Foreign Direct Investment in NBFC Sector

By | August 11, 2019
Foreign Direct Investment in NBFC Sector

A particular type of company that is involved in carrying out the business of acquisition of shares, loans and advances, insurance business, acquisition of stocks, chit business or bonds hire- purchase is known as NBFC i.e. Non- Banking Financial Institutions. Any institution whose main business revolves around sale or construction or purchase of immovable property, agriculture and industrial activity does not fall under the ambit of such financial institution.

India went through the period of liberalization in 1991. After this period of liberalization, major changes were seen in the economy of India. One of them is the keen interest shown by the foreign investors to invest their money in the Indian market especially in the Non- Banking Finance Companies. Foreign exchange management act, 2000 is the key to regulate the investments done by foreigners and foreign exchange. Along with it, RBI regulates the operations and working of NBFCs by virtue of the framework created by the RBI Regulation Act of 1934 as well as the directions that are issued by the RBI.

The government had removed the bar on FDI in the NBFC sector and enabled foreigners to invest completely in the services other than those relating to the finance that is carried out by this sector. Other financial services are inclusive of the those activities that are not regulated or controlled by any of the regulators of financial sectors, for instance, IRDA, SEBI, RBI, National Housing Bank, Pension Fund Regulatory & Development Authority or any other regulator of the financial sectors, as per the notification passed by the government.

A notification was released by RBI on 9th of September 2016 with a motive of amending Foreign Exchange Management  (Transfer and Issue of Securities to Persons Resident Outside India) Regulations, 2000. This was done as a step to make the investments done by the foreigners in the sector of Non- Banking Finance Companies an easier task. The government has taken steps by incorporating various changes in the financial budget of 2017- 18 and brought new FDI norms for the NBFC sector. This was done with the motive of boosting up the economic activities in the financial sectors.

CHANGES DONE BY BUDGET 2017-18

Some of the changes introduced by the government in the financial year of 2017- 18 are as below:

  1. FDI in NBFC: there is a huge demand for funding in the NBFC sector and this demand is growing on a day- to- day basis. Pursuant to this, the government has taken a liberal point of view for the FDIs in NBFC. This has enabled venture capitalists as well as the foreign banks to make an investment in NBFCs. This step has taken the centre of attraction as it has made the process of lending very easy and secure which, in turn, allowed the Fintech Companies to grow at a very good pace.
  2. 100% FDI in Automatic Route in NBFC: as per section 47 of the FEMA Act, the new norms has allowed 100% FDI in the sector of NBFC through the automatic route. This investment through the automatic route is also subject to 18 specified activities of NBFCs. There are certain specific activities of NBFCs in which foreign investment was allowed with the help of the automatic route. These activities include underwriting, merchant banking, portfolio management services, asset management, stockbroking, custodial services, venture capital, leasing & finance, factoring, credit card business, housing finance, investment advisory services, activities based on on- fund, rural credit, credit rating agencies, forex broking, money changing business, financial consultancy and many more. Due to the introduction of the new amendment, the investment has to be done according to the sectoral regulations as well as the provisions under the Foreign Exchange Management Regulations, 2000 with the amendments that are incorporated at a time to time basis.
  3. Elimination of Minimum Capitalization Norms: the norm mandating a minimum capital got eliminated because a lot of regulators are now bound with the norm of fixed and minimum capital in place. Further, the list comprising of non-fund based activities have become a subject to the requirements of minimum capitalization.
  4. Regulatory Compliance and Risk Management for NBFC: the amendment has led to the formation of a strict and complex environment for the regulation of FDIs in the NBFC sector. It is a very difficult task to make NBFCs comply with the regulations and provisions. Further, it is also required by the investment in NBFCs done by the foreigners to meet the guidelines laid down by RBI. In contrast to it, the filing process has been made even more simple by RBI as now filing can be done with the help of an online form through the portal of RBI.

Along with these changes, the above-mentioned notification introduced two key relaxations for the NBFC sector. These relaxations are as follows:

  1. It permitted 100% FDI via the automatic route for the other financial services as well but these services are subject to the regulations framed by any of the various regulators of financial sectors present in the market.
  2. Any kind of norms for additional capitalization that are linked to the foreign ownership under the provisions of the FDI policy was removed. This was done because a large chunk of regulators have already accustomed their business according to the provision of minimum capitalization as well as they are not controlled by any regulator in the financial sector. Thus, all the unregulated NBFCs are subject to the prior approval of the government.

