. Revival of 1999 circular with additional requirement Recently in a circular is issued in 2006, the Press Release was in a way revived from its ashes by the RBI, and a new credential was given to it in the form of requirement of an annual certificate to be given by the auditor of the NBFC in support of commencement/continuance of business of NBFI and fulfilling the criteria of principal business. The Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 2007 (both deposit taking and non-deposit taking), also reiterated the requirement of obtaining auditors certificate with the addition that such certificate shall also indicate the asset/income pattern of the NBFC for making it eligible for classification as Asset Finance Company, Investment Company or Loan Company. 33. Continued. Such a certificate from the auditors was required to be submitted with reference to the position of the company as at the end of the financial year ended March 31 and to be submitted latest by June 30 every year. 34. Intention of RBI behind Auditors certification The Reserve Bank of India in the circulars issued by it in this regard from time to time has also clarified the intent of obtaining such annual certificate. It is a usual practice that the RBI grants Certificate of Registration (CoR) to new companies on the basis of their intention to engage in the business of NBFI, however, such an intention may not have materialized and the said company may not engage in NBFI activity even though it holds CoR from the RBI. In the case of an existing company which holds CoR to carry on NBFI business, its business profile may have undergone a change over a period of time and the criteria of principal business may not be fulfilled anymore. 35. Continued Hence, it is possible, that there would be companies holding the COR to commence/carry on the business of NBFI without actually undertaking NBFI activity. These companies continue to hold the COR even though they are not required to hold the COR granted by RBI. Thus, to ensure that only NBFCs which are actually carrying out financial business as its principal business holds COR, the requirement of annual certification from the auditors have been brought in. 36. Are Assets Income determining factors??? There can be a case where a company runs several businesses, and the income/asset attributable to none of the business is over 50% - say, a company has business X, 30%, business Y, 30% and business Z 40%. Z is a financial business. As per RBI circular, this company does not have principal financial business. Does that mean the company does not have any principal business at all? 37. Continued It is quite natural that the income of a company cannot be stable year after year. Income may fluctuate and, the income in a particular year may fall below 50%. Strictly by the circular, a temporal decline in the income below the required threshold disqualifies an NBFC from carrying on business as such. What implications will be ? Deregistration/disqualification have? Will the company stop what it was doing? Will the company be required to surrender its COR? 38. Continued the next year the income level of the company rises above 50%. Does that mean the company should apply for registration all over again? This sounds patently unreasonable. Conclusion there is no ambiguity in the fact that it is the primary activity carried on by the company which gives it a character and although the figures reported in the balance sheet reflects the business activity of the company, but the same cannot be the sole criteria to determine the character of a company. Judicially also, the Courts have put weight age on the primary activity carried on by the company rather than its assets and income to determine its true character. 39. Some Judicial Pronouncements In Assistant Registrar of Companies v. H.C. Kothari and Others (decided on 10.10.1991) the Madras High Court in a case concerning section 372 of the Companies Act, 1956 (since repealed) held that an investment company is, therefore, a company whose principal business is the acquisition of shares, debentures or other securities. It is clear that the income derived from the business is not the criteria. The test would rather be, as to what the principal business of the company is. A balance sheet should show what the principal business of the company is. 40. Another Case.. In D.C. Kothari and Another v. Assistant Registrar of Companies (decided on 24.04.1992) , the Madras High Court observed that the term Principal business though not defined under the Act, as commonly understood, it would mean the prime business carried on by the company at the relevant point of time and the major source of income, etc. 41. Continued The Income Tax Appellate Tribunal (Ahmedabad) in Barkha Investments And Trading Co. Pvt. Ltd. v. Income-Tax Officer (decided on 07.10.1997) wherein the Supreme Court said that, in the expression, wholly or mainly in the dealing in or holding of investments, the word mainly in that clause must necessarily take its colour from the word wholly preceding that word in those provisions. In other words, the company which comes within the scope of those provisions must be one whose primary business must be in the dealing in or holding of investments. If a company engages itself in two or more equally or nearly equal important business activities, then it cannot be said that the companys business consists wholly or mainly in the dealing in a particular thing. Further, even in a case where a company has more than one business activity and one of its activities is more substantial than the others, unless that activity is the primary activity of the company, it cannot be said that that company is engaged in wholly or mainly in any one of its business activities. 