How to Raise Fund in NBFC? Is FDI a Good Option?

Ashish M. Shaji

14 Dec, 2020

Government allows 100% FDI in ‘other financial services by NBFC. This is great opportunity for Indian fin-tech startups to raise debt/equity funding from overseas investor. The process to raise fund in NBFC has been simplified vastly. In this article we have described about How to Raise Fund in NBFC? We will also find out if FDI is a good option.

Post demonetization the demand of loan has increased rapidly and with the robot fast and automated loan processing system, NBFCs are using technology and are able to grow their books value consistently. 

Indian banks are struggling due to traditional lending method and also RBI regulation is high as compared to NBFC.

In 2017, NBFCs improved their performance as per the RBI’s financial stability report. It says NBFC loans book grew up by 16.6% in the year 16-17 which is 200% as fast as the 8.8% credit growth across the Indian banking sector. Most of the NBFCs are able to generate highest IRR 25% to 32% p.a.  Short term SME & Personal lending seems to be useful for fin-tech start-ups.

What are NBFCs?

A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans and advances, acquisition of shares, stock, bonds hire-purchase, insurance business.

But does not include any institution whose principal business objective is agriculture or agriculture allied activity, ordinary business activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.

India witnessed a significant interest of foreign investors in the Indian NBFC sector post liberalization of economy.

Raising fund in NBFC: Law Governing the Foreign Investments in NBFCs

All the provisions regarding foreign exchange are regulated by the FEMA, 2000 and the working and operations of NBFCs are regulated by the Reserve Bank of India (RBI^[1]) within the framework of the RBI Regulation Act 1934 and the directions issued by it. FDI in NBFCs has been allowed up to 100% subject to the minimum capitalization norms as issued by the Government.

2017 RBI FDI Policy for NBFC

As per the FDI policy, foreign investment in NBFC sector is permitted under the automatic route. An automatic route is one where no Foreign Investment Promotion Board (FIPB) or RBI approval is needed before making the proposed investment. In automatic route up to 100%, foreign investment is permitted without the approval of FIPB.

In accordance with the regulations framed under FEMA, all foreign transactions are required to be routed only through entities licensed by the RBI. These regulations guide the fund in NBFC process.

Foreign investment was allowed under automatic route only in the below mentioned non-banking financial service activities which are as follows:

• Merchant Banking
• Underwriting
• Portfolio Management Services
• Stock Broking
• Asset Management
• Venture Capital
• Custodial Services
• Factoring
• Leasing & Finance
• Housing Finance
• Credit Card Business
• Micro Credit
• Rural Credit
• Non-fund based activities
• Investment Advisory Services
• Financial Consultancy
• Forex Broking
• Credit Rating Agencies
• Money Changing Business

FDI Fund in NBFC are allowed through automatic route subject to compliance with the minimum capitalization norms and on the establishment of NBFCs, with the requisite capital under the FEMA Regulation, subsequent assortment either through Parent NBFC or through associate NBFCs could be undertaken without any further authorization. NBFCs, however, have to comply with the RBI Guidelines issued from time to time.

These investments were subject to the following minimum capitalization norms:

1. The US $0.5 million for foreign capital up to 51% to be brought up front.
2. The US  $5 million for foreign capital more than 51% and up to 75% to be brought up front.
3. 50 million foreign capital more than 75% out of which $7.5 million to be brought up front and the balance in 24 months.
4. The NBFC’s having foreign investment more than 75% and up to 100%, and with a minimum capitalization of $50 million, can set up step down the associate company for specific Non-banking financial company activities, without any restriction on the number of operating associate company and without bringing in additional capital requirement.
5. Joint Venture which is 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.

Capitalization for Non- Fund based activities

Non-Fund activities include Investment Advisory Services, Financial Consultancy, Forex Broking, Money Changing Business and Credit Rating Agencies.

The US $0.5 million to be brought upfront for all permitted non-fund based NBFCs irrespective of the level of foreign investment.

Raising fund in NBFCs: Changes in the FDI Policy

The Government of India, in order to boost up the economic activities in financial sectors, has approved some changes pertaining to the FDI requirements to ensure timely fund in NBFC.

The Reserve Bank of India on 9^th September 2016 released a notification amending the Foreign Exchange Management (Transfer and Issue of Securities to Persons Resident Outside India) Regulations, 2000, as a measure to make the foreign investments in the ‘non-banking financial services’ sector easier. This Notification operationalizes the policy which was announced on 10^th August 2016.

The two key relaxations which have been introduced by this Notification are:

• 100% FDI through the automatic route is now permitted in “Other Financial Services” as well, provided such services are regulated by any financial sector regulators.
• Any form of additional capitalization norms linked to foreign ownership under FDI policy has been eliminated as most of the regulators have already fixed minimum capitalization norms and which are not regulated by any financial sector regulators i.e. unregulated NBFCs will require prior government approval.

Conclusion

These changes of doing away with the minimum capitalization norms is a boon since it will spur economic growth by increasing FDI in the NBFC sector. Increasing FDI will be beneficial for the business due to the relatively easier and faster sanction of loans with favorable interest rates. This is certainly a welcome move and is expected to provide a much-needed boost to this sector in terms of raising fund in NBFC.

Read our article: How are NBFCs different from Banks (NBFC Registration)?