Constitution of Committees of the Board by NBFC

Swetha Dhinesh

07 Jun, 2023

Compared to other organisations, the corporate governance of Non-Banking Financial Companies is distinct and special. It is a result of the NBFC’s actions being less transparent. As a result, it becomes challenging for shareholders and creditors to keep tabs on the operations of the NBFCs. The complexity and breadth of their business risks and the repercussions of improper risk management set these financial institutions apart from most of these organisations.

The changes occurring throughout the world have undoubtedly had an impact on the NBFC industry in India. It is critical to raise the standard of corporate governance for Indian NBFCs. The RBI sets prudential standards and principles. The constitution of committees of the Board by NBFC is discussed below.

Non-Banking Financial Companies

A Non-Banking Financial Corporation (NBFC) is an organisation that is registered under the Companies Act, 1956 and the Companies Act, 2013 and that engages in the lending, hire-purchase, leasing, insurance, and, in some situations, the receipt of deposits, as well as the acquisition of stocks, shares, and chit funds, among other activities. The Reserve Bank of India and the Ministry of Corporate Affairs jointly oversee the NBFCs’ operations.

Constitution of Committees of the Board

There are three committees according to the Reserve Bank of India’s directions:

1. Audit Committee
2. Nomination Committee
3. Risk Management Committee

Constitution of Audit Committee

Each applicable NBFC must establish an audit committee, and it must include at least three members of the Board of directors.

1. The Audit Committee is the committee that a non-banking financial company established in accordance with Section 177 of the Companies Act, 2013.
2. The Audit Committee established in accordance with this direction shall have the same authority, responsibility, and obligations as described in Section 177 of the Companies Act of 2013.
3. To evaluate the operational risks that the NBFCs face, the Audit Committee must ensure that an information system audit of the company’s internal systems and processes is carried out at least once every two years.

The obligation and responsibilities of the audit committee

Under Section 177 of the Companies Act, it has laid down certain obligations and responsibilities of the Audit Committee, which are discussed below:

1. The majority of the Audit Committee’s members, including its chairperson, should be capable of reading and understanding the financial statements.
2. Each Audit Committee must operate under the written guidelines established by the Board, which should, among other things, include the following.
   1. The recommendation for the appointment, remunerations, and terms of the company’s auditors. 
   2. The review and monitoring of the auditor’s independence and performance, as well as the efficiency of the audit process.
   3. The examination of the financial statement and the auditors’ report thereon; and
   4. The approval or any later modification of the company’s transactions with related parties.
3. Before submitting the financial statements to the Board, the Audit Committee may request the auditors’ comments on internal control systems, the audit’s scope, including the auditors’ observations, and a review of the financial statements. The committee may also discuss any pertinent issues with the company’s management, statutory and internal auditors, and the auditors.
4. The Audit Committee shall have the power to inquire into any matter relating to the matters listed in written guidelines established by the Board. For this purpose, the Audit Committee shall have the power to seek professional advice from outside sources and shall have full access to information found in the company’s records.
5. In meetings of the Audit Committee, when it reviews the auditor’s report, the company’s auditors and key managerial staff shall have a right to be heard but shall not have a vote.
6. Each listed business, or class of listed firms, must set up a vigil mechanism for directors and staff to report legitimate concerns in accordance with any applicable regulations.
7. The vigil mechanism described above shall contain provisions for suitable safeguards against the victimisation of persons who utilise such mechanism and for direct access to the Audit Committee chairperson in appropriate or exceptional cases:

The company should disclose the specifics of the establishment of such a mechanism on its website if one exists, and in the board report.

Nomination Committee 

To verify the “fit and proper” status of proposed/existing directors, all applicable NBFCs shall establish a Nomination Committee. Section 178 of the Companies Act of 2013’s Companies Act shall apply to the Nomination Committee established pursuant to this direction from RBI.

• The financial sector knows how crucial it is to pick directors with the necessary qualifications. According to Section 45-IA(4)(c) of the RBI Act, 1934¹, it is necessary to make sure that the general nature of the management or the proposed management of the NBFC shall not be prejudicial to the interest of its present and future depositors when evaluating the application for Certificate of Registration to conduct the business of the non-banking financial institution. To ensure the “fit and proper” criteria of proposed or current directors, the Reserve Bank of India has advised all NBFCs-ND-SI to establish a Nomination Committee.
• In light of this, every NBFC should establish a Nomination Committee. The Board will provide guidance to the nomination committee as it operates. The company is required to form the Nomination and Remuneration Committee with a minimum of 3 Non-Executive Directors, with half of the members being Independent Directors (ID), in accordance with Section 178 of the Companies Act, 2013². It will be called when needed, with a quorum of one-third of the members, and consensus will cast votes. 
• The nominating committee has to comply with the policy periodically set by the RBI for determining the fit and proper standards at the time of appointment of Directors and on an ongoing basis. 
• The Board may also request the nomination committee to investigate any other pertinent behaviour. The Board must provide its approval before any changes to the Nomination Committee’s current members. 

Constitution of Risk Management Committee

All applicable NBFCs must establish a risk management committee and an asset liability management committee to manage integrated risk.

The Asset Liability Management Committee (ALCO), which was established to keep track of the asset-liability gap and plan strategies for risk mitigation, is necessary to address the market risk for NBFCs. The Board shall establish the Risk Management Committee in addition to the ALCO to manage the integrated risk. Additionally, in accordance with RBI Master Direction – Information Technology Framework for the NBFC Sector, the company shall appoint a Chief Risk Officer (CRO). 

Fit and Proper Criteria

• All applicable NBFCs must see to it that a policy is established with the Board of Directors’ approval for determining the qualifications of the directors both at the time of appointment and on an ongoing basis. The policy of the Fit and proper criteria shall be according to the guidelines prescribed in Annexure 1.
• Obtain an undertaking and declaration from the directors providing additional information on the directors. The declaration and undertaking must follow the guidelines in Annex 2, which is given in the master direction “NBFC Corporate Governance (Reserve Bank) Direction.
• Obtain a Deed of Covenant signed by the directors, which must follow the format in Annex 3. 
• Submitting the quarterly statement on director changes and a certificate from the NBFC’s managing director attesting to the use of fit and proper criteria in director selection to the Reserve Bank. 
• Within fifteen days of the end of the relevant quarter, the statement must be received by the Reserve Bank’s regional office. The auditors should certify the NBFCs’ statement for the three months.
• Given that the Bank reserves the authority, if it deems it necessary and in the public interest, to assess the directors of any non-banking financial organisation regardless of the asset size of such non-banking financial company.

Conclusion

Corporate governance, which is applicable to all corporate sectors, is essential to safeguarding stakeholders’ interests. The Reserve Bank of India periodically proposes various corporate governance principles for NBFCs’ consideration in order to help NBFCs adopt best practices and increase transparency in their operations. The constitution of the committee of the Board NBFC is one of the regulatory moves from the side of the Reserve Bank of India.

Read our Article:Closure of branch by non-banking financial company (NBFC)

1. https://en.wikipedia.org/wiki/Reserve_Bank_of_India_Act,_1934
2. https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf