NBFC

Requirement of maintenance of liquid assets by NBFC -D

One of the major driving forces for the development of the Indian economy is NBFC. Due to its customer-focused business practices, this industry has experienced enormous development over the past several years. Their operating procedure has an odd resemblance to that of conventional banks. As per the direction from the Reserve Bank of India, the requirement of maintenance of liquid assets by NBFC-D has to be followed by NBFCs, which is discussed in detail in this blog.

Non-Banking Financial Company

A non-banking financial company (NBFC) is a business registered under the Companies Act, 1956 (now the Companies Act, 2013) that engages in the business of advances and loans, acquisition of stocks/shares/debentures/bonds/securities issued by our Government or local authority or other marketable securities of a like hire-purchase, nature, leasing, insurance, and chit business. However, it excludes institutions whose primary business is that of agriculture activity, industrial activity, or other similar activities.

A non-banking financial company (Residuary non-banking company) is an organisation whose primary activity is the receipt of deposits under any scheme or arrangement, whether in a single payment, over time through contributions, or in any other way. 

Requirement of Maintenance of Liquid Assets

Every NBFC-D shall make investment and continue the investment in India in unencumbered approved securities valued at not more than their current market value in an amount that shall, at the time of closing of business on any day it should, not be less than 15 per cent of the “public deposit” as defined in Subsequent debt in the same direction, outstanding at the close of business on the final working day of the second preceding quarter.

The above requirement shall be subject to all other provisions of Section 45-IB of the RBI Act in the same manner as if the term “public deposit” were the same as the term “deposit” as defined in the direction.

However, these Non-Banking Financial Companies shall be permitted to invest an equal amount or in excess of 10% of public deposits, in unencumbered approved securities, with the balance in unencumbered securities.

• Term deposits in any regulated Small Industries Development Bank of India (SIDBI) or the National Bank for Agriculture and Rural Development (NABARD), and the Scheduled Commercial Bank.

• Bonds issued by SIDBI or NABARD^[1], 

Furthermore, the total amount invested in unencumbered permitted securities, term deposits, and the aforementioned bonds must not be less than 15% of public deposits.

Subsequent Debt

“Subordinated debt” refers to a debt instrument that is fully paid up, unsecured, and subordinated to the claims of other creditors. It is also free of restrictive clauses and is not redeemable at the holder’s request or without the approval of the non-banking financial company’s supervisory authority. Such an instrument’s book value shall be discounted in accordance with the provisions of this:

Remaining Maturity of the Instruments	Rate of Discount
Up to first year/ one year	100 per cent
Above one year but upto two years	80 per cent
Above two years but upto three years	60 per cent
Above three years but upto four years	40 per cent
Above four years but upto five years	20 per cent

That should be within the bounds of such discounted value not exceeding 50% of Tier I capital;

Brief Note On Section 45 IB Of The RBI Act, 1934

The guidelines for the maintenance of liquid assets for Non-Banking Financial Companies are contained in Section 45 IB of the RBI Act of 1934. It already existed before the Reserve Bank of India introduced the Liquidity Coverage Ratio. 

The deposit-taking NBFC is required by the aforementioned Act to maintain a minimum level of liquid assets equal to 15% of all outstanding public deposits as of the final business day of the second preceding quarter. 

Every non-banking financial company shall invest in unencumbered approved securities in India valued at a price not more than the current market price of such securities and shall continue to do so in an amount that, at the close of business or last business on any day, shall not be less than 5 per cent or such higher percentage not exceeding 25 per cent as the Bank may, specified from occasionally and by notification in the Official Gazette.

According to section 45IB (5) (ii) of the RBI Act, 1934, “unencumbered approved securities” refers to approved securities that have not been drawn against, used, or encumbered in any way and have been deposited by a non-banking financial company with another institution for an advance or other arrangement;

NBFCs have been instructed to keep the required securities of liquid assets in a dematerialised form with the aforementioned organisations at the location of the company’s registered office. However, an NBFC may only do so after requesting RBI’s written consent if it wishes to entrust the securities at a location other than its registered office. The above-mentioned liquid assets are to be used for paying depositor claims. Depositors don’t have a direct claim on liquid assets, nevertheless, because deposits are by their very nature unsecured.

Reason for maintaining liquid assets by NBFC 

Deposit-taking Non-Banking Financial Companies keep liquid assets primarily to ensure the availability of money to meet their deposit repayment obligations. Here are a few explanations for why NBFCs must keep liquid assets:

Liquidity Management: NBFCs can efficiently manage their short-term liquidity requirements by maintaining a portion of their assets in liquid form. To make sure they have enough money to meet sudden or urgent payback demands from depositors.

Financial Stability: Requiring NBFCs to keep liquid assets helps to ensure the sector’s overall financial stability. It assists in avoiding scenarios in which NBFCs experience a liquidity crisis or go bankrupt because there are insufficient funds available. Achieving adequate liquidity management lowers the chance of financial system disruptions and supports the efficient operation of NBFCs.

Protection of Deposits: NBFCs that accept deposits from the general public have a responsibility on their balance sheet as a result. These NBFCs can protect the interests of depositors by retaining liquid assets because they will always have money on hand to honour withdrawals from deposits and meet maturity obligations.

Conclusion

The Reserve Bank of India (RBI) requires deposit-taking Non-Banking Financial Companies to maintain liquid assets as part of its prudential standards. To get and maintain their regulatory licenses and conduct safe and responsible business practices, NBFCs must adhere to specific regulations.

Read our Article: Fit and Proper Criteria for NBFCs