Laws relating to NBFCs in India

Laws relating to NBFCs in India | Overview

Prudential Norms relating to NBFCs
There are various compliances that are required to be made under the Directions are
Anti-Money Laundering Standards
Know Your Customer Guidelines
Fair Practices Code
Reporting of Frauds
Application of Legislation

All non-banking financial companies – NBFCs are those companies that got their registration done under the provisions of the Companies Act, 2013. Pursuant to this, they are required to fulfil all the requirements under the Act. There are various compliances such as Share Capital, Board of Directors, Meetings, Audits, the publication of books of accounts, management structure, maintenance of books of accounts, share capital and other general conduct according to the provisions of the Companies Act 1956.

Along with the above-mentioned mandates, they are also under an obligation to fulfil the specific requirements of the RBI that are released by way of the directions and other notifications as well as the amendments by the RBI.

Prudential Norms relating to NBFCs

RBI had issued two sets of directions in a detailed manner. These directions were based on the Prudential norms, which are as follows:

Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007[1]
Non-Banking Financial (Non- Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007[2]

The directions inter alia lay down the guidelines on asset classification, income recognition and provisioning requirements that are applicable to exposure norms, NBFCs, disclosures in the balance sheet, the constitution of the audit committee, restricting the investment done in real estate and unquoted shares and building as well as the requirement of capital adequacy.

There are various compliances that are required to be made under the Directions are:

Framing and implementing Policies: the investment policy for the company is framed by the Board of Directors and they work for getting it implemented. Along with it, the BOD of every NBFC that is intending to grant or grants call loans or demands shall look forward to framing a policy for the company and implementing the same.
Accounting Standards and Guidance Notes: these notes are issued by ICAI. These notes have to follow to the extent they are in line with any of the directions passed by the RBI.
Disclosure in Balance Sheet: according to the para 9 of the directions,[3] it is required by every NBFC to disclose separately in its balance sheet without netting from income or against the value of the assets.
Constitution of an Audit Committee: Every NBFC with a total asset value of Rs. 50 crore or more is required to constitute an audit committee as per the last audited balance sheet. Such a committee comprises of not less than 3 members from the Board of Directors.
It is required by all the NBFCs present in the market to prepare their balance sheet as well as profit and loss account on the last day of each financial year i.e. 31^st March of every year.

ANTI- MONEY LAUNDERING STANDARDS

The prevention of money laundering act was passed in 2002 and came into force on 1^st July of 2005. Certain concurrent and exclusive powers got conferred on the director of Financial Intelligence Unit OF India (FIU-IND) by virtue of the provisions under the PMLA.

Further, there are certain obligations that were provided by the Notification of RBI. Some of them are below:

It is a mandate for NBFCs to comply with the provisions of PMLA, 2002 as well as the rules that were notified thereunder. NBFCs are also required to take all the steps that are necessary for ensuring compliance with the requirements laid down by sec 12 of the Act.
It is required by the NBFCs to get a profile prepared for each and every customer. This profile finds its basis on the classification of risk. It is also mandated to review this classification periodically.
Forward Cash Transaction reports (CTR) for every month to FIU- India and latest by 15^th of the succeeding month. Further, it is also clarified that the reports of cash transactions from the offices/ branches of NBFCs to their Principal Officer should be submitted invariably on month- to- month basis and it is also required by the Principal Officer to ensure that CTR is submitted to FIU- IND for every month within the prescribed time schedule.
It is also required by NBFCs to prepare the Suspicious Transaction Reports (STRs) only if they have sufficient grounds for believing that the transaction is comprising of the proceeds of crime typically irrespective of the transaction amount. Further, the upper limit that is envisaged for predicate offences is provided in part B of the Schedule of PMLA, 2002.

KNOW YOUR CUSTOMER GUIDELINES

The guidelines on the norms of ‘Know Your Customer’ were issued by RBI through its circular DNBS(PD).CC No. 34/10.01/2003-04 dated 6^th of January 2004. It was advised to NBFCs to follow a certain procedure for customer identification for getting the accounts opened as well as keeping a continuous check on the transactions that appear suspicious in nature with the objective of reporting it to the authority concerned.

The guidelines on ‘Know Your Customer’ were revisited in the context of the various Recommendations given by the Financial Action Task Force (FATF) on the standards of Anti Money Laundering (AML) and on Combating Financing of Terrorism (CFT). These standards were accepted as the benchmark internationally for getting the guidelines for Anti Money Laundering framed as well as combating the finance provided to the policies of terrorism by the regulatory authority.

These guidelines on KYC norms are applicable equally to NBFCs. It is advised to all the NBFCs to adopt them subject to suitable modifications according to the activities undertaken by them. It is also required by them to formulate a proper policy framework on Anti-Money Laundering measures as well as Know Your Customer and implement them with a prior approval taken from the Board. It also has to be made sure that there is full compliance by NBFCs with the provisions of this circular before 31^st December of 2005.

The guidelines on the norms of ‘Know Your Customer’ are comprised of the following:

Customer Education
Customer Identification Procedure (CIP)
Risk Management
Customer Acceptance Policy (CAP)
Monitoring of Transactions
‘Know Your Customer’ Standards

FAIR PRACTICES CODE

It was advised to NBFCs on 28^th of September 2006 to comply with the broad guidelines on Fair Practices,[4] which are supposed to be framed and get approval from the Board of Directors of all the non-banking financial companies inclusive of RNBCs.