42. International Perspective California Code of Regulations, Title 18, reg 23183 sub-section (a) defines a financial corporation as a corporation which predominately deals in money or moneyed capital in substantial competition with the business of national banks. In Australian Revenue Ruling No. SD 246, it was observed that in determining a persons principal business, consideration will be given to a number of factors including the number of transactions, the amount of staff time spent, and the turnover in relation to each business activity to determine what proportion each bears to the total business. In general, consideration will not be given to figures contained in a companys balance sheet or profit and loss account where such activities are reported on a net basis. Principal does not necessarily mean more than 50%. If a company conducts various businesses, the largest of which is, say, 30% of its total business activities, that 30% activity is its principal business. 43. Conclusion.. It is thus clear that the criteria laid down by the RBI to determine the principal business based on asset-income has been applied in a manner which could not have been the intention. The Circular has specified such classification as guidance to the companies which are not required to hold COR due to non-continuation of financial business as a principal business. It cannot be used as a weapon to de- register/ disqualify companies from holding their COR based on a particular years financial statement. The circular, in any case, is only a guidance issued by the RBI and cannot have the force of law. It must be interpreted in a manner to uphold substance over form and not to create hindrances in the business activity of the company on the basis of their yearly results. 44. RBI/2013-14/36 DNBS (PD) CCNo.334/03.02.001/2013-14 In addition to the Report made by the Auditor under section 227 of the Companies Act, 1956, the Auditor shall make a separate report to the Board of Directors of the Company. Matters which are be included in the Report have been specified in NBFC Auditors Report ( Reserve Bank) Directions, 2008. In Case of NBFC- ND:- i. Whether the Board has passed a resolution for non- acceptance of Public Deposits; ii. Whether the company has accepted the Public Deposits during the relevant period/year; iii. Whether company has complied with the prudential norms relating to income recognition, accounting standards, asset classification and provision for bad debt as applicable to it in terms of Non- banking financial ( Non- Deposit Accepting or Holding) Companies Prudential norms ( Reserve Bank) Directions, 2007. 45. Reporting Requirement of Auditors Where in the Auditors Report, the statement if unfavourable or qualified, the Auditors Report shall also state the reason for the same. Exception Report :- An Exception Report shall be given where in the opinion of Auditor, the company has not complied with : the provision of chapter III B of RBI Act, 1934; or The NBFC Acceptance of Public Deposits ( Reserve Bank) Directions, 1998; or NBF( Deposit Accepting or Holding) Companies Prudential Norms ( Reserve Bank) Directions, 2007; or NBF ( Non- Deposit Accepting or Holding) Companies Prudential Norms ( Reserve Bank) Directions, 2007; containing details about non compliance in respect of the Company to the Regional office of Department of Non- Banking Supervision. 46. RBI/2013-14/44 DNBS (PD) CC.No.342/03.10.001/2013-14 In order to enable NBFC to adopt best practices and greater transparency in their operations following guidelines are proposed for all Deposit Taking NBFC with deposit sixe of Rs.20 Cr. or more and all non- deposit taking NBFC with asset size of Rs.100 Cr. & above. 47. Continued. Constitution of Audit Committee : Same as prescribed in Directions 2007 as per Para-11. Constitution of Nomination Committee : NBFC-D with deposit size of Rs. 20 Cr. or above & NBFC-ND-SI may form a Nomination Committee to ensure Fit & Proper status of proposed/existing Directors. Constitution of Risk Management Committee : The market risk for NBFC with deposit size of Rs.20 Cr. or above & NBFC-ND-SI as on the date of latest audited balance sheet is addressed by Asset Liability Management Committee ( ALCO) constituted to monitor the asset liability gap to mitigate the risk associated. 48. Continued Disclosure and Transparency The following information should be put up by the NBFC TO THE Board of Directors at regular intervals as may be prescribed by the Board in this regard : Progress made in putting in place a progressive risk management system, risk management policy & strategy followed, conformity with corporate governance standards viz. composition of various committees, their roles & functions, Periodicity of meetings etc.