NBFC

Step by Step Analysis of Foreign Funding in NBFC

India has witnessed a significant interest in foreign Funding in NBFC Sector of India post 1991.Conventionally, India had a bank-dominated financial services sector. However, the importance of Non-Banking Financial Company (NBFC) has been recognized not only as a supplement to mainstream banking in meeting the increasing financial needs of the corporate sector but also for distributing credit to the unorganized sector and to small local borrowers.

What is NBFC?

RBI has defined NBFC as a financial institution whose principal business is to grant loans and advance, acquire shares/stocks/bonds/debentures/securities issued by Government or local authority, lease, hire-purchase, insurance business, chit business, receive deposits under any scheme or arrangement.

In addition to above, RBI has also listed the exclusion activities to NBFC which are agricultural activity, industrial activity, trading and purchase or sale of immovable properties.

How has NBFC Emerged Growth in India?

NBFC has played a critical role in the growth of Indian economy. NBFCs are diversifying financial needs of the economy. The Indian government understands that industrial growth is impossible in an environment where banks are unwilling to finance new businesses. Thus NBFCs helps to achieve financial needs.

Does NBFC Attract the Foreign Investors?

Indian government initiatives like Make-in-India, Start-up India, Smart Cities, Housing for all which unlocks a door for the foreign investors. Foreign funding in NBFC

Liberalization in the existing foreign direct investment (FDI) regime in India, has proclaimed a significant change for NBFCs.

What are the norms for Foreign Direct Investment (FDI) in NBFCs?

NBFCs are governed by the policies and guidelines as issued from time to time by the Reserve Bank of India. FDI in NBFCs has been allowed up to 100% since 1997 subject to the minimum capitalization norms.

FDI in NBFC was permitted under the automatic route in only eighteen identified sub-sectors which were listed out below. Further, any foreign investment also attracted minimum capitalization norms.

Eligible Activities under 100% Automatic route:

• Merchant Banking
• Under Writing
• Portfolio Management Services
• Investment Advisory Services
• Financial Consultancy
• Stock Broking
• Asset Management
• Venture Capital
• Custodial Services
• Factoring
• Credit Rating Agencies
• Leasing & Finance
• Housing Finance
• Forex Broking
• Credit Card Business
• Money Changing Business
• Micro Credit
• Rural Credit
• 100% foreign-owned NBFCs with a minimum capitalization of US$ 50 million can set up step down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without bringing in additional capital. The minimum capitalization condition shall not apply to downstream subsidiaries.
• Joint Venture 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 norms.

What are the Challenges faced under the Existing Framework?

There were many challenges faced by the investors in addition to the restricted ambit of activities open to FDI earlier. For instance:

• Asset Management Activity, even though technically a fee-based activity, was treated as a ‘fund-based’ activity for the purpose of capitalization, thereby attracting prohibitively high capitalization norms linked to foreign ownership.
• The list of allowable activities under the current list did not include ‘investment activities’, some regulatory ambiguity existed for asset managers in terms of investing their own capital, whether as a sponsor or otherwise, in funds since it could be viewed as a restricted activity requiring Foreign Investment Promotion Board (FIPB) approval.
• Whenever a majority foreign-owned asset management entity created a step down joint venture or a subsidiary, it attracts additional capitalization requirements. This additional capital would have to be brought in through fresh infusion in the parent, thereby further disturbing the foreign investment at the parent entity level.

The issue of New Liberalized Policy:

Expansion of Eligible Activities:

Foreign Direct Investment in NBFCs are no longer restricted to the 18 stipulated activities but have been permitted across all other financial services carried out by NBFCs. This means that as long as the NBFC is subject to a regulatory authority such as the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Pension Fund Regulatory and Development Authority (PFRDA), Insurance Regulatory and Development Authority (IRDAI) etc., it is permitted to raise 100% FDI under the automatic route, irrespective of the activity it performs.

For example, once a commodity broking license is approved by SEBI, a commodity broking company will not require any further approval from the Foreign Investment Promotion Board (FIPB) for bringing in foreign direct investment.

Relaxation on Capitalization Norms for FDI in NBFC:

The Government has also done away with the minimum capitalization requirements under the FDI policy^[1]. NBFC would need to require to comply with capital norms mentioned above. They need to comply with capital requirements fixed, if at all, by the relevant sectoral regulatory authority only to get Foreign Funding in NBFC.

In addition to above other Conditions to be fulfilled:

• Foreign investment will be subject to ‘conditionality’, including minimum capitalization norms, as specified by the concerned Regulator/Government Agency.
• The financial service activities need to be regulated by one of the Financial Sector Regulators. The activities which are not regulated by any Financial Sector Regulator or where only part of the financial services activity is regulated, or where there is doubt regarding the regulatory omission, foreign investment up to 100% will be allowed under the Government approval route.
• Any financial services activity which is specifically regulated by any particular statute, the foreign investment limits will be regulated as stipulated under the particular statues.
• Downstream investments by any entities will require complying relevant sectoral regulations.

Impact of New Regulations:

Impact on Activities:

• While inviting foreign funds, one of the major difficulties faced by NBFCs was about the interpretation of the permitted 18 activities. Financial services being a dynamic sector, the nature of financial services has been evolving and there was no definition or basis for ascertaining the services from which these 18 activities evolved. Further, there was lack of a practical or reliable mechanism for investors to ask questions relating to whether or not a certain activity is covered within the permitted 18 activities. It would not be incorrect to say that this uncertainty, at times, restricted highly potential businesses from accessing foreign funds.
• With permission for inflow of foreign investment in “Other Financial Services” on automatic route, the sector is collected a remarkable diversity of players and businesses being intermediaries between mainstream banking and unorganized sectors.

Impact on Capitalization Norms:

• In addition to the minimum capitalization requirements fixed by the relevant sector regulatory authority, the RBI has also stated minimum capitalization requirement to comply with. Additionally, it was unfair to subject a merchant banking and custodian services to similar capitalization norms without taking the market and investment environment into consideration.
• To remove the vexatious requirement of complying with multiple capitalization norms, the FDI policy does not stipulate any minimum capital requirements anymore. This means that NBFC would need to comply with capital requirements fixed, if at all, by the relevant sectoral regulatory authority only.
• For instance, Asset management activities which are regulated by any Financial Sector Regulator should not be subject to the minimum capitalization norms linked to foreign ownership.
• Fund managers who also act as sponsors for AIFs would not require any approval from FIPB to invest in their own funds.
• Those NBFCs which falls under the approval route, the minimum capitalization requirements will be decided by the Government.

Conclusion:

The liberalization of FDI in the financial services sector is a welcome move. It is expected to provide a much-needed boost to the sector.

This move is likely to particularly benefit domestic fund management and advisory businesses which may now raise foreign capital under a relaxed regime, without adhering to the previously prescribed minimum capitalization norms.

The new norms would also further the intent of the Government to inspire global fund managers to provide Foreign Funding in NBFC.

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