This recent change through which the government has done away with the mandate of minimum capital has proved to be a boon. This is so because it will help to spur the growth of the economy as it aimed at the increase of FDI in the sector of NBFC. The more FDIs in NBFCs, the more beneficial it is for the business because the loans with favourable interest can be easily and fastly sanctioned.

LAW REGULATING FOREIGN INVESTMENT MADE IN NBFC

The Government had come forward with FEMA, 2000 for the regulation of the transactions of foreign exchange. While the operations of NBFCs were regulated or controlled by the Reserve Bank of India with the help of the RBI Regulation Act of 1934. Though 100% FDI is permitted in the sector of NBFCs, it is subject to the various norms of minimum capitalization that the government had issued.

All the provisions in relation with the foreign loans are governed by the Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulation, 2000, Foreign Exchange Management Act, 1999 and the regulations passed by RBI.

NBFC AND FOREIGN LOANS

The loan which is taken from foreign institutions is known by the term ‘External Commercial Borrowings’ (ECB). These loans can be easily obtained from foreign financial institutions or foreign banks. Further, ECBs can be obtained from a shareholder as well but such a shareholder should not be the resident of India but owns a minimum of 25% of the total shares of the borrower company.

As per the guidelines passed by RBI, ECBs can be obtained when the necessary conditions get fulfilled but only in some specific sectors. It is a mandate to comply with the procedure laid down by RBI for obtaining foreign loans in a Non-banking financial company. Further, there is no requirement of prior approval of RBI for availing foreign loans.

MODES OF FOREIGN INVESTMENT

The investment made by foreigners in the Non-banking financial company can be availed in many ways. For instance, RBI allows them to invest in liquid currency. In addition to it, they can also make the investment by the way of getting loans converted to shares, exchanging shares, exchanging some of the skill sets and many more.

MATURITY PERIOD AND INTEREST

There are various rules and regulations provided in the Foreign Exchange Management Regulation when it comes to the regulating External Commercial Borrowing. There are some rules specifically for the period of maturity as well as the amount of interest that needs to be paid. The interest that is charged by the government along with other fees and expenses that are to be paid for availing the foreign loans form the cost of ECB. It is mandatory for these costs to be within the stipulated limits that are measured according to the rate of reference that is termed as London Interbank Offered Rate or LIBOR.

The reference rates are as follows:

  1. For all those loans whose period of maturity is between 3 to 5 year, the interest for the same will be around 3.5% over the time span of six months the LIBOR and
  2. For all those loans whose period of maturity is more than that of 5 years, the ceiling of interest would be more than that of 5% over the time span of six months the LIBOR.

PROCEDURE OF TAKING FOREIGN LOANS

It is required by NBFCs to make the submission of Form 83 with the Dealer Bank who is authorized to get LRN number in order to take foreign loans by virtue of the automatic route available. This Loan Registered Number has to be certified by none other than a chartered accountant or a company secretary.

After obtaining the LRN, a copy of Form 83 is required to be forwarded to the Department of Statistics and Information Management of RBI. The task of forwarding the copy is imposed on the AD Banks. A loan can be availed only when the LRN number is allotted.

CONVERSION OF LOANS INTO EQUITY

Whenever a matter arises where it is difficult for a Non-banking financial institution to pay the debts back, they are provided with the opportunity of converting their loans into equity but only after the prior approval of the one who had lent his/ her money. Further, it is required to ensure that the shares got issued under the pricing guidelines under the provisions of FEMA. These conditions have to be complied with when a company desires to get its loans converted into equity.

CONSEQUENCES OF VIOLATION OF ECB REGULATIONS

If there is any contravention of the provisions of the regulations issued for ECB, the defaulting person is liable to pay the amount that is thrice of the total amount involved in the matter. This punishment was laid down by virtue of sec 15 of the Foreign Exchange Management Act.

The corporate entities that are under the investigation conducted by RBI are required to avail foreign loans through the approval route. If there is a violation that is continuous in nature, then the entities are liable to pay an additional cost of Rs. 5000/- that is payable per day. These are the cases where the intention of the entities is taken into consideration. Henceforth if any case emerges that involves unintended violations, the rectification of such a breach is possible. It is rectified by getting it compounded with RBI, which may, in turn, help the entities to get a lower penalty.

Suggested Readings

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Akriti Gupta
Author: Akriti Gupta

Akriti Gupta is a fourth-year learner of BBA LLB programme in Symbiosis Law School, NOIDA. She has done moots and has various publications in her name. Mooting and research papers have helped her a lot to enhance her researching and drafting abilities.

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