What are the Sources of Business Funding for NBFCs?

Swetha Dhinesh

09 Mar, 2023

NBFCs stands for Non-Banking Financial Corporations. Non-Banking Financial Corporation is a firm registered under the Companies Act of 1956 and the Companies Act of 2013^[1] that engages in lending, hire-purchase, leasing, insurance, receiving deposits in particular circumstances, chit funds, stock and share acquisition, among other activities. The Reserve Bank of India and the Ministry of Corporate Affairs jointly manage the NBFCs operations. Financial Institutions like NBFCs have two-fold funding requirements. After obtaining a license but not a banking license, non-banking financial companies offer credit services. These businesses don’t rely on Current Account Savings Account (CASA) deposits for financing. Only banks are eligible for CASA deposits, and the RBI licenses banks to receive funds from the general public. NBFCs are not held to the same banking regulation and oversight standards as traditional banks.

Non-Banking Financial Companies

An NBFC is a company whose primary business funding is accepting deposits under any scheme or arrangement through any channel (Residuary non-banking company). But the functions which are excluded from the definition are Agricultural Work, Commercial Activity, any purchase or sale of goods other than securities, selling /buying or building any immovable property and rendering any services. 

Types of NBFCs

The various Non-Banking Financial Company types that exist in India, together with the activities they carry out, are listed below:

• Asset Finance Company- Provides financial for tangible assets, such as cars, tractors, and generators, that support economic or productive activities. “Primary business” refers to an organisation that finances real or tangible assets supporting economic activity. The income from those assets must constitute at least 60% of the organisation’s total assets and income, respectively.
• Investment Company: Purchasing securities with the intent to sell them again.
• Loan Company: A loan company extends loans or funds operations other than its own. However, an asset finance company is not covered by this.
• Infrastructure Finance Company: Is a Non-Banking Financial Company that possesses the following characteristics:
  • It invests at least 75% of its total assets in infrastructure loans.
  • It has at least Rs.300 crore in net-owned funds.
  • It has a credit rating of at least 75% of its total assets or a comparable level.
  • It has a Capital to Risk-Weighted Assets Ratio of 15%.
• Systematic Important Core Investment Company: Purchases securities and shares principally for the purpose of investing in equity shares.
• Infrastructure Debt Funds: It is a business that is licensed as an NBFC that helps finance long-term infrastructure projects. It raises money by issuing bonds with a minimum 5-year maturity that are denominated in rupees or dollars. Infrastructure Finance Companies can only sponsor IDF.
• Micro-Finance Institutions: Extends loans to those who are economically underprivileged. Additionally, they render assistance to small and medium-sized businesses.
• Mortgage Guarantee Company: Financial Institutions that have a net owned fund of at least Rs.100 crore and a mortgage guarantee business that accounts for at least 90% of their business revenue or 90% of their gross income.
• Non-Operative Financial Holding Company: These financial institutions allow promoters and promoter groups to establish new banks. It is a wholly-owned NOFHC that, to the degree permitted by the relevant regulatory requirements, that holds banks as well as other financial services companies governed by the RBI or other financial sector regulators.
• Factor (NBFC- Factors): It is in the business of buying an assignor’s receivables or extending loans by a security interest on the receivables at a discount.
• Account Aggregator: Gathers and provides data on a customer’s financial assets to the customer or other parties upon request in a consolidated, organised, and retrievable manner. 

Essentials of Business Funding in NBFC

Any registered NBFC start-up that wants to achieve its business goal has to raise money. Even with a strong business plan, an NBFC may fail for a lack of funding. Due to the fact that it attracts the interest of Fintech Companies, NBFC plays a significant role in India’s expanding economy. As a result, fintech firms and NBFCs work together to develop innovative technology-driven tools.

To achieve the objective of financial stability, NBFC must make sure that the proper amount of money is allocated to each of its segments. Since business finance for NBFC is a never-ending process, it should be discussed frequently.

Non-banking financial companies cannot effectively raise money from the RBI at lower rates than banks. As a result, they have to raise money at a higher rate, which raises the hurdle rate to keep the Net Interest Margin(MIM) between 1 and 3%. It encourages them to look for various alternatives, such as external commercial borrowing and the issuance of public bonds.

