What is the Complete Process of NBFC Due Diligence in India?

Swetha Dhinesh

12 Apr, 2023

One of the essential components of India’s financial services sector is a Non-Banking Financial Company. The Reserve Bank of India Act, 1934’s Section 45-I, governs the registration of businesses like NBFC. It can also be explained as an alternative source of finance for different types of enterprises, such as micro and small-sized ones, for building out infrastructure and allocating funds, etc. NBFCs are run and governed by the Central Bank of India and registered under the Companies Act. The appraisal of a business, particularly to determine its assets and liabilities and assess its commercial potential, is referred to as the NBFC Due diligence.

What does NBFC’s due diligence entail?

Prior to signing a contract, a business or individual is investigated, or a specific standard of care is exercised. There are four main categories of due diligence: legal, financial, commercial, and others. The entity is evaluated on each segment using a different questionnaire. The legal Due diligence goal is to review the legal foundation of the transaction, the legal framework, contracts, loans, property, employment, and, if applicable, any existing litigation. Although it may be required by law, the phrase is more frequently used in reference to volunteer inquiries. The procedure by which a prospective acquirer assesses a target firm or its assets for an acquisition is a typical illustration of Due diligence in numerous industries.

According to the theory behind due diligence, conducting this kind of investigation makes a significant contribution to making informed decisions by increasing the quantity and quality of information that is available to decision-makers and by ensuring that this information is routinely used to reflect on the decision at hand and all of its costs, benefits, and risks.

Due Diligence Methods

An NBFC’s due diligence process would entail evaluating its operations in order to identify its assets and liabilities and determine its commercial viability. Any investor intending to invest in an NBFC would thoroughly evaluate the same to be certain of the decision to invest on every front. There are four different types of due diligence that investors conduct. The different kinds of due diligence methods are described below:

Legal Due Diligence

This entails examining the legal foundation of every transaction made by the NBFC, including all contracts, properties, loans, pending legal proceedings, and cases, as well as the employment policies and overall legal framework. The following issues will be taken into account:

• If the NBFC has been properly incorporated in accordance with the applicable legislation; 
• If different compliances, such as submitting returns, maintaining accounts, etc., are being made;
• If the NBFC is involved in any ongoing legal proceedings;
• If there is any legal position with respect to its assets and obligations; 
• Any other relevant legal issues.

Financial Due Diligence

Financial due diligence for NBFCs entails a financial analysis of the company, with a primary focus on supplying the required financial data. It entails looking at the NBFC’s financial data, which includes data on its assets, liabilities, obligations, cash flow, management, and capital, among other things. It would primarily cover the following topics: 

• The accuracy and genuineness with which the company’s accounts are kept. 
• The company’s credibility and creditworthiness. 
• The company’s overall financial soundness.

Commercial Due Diligence

It entails assessing the NBFC as a component of the business market to which it belongs. It entails a thorough examination of the company’s strategy, customer relationship, business plan analysis, anticipated sales, the popularity of the business, competitive analysis, etc. The evaluation would include the following:

• How well the NBFC performs in relation to its rivals in current market conditions.
• The NBFC’s relationship with its customers.
• Goodwill of the NBFC.
• The NBFC’s marketing and sales initiatives over a specific time period;
• Anticipated potential for growth for the NBFC.

Other (Miscellaneous) Due Diligence

 It involves conducting thorough research on other crucial elements that make up an NBFC, such as taxation, intellectual property, information technology systems, the organisational structure of the NBFC, the hierarchy of management, the channels of communication used by the firm, etc. It is evident that an NBFC’s due diligence would involve a 360-degree examination of its performance in all areas of its operations, including the legal, financial, commercial, and other aspects. Due diligence provides investors with a clear understanding of how an NBFC is perceived from all angles, so they can assess the investment choice fairly.

Process of NBFC due diligence

The due diligence process starts with collecting or gathering information, then analysing the company’s information, checking legal requirements as part of NBFC due diligence, and verifying the document’s authenticity at the end. The process of due diligence for an NBFC is discussed below.

NBFC Due Diligence Information Gathering

The information’s source, reliability, and correctness matter most during due diligence and it is crucial to emphasise them. Information can be gathered in a systematic way to determine compliance. Adopting only true information relevant to NBFC’s due diligence before starting the process is crucial. The source of information gathered for the purposes of due diligence must also be trustworthy because it forms the basis for the entire NBFC due diligence process and the investment decision that results from it.

Information from the company’s financial records, Market Data, Business News, Directors of the Company, and Corporate Financials are sourced from which this information can be obtained, and it should be used to carry out the exercise of NBFC due diligence.

Before gathering the data, the following process should be made:

• Make a list of every type of information needed to conduct the NBFC Due Diligence exercise;
• Finding the sources from which the data is being gathered;
• The hiring of experts to complete the entire NBFC due diligence procedure and gather the pertinent data.

Important Aspects Included in the NBFC Due Diligence Process

As part of the NBFC Due Diligence process, the following papers are scrutinised:

Legal, Financial, Commercial, and Other factors can be incorporated into the questionnaire to examine the NBFC’s Due diligence. In order to make a decision, the following subheads of the target company’s information are analysed:

• Meeting minutes and secretarial compliance 
• Corporate and Financial Matters
• Foreign and overseas direct investment, if any.
• All of the significant contracts that the NBFC engaged into
• RBI requirements for compliance with various regulations
• Financials Real Estate and Property Assets Held by the NBFC 
• NBFCs’ pending legal disputes
• Insurer claims made by NBFCs
•  NBFC Human Resource (HR) Capabilities and All HR Compliances
• Taxes and Intellectual Property Compliance

Checking legal requirements as part of NBFC due diligence

The NBFCs are required by law to abide by a number of statutory requirements. Which are:

• Registration with Financial Intelligence Unit- India (FIU-IND)
• Based on September 23, 2008, DNBS (PD) CC No. 129/03.02.82/2008-09 circular, Auditor Report to Directors & Certificate from a Statutory Auditor (SAC)
• In accordance with Section 45-IC, Statutory Reserves must be created at a 20% profit.
• Registration with Information Utility that has been set up under the Insolvency and Bankruptcy Code, 2016
• Business registration with the Central KYC Portal.
• Membership in the Credit Information Company, 
• Registration with the information utility established under the IBC (CIC)
• Nominated Counsel Appointment in Delhi High Court

Verifying the documents’ authenticity

• When performing due diligence, the evaluator must ensure that the examined documents are authentic. It is the responsibility of the hired specialists performing the activity of due diligence to confirm the authenticity of the following documents:
  • NBFC GST registration 
  • Certificate of Incorporation of the NBFC
  • Registration TAN & PAN

• All the documents were filed to the MCA^[1], RBI, and other regulatory agencies to do NBFC activity.

• The validity of all additional registrations and authorisations obtained by the NBFC from various regulatory organisations must also be confirmed for the evaluator’s satisfaction. The evaluator must keep these documents on file until the Due Diligence process ends.

• Other essential documents must be kept on file by an NBFC as part of the ongoing business until the Due Diligence process is complete. The documents are listed below:
  • Board decisions made up until the due diligence date of exercise
  • Minutes of all meetings held up until the end of the due diligence
  • Reports of statutory audits
  • A list of the complete net worth of the company.

Conclusion

The thorough due diligence that NBFCs conduct takes time and demands attention to detail. Because making the wrong investment decision could severely impact both the investor and the economy, its importance cannot be underestimated or ignored in any way. Thus, selecting a specialist with years of experience and a keen eye for detail is typically advised.

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