The code of fair practices that are framed and got approval by the board of directors is required to be published and then, disseminated on the website of the company so that it can be readily available to the public at large.

There are some draft guidelines focusing on Fair Practice Code for NBFCs. Some of them are as follows:

Applications for loans and their processing: the forms for loan applications should be comprised of relevant information that is capable to affect the interests of the borrower. This will help to do a meaningful comparison can be done with the other terms and conditions that are offered by various other NBFCs in the market so that the borrower can make an informed decision.
Appraisal of loan and terms/conditions: NBFCs are required to convey the data to the borrower in writing. This data includes the amount of loan that got sanctioned along with the terms and conditions, the method of application as well as the annualised rate of interest. They are also required to keep a track and record the acceptance of the terms and conditions by the borrower.
Disbursement of loans inclusive of the changes in terms and conditions: the notice relating to any changes in the NBFCs have to be served to the borrower. This change can be in terms and conditions, interest rate, payment of charges, disbursement schedule, service charges and so on. These changes can be brought into effect only prospectively.
Post disbursement supervision: the policies of post disbursement supervision has to be constructive in nature and the genuine difficulties that are faced by the borrowers must be taken into due consideration.

REPORTING OF FRAUDS

Though the NBFCs are imposed with the primary responsibility of preventing frauds, they can also adopt a system that reports about the frauds taking place. The system for the same has to prescribe to the following requirements:

They have to make sure that there is a reporting system to which all the frauds can be reported without any possible delay.
The accountability with respect to the delays caused by getting the fraud cases reported to the Reserve Banks has to be fixed to NBFCs in the market.
They are also required to adhere strictly to the timeframe that is fixed for getting the fraud cases reported to the Reserve Bank of India. In case of any default, there lies a penal action against the defaulting NBFC as per the provisions of Ch V of the RBI Act of 1934.
NBFCs are also required to submit the returns. For this, it is required to nominate an official of the rank of General Manager.
To bring uniformity in reporting the matters, there has been a classification of frauds on the basis of the Indian Penal Code. The classification is as follows:

If there is a criminal breach of trust or misappropriation of trust.
If there is any fraudulent encashment done through forged instruments or manipulating books of accounts or through any fictitious account.
Any kind of unauthorised facility for credit that is extended for illegal gratification or reward.
If there is any shortage of cash or negligence.
If there is any forgery or cheating.
If there is any kind of irregularity in the transactions of foreign exchange.
If there is any other type of fraud not emerging out of any of the specific heads.

APPLICATION OF LEGISLATION

If a Non- Banking Financial Company is carrying on the business of lending money to the public, then it is required to comply with the provisions under Chapter III B, Chapter IIIC and Chapter V of the RBI Act, 1934.
If a Non- Banking Financial Company is carrying on the business of merchant banking, then it is required to comply with the provisions under the SEBI Act, 1992 and SEBI Merchant Banking Regulations, 1992.
If a Non- Banking Financial Company is carrying on the business of the venture capital fund company, then it is required to comply with the provisions under the SEBI Act, 1992.
If a Non- Banking Financial Company is carrying on the business of acquisition of stocks, shares, debentures, bonds or any other security issued by a local authority or Government or marketable securities of a like nature, then it is required to comply with the provisions under SEBI Act, 1992 and Securities Contract Regulation Act, 1992.
If a Non- Banking Financial Company is carrying on the business of housing finance institution, then it is required to comply with the provisions under the National Housing Bank Act, 1987.
If a Non- Banking Financial Company is carrying on the business of leasing/ hiring goods, then it is required to comply with the provisions under Hire Purchase Act, 1972 and Chapter IIIB of the Reserve Bank of India Act, 1934.
If a Non- Banking Financial Company is carrying on the business of insurance, then it is required to comply with the provisions under Insurance Act, 1972 and Insurance Regulatory and Development Authority Act, 1999.
If a Non- Banking Financial Company is carrying on the business as that of the chit fund company, then it is required to comply with the provisions under Chit Funds Act, 1982 and Miscellaneous Non- Banking Companies (Reserve Bank) Directions, 1977 and Know Your Customer Guidelines framed for NBFCs.
If a Non- Banking Financial Company is carrying on the business of Nidhi Company- Mutual benefit Financial Company, then it is required to comply with the provisions under Section 620A of the Companies Act, 1956.
If a Non- Banking Financial Company is carrying on the business of Micro Finance Company, then it is required to comply with the provisions under the Micro Financial Sector (Development and Regulation) Bill 2007.

[1] Contained in Notification No. DNBS. 192/ DG (VL)- 2007 dated February 22, 2007 for deposit-taking NBFCs

[2] Contained in Notification No. DNBS. 193/ DG (VL)- 2007 dated February 22, 2007 for non- deposit taking NBFCs

[3] It is required by every NBFC to take into consideration the time lag between an account that is non- performing, its recognition as such, the erosion in the price of the security charged over time and the realisation of the security, make provisions against loss assets, doubtful assets and substandard assets as provided in the para.

[4] Guidelines on Fair Practices Code- [DNBS (PD) CC No. 80 / 03.10.042 / 2005-06 dated September 28, 2006]