NBFC

RBI Imposes Constraints on Overseas Business of NBFCs

Recently, NBFCs have experienced multiple instances of controversial news, and this is just another one. Restrictions have been placed by the RBI on overseas business of NBFCs. The new regulations restrict overseas investment to a quarter of the previous allowance, unlike the previous regime that did not differentiate between NBFCs and NBNFCs (expanded as non-banking non-financial companies).

Moreover, NBFCs cannot receive automatic approval for investment, as they must secure a no-objection certificate from the RBI before investing in foreign countries. The aforementioned change occurred through the issuance of the NBFC (Opening of branch/subsidiary/joint venture/representative office or undertaking investment Abroad by NBFCs) Directions, 2011(Directions) on 14 June 2011.

Hence, NBFCs (including those that take deposits and those that do not) must obtain RBI’s NOC before setting up any branch, subsidiary, Joint Venture, or Representative Office overseas. The instructions specify requirements for investment, both specific and general.

Brief About Overseas Business of NBFCs

The general Master Circular on Direct Investment by Residents in Joint Venture (JV)/ Wholly Owned Subsidiary (WOS) abroad includes Overseas direct investment (ODI). Before the specific directions outlined in the Directions above, there were no distinct guidelines that applied to NBFCs.

Therefore, NBFCs were included under the Master Circular just like NBNCs. The Directions are not new, they are a formalization of RBI’s draft Guidelines for extending NOC for opening branches/subsidiaries/joint ventures/representative offices or making any investment overseas, which was released in 2008.

The guidelines are prescribed for both general and specific provisions as well pertaining to overseas business of NBFCs. In previous years, NOC was given on a case-by-case basis following the draft guidelines. While not new, the current Directions issued are significantly more detailed and comprehensive.

Therefore, it clearly outlines the regulatory prerequisites for acquiring the NOC and investing in the project. The instructions are in addition to the ones specified by the Foreign Exchange Department (FED). The Master Circular contains the general conditions of the FED.

What are the General Conditions Mentioned Under RBI Direction?

The Direction, as mentioned above, has laid down some of the general conditions for opening a branch or any subsidiary or joint venture or representative office or to make any investment abroad.

Below, it has been discussed properly such as:

• No investment is permitted in non-financial sectors
• No direct investment is allowed in activities prohibited by FEMA or in sectoral funds Investment is allowed only in entities having their core activities regulated by a financial sector regulator in the host jurisdiction or country. 
• Aggregate overseas investment not to exceed 100% of their NOF, i.e. Aggregate investment of more than 100% of NOF. 
• Investment in a single entity, including step-down subsidiaries more than 15% of NBFC’s owned fund. The same to done by way of equity or fund-based commitment.
• Any Special Purpose Vehicle established or foreign acquisition is considered an investment/subsidiary/joint venture based on the percentage of investment in the overseas entity.
• Annual certification by the auditors and submission to the DNBS Regional Office is required to comply with the Direction.
• Quarterly profits must also be sent in the specified layout to both the Regional Office of the DNBS and the Department of Statistics and Information Management. This return includes multiple disclosures related to CRAR, NOF, remittance amounts, cumulative investment, financial information, and more.
• Level of Non-Performing Assets more than 5% of net advances
• There should be profit incurred by NBFC in the last three years along with satisfactory performance.
• NBFC to also comply with regulations of FEMA 1999.
• Compliance with the KYC norms.

What are the Specific Conditions Mentioned Under RBI Direction?

The RBI Direction outlines specific conditions for opening branches overseas. However, current branches can still operate if they adhere to the specified conditions in the Directions.

Some of the crucial specific terms are:

• If a parent NBFC decides to establish a subsidiary or joint venture in another country, it is not allowed to provide any kind of implicit or explicit guarantees to or for the subsidiary or joint venture.
• The NBFC’s liability in the planned foreign entity will be limited to its equity or fund-based investment. The information will be revealed in the balance sheet of the subsidiary or joint venture.
• The affiliate or partnership should not just exist in name only. However, activities like financial advisory services with minimal assets are considered an exemption.
• The subsidiary or joint venture should not be utilized to generate funds for developing assets in India.
• The parent NBFC must receive regular reports or audit reports on the business activities carried out by the subsidiary, which must be provided to RBI and its inspection officers. 

Comparing Restrictions & Permissions for Overseas Investments

A comparative analysis of the statement of the restricts and permissions in the case of the abroad investment has been discussed below for your better understanding of investment by the NBFCs & investment by the NBNC:

1. Amount of Investment Allowed for NBFC

Aggregate overseas investment should not exceed more than 100% of the NoF by NBFC, whereas up to 400% of the net worth by the NBNC.

2. Extension of Guarantees

NBFCs setting up foreign branches are not permitted to offer guarantees whereas the Indian party is allowed to extend under CG also to their first level step down their JV or WOS abroad under the automatic route by NBNFC.

3. Investment in Single Entity & Group Companies     

Investment in a single business model or entity entails the step-down not to be more than 15% of the NBFC’s funds whereas for NBNFC there is as such no prescribed limit.

4. Method of Funding

For NBFC the mode of funding can be equity and fund-based commitment whereas for NBNFC the mode of the fund can be capitalisation of exports, swap of shares, proceeds of ECB or FCCBs, in exchange for ADRs or GDRs, balance held in the EEFC account, proceeds of foreign currency raises through ADR or GDR, drawl of foreign exchange from AD bank in India.

5. Mode of Investment

There is no such route prescribed, so do the general guidelines prevail for NBFC, whereas the NBNFC has both the approval as well as automatic route as the mode of investment.

6. Requirement of CRAR

For NBFC-D has do not less than 12% (such ratio shall not be less than 15% by 31^st March 2012). For NBFC-ND-SI 15% (was 12% until 31.03.2010 & should have been 15% by 31.03.2011). NBFC-ND (other than NBFC-ND-SI) should not be less than 10%.

There is no such requirement except in the case of investment in the financial sector which has to be guided by the prudential norms of the regulatory authority concerned for NBNFC.

7. Operational Limits

NBFC has to maintain the required level of NoF after accounting for investment-Sec 45-IA, whereas for NBNFC, there is no such requirement.

8. Branch Restrictions

NBFCs cannot open a branch abroad whereas the NBNFCs investing in the foreign entity engaged in the real estate or the banking business are subject to the prior approval of RBI.

9. Level of NPAs

The level of NPAs for NBFCs cannot exceed 5% of the net advances, whereas for NBNFC, no such requirement is there.

10. Writing off Capital

For writing off capital no such provision however we are of the view that the restrictions apply to the non-financial companies will apply here too for NBFC whereas NBNFC Indian parties setting up WOS/JV may write off the capital or other receivables subject to the limit of 25% in case of listed companies under the automatic route, and 25% in case of unlisted companies under the approval route, subject to reporting to RBI for NBNFC.

11. Disinvestment

There is no such mode prescribed. However, we believe that the procedure applicable to the NBFC is appropriate whereas for NBNFC the modes of disinvestment are transfer, write off and hedging.  

Conclusion

The RBI’s new constraints on NBFCs’ overseas activities aim to enhance financial stability through stricter regulation. This forces NBFCs to reassess their international growth strategies and strengthen risk management. While challenging, these measures encourage NBFCs to focus on solidifying domestic operations and finding sustainable paths for future expansion.

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