Sources of Business Funding for NBFC

Long-term Loans

These are the loans that were obtained in discrete amounts from banks once the NBFC decided on the volume of funds that would be stationed during regular business operations. The advantage of doing this is that banks can typically lend at significantly lower rates due to the structure of the CASA deposits, which benefits non-banking financial companies with a more unfavourable risk-return profile. These loans can have a structured or bullet repayment plan, and they can be backed by G-secs (supervised by the Treasury Department). The repayment schedules for the assets on the balance sheet should ideally match up with this repayment. To borrow significant amounts of money at a low-interest rate, you must have an excellent credit rating.

Small-term Loans

Publish commercial papers to fund short-term loans, and Non-Banking Financial Companies can issue commercial papers to raise the necessary Funds. It is a short-term, unsecured promissory note with a tenor of three to twelve months issued by financial companies. According to the Reserve Bank of India, NBFCs can list commercial papers if their net value is at least INR 100 crores.

Foreign Direct Investment

According to the FDI policy, automatic route foreign investment is allowed in the NBFC sector. Thus, foreign investors can participate directly in NBFCs without RBI or FIPA authorisation. Foreign Investment is one of the best sources of funding for NBFC. An enormous rise in foreign investors in NBFCs was noticed in 1991 and the post-liberalisation era in the Indian economy.

• The automatic method is one in which the planned investment can be made without first obtaining the Reserve Bank of India or the Foreign Investment Promotion Board (FIPB) permission. Without FIPB approval, foreign investment of up to 100% is allowed under the automatic route.
• According to the rules established under FEMA, all foreign transactions must be handled exclusively through organisations that have been granted a license by the RBI.
• Only non-banking financial service activities are eligible for foreign investment under the automatic route.
• Merchant banking, underwriting, portfolio management services, stock broking, asset management, venture capital, custodian services, factoring leasing & finance, housing finance, credit card business, microcredit, rural credit, non-fund-based activities, investment advisory services, financial consulting, forex broking, credit rating agencies, money changers, etc. are just a few examples.
• After 2016, FDI in these NBFCs is permitted without any minimum capitalisation requirements.
• To speed up the development of the non-banking financial sector, the government has revised the FDI rules for NBFCs. Another benefit is the elimination of the minimum capitalisation standards.
• The NBFC business model will benefit greatly from the rapid growth of Foreign Direct Investments as a result of the quicker and easier approval of funds at competitive interest rates.

Issue Bonds

By issuing bonds, NBFCs can obtain significant funding at the lowest prices. It is part of the daily practice that lowers the rate of funding sources. The bond’s coupon rate was chosen rate which should fit their dating profile. The bond maturity profile aligns with the financial companies’ interest payback schedules. The ability to issue bonds to retail investors gives NBFCs a significant edge during the bond placement process.

Securitisation of Loan

NBFC is securitising and selling their loans in the market. Securitisation is a key instrument used by HFCs and NBFCs to manage liquidity, raise capital, and fix ALM mismatches.

RBI Guidelines for NBFCs

The following rules must be followed by the company when obtaining Its Certificate of Registration:

• They should not accept deposits that are payable on demand.
• The RBI does not guarantee that any deposits made in the company will be repaid.
• A minimum of 12 months and a maximum of 60 months should be specified in the deposits.
• The maximum rate of interest that the RBI has set for loans and advances is not permitted to exceed.
• The RBI must be given all relevant information about the company as well as any alterations to the company’s structure.
• Deposits made by the general public are unsecured.
• In accordance with the Companies Act, the firm is required to provide an audited balance sheet each year.
• Annually, a statutory return on the deposits taken by the company has to be provided in the form of NBS.
• A quarterly report on the company’s liquid assets must be submitted.
• The Corporation must be able to refund all deposits or funds obtained from the public, according to a declaration by the auditors.
• The company must keep liquid assets at a minimum of 15% of the public deposit.
• RBI must receive a credit rating, which must be obtained twice a year.
• Companies with a Public deposit of at least Rs. 20 crore or assets worth at least Rs. 100 crore are required to submit an ALM (Asset Liability Management) return every six months.

Conclusion

A review of Non-Banking Financial companies’ past financial results indicates that they are emerging as a key source of lending for infrastructure for micro and small businesses. Since the Great Recession, NBFCs have expanded both in size and variety, significantly contributing to the ability of traditional banks to meet lending requests. The different players in the current Public to Public, business-to-business, and business-to-consumer lending market have the opportunities to grow further and are readily available as a progressively significant part of India’s economic aspect.

Also Read:
What is a Non Banking Financial Company (NBFC)?
Non-Banking Financial Institutions: What They Are and How They Work?