NBFC Housing Finance Companies (HFCs) have been in existence for a while now. They are formed through Company registration with the Registrar of Companies (RoC) followed by licensing procedure from RBI. The revamped Companies Act of 2013 brought many new provisions to the fore and got rid of many ambiguities. However, when it came to NBFC Housing Finance Companies, the Act again had some unclear points that needed explanation. To rectify this, the Govt. brought the Companies (Amendment) Act 2017. This amendment gave a clear picture of things regarding the NBFC HFCs and cleared all the doubts. In the following sections, we will be getting into details of various provisions of the Act concerning HFCs. We will also understand the Fair practice code and other business models for NBFCs.
Understanding Section 186 Provisions for HFCs
Section 186 of the Act has provisions concerning loan and investments for a corporation. As per Section 186(1), the subsequent transactions can be considered an investment with a couple of exceptions:
- Purchase or subscription of shares.
- Purchase or subscription of warrants; and
- Purchase or subscription of debenture bonds and similar debt-based securities.
The exceptions to the above definition are:
- Making loans or advances; and
- Any fiscal transaction like the acquisition of lease, receivables, or other credit facilities.
Companies (Amendment) Act, 2017 and HFCs
As mentioned in the introduction of this piece, to resolve the ambiguities after the 2013 Act, an amendment was brought in the year 2017 to include the missing provisions related to NBFC compliance. MCA (Ministry of Corporate affairs) formed a CLC (Companies Law Committee) to usher in the changes to the existing Act. On the suggestions made by the panel of CLC, there were changes incorporated into the existing ACT and the Companies Act of 2017 came into existence. Amongst all the changes, the most noticeable and perhaps the most important in the HFCs context was the amendment to Section 186.
Amendments to Section 186
Certain relaxations were introduced in Section 186 of the Act. It states that no firm can (directly or indirectly) lend any:
- Loan to a person or a company.
- Guarantee a loan to a person or company; and
- Acquire securities of the other companies via subscription, purchase, or any other method.
However, the Section also states that over 60% of a company’s paid-up share capital or for 100% of its free reserves and securities premium account, whichever is more, the company’s Board can approve providing a loan, guarantee, security, or investment under section 186(2) by passing a resolution at the board’s meeting.
Requirements of Section 186
1. Taking Approval in Board Meeting
Section 186 states it as the primary requirement that Board’s approval is necessary regardless of the amount of loan being granted or capital being invested by the company.
- The Board’s approval should be unanimous.
- A mere resolution via the committee of directors will not be enough.
- Approval of members must be given through a special resolution signed by all members.
Exceptions to the rule:
- If the company gives the loan to its subsidiary or joint venture (JV).
- If the company gives guarantee or security to its subsidiary or joint venture (JV) and
If the company acquires securities of its wholly owned subsidiary by subscription or other methods.
2. Approval of Public Financial Institution
An approval before taking the loan must be taken from the PFI or public financial institution. Although in some cases the following exceptions work:
- If the aggregate of loan, security, investments, or guarantee is not over the given limit.
- There is no default in repayment of instalments of the loan.
- The rate of interest must be over revenue of state security closest to the said loan period.
- There must not be any existing default related to deposits.
- When a corporation fails to repay the deposits or interest on the maturity, then the corporate can only take a loan, make an investment, buy security, or guarantee it only after fully paying the default.
The company should also disclose all its particulars of investments made. For example, whether a loan is to be given, or a guarantee or security is to be given or an investment that must be made should be disclosed by it in its budget.
Non-Applicability of Section 186
The norms of Section 186 in the Companies Act, 2013 are not applicable in the following scenarios:
In case of a loan, guarantee, any security, investment made by:
- Banking company
- HFC (Housing finance company) and
- Insurance company
“The investment company” here means a corporation that deals or deems to deal with the acquiring shares, debentures, and other forms of securities. If the corporation’s assets are within the set limit of 50% of its total assets or if its income is from the investment business constituting at least 50% of the gross income then it will be called an investment company.
Now in the following segments, let us discuss the filings and exceptions for the NBFCs and NBFC housing finance companies.
Filing Exemptions to NBFC and Housing Finance Institutions
RBI has given certain exemptions for some NBFCs and HFCs (Housing Finance Companies or institutions). It has brought them to an equivalent level as now the Finance Act 2019 has given the RBI powers to regulate Housing Finance Companies like the NBFCs. RBI has cleared that NBFCs and HFCs (Housing Financial Companies) are exempted from the Chapter IIIB of the RBI Act, 1934. As of 2019, RBI maintained that the HFCs will be treated like non-banking entities.
Fair Practice Code for NBFC
Using the Fair Practice Code in NBFC implies that the entity is working as per the rules stated by the RBI. It also means that they are not performing any activity which discards those guidelines. The Fair Practice Code for any financial company justifies its functioning as per the rules of the RBI. As per the code, these companies are not allowed to disobey the NBFC guidelines of the regulatory body.
Why Was Fair Practice Code Introduced?
Given below are the reasons why the Fair Practice Code was introduced for Indian NBFCs.
- Adapting business practices that meet the needs of the customer.
- Setting new standards for customer satisfaction by devising new strategies for grievance redressal.
- Following methods of business operations that are ethical, and do not compromise on the integrity of the institution.
- Giving the best possible information to the customer regarding the products and services suitable to them.
- Maintaining all the general fair practices of doing business.
Fair Practice Code guidelines for NBFCs
1. Code for Application of a loan and its processing:
- The means of conveyance for the borrower of the loan must be within the language he can easily understand. This means that NBFCs cannot use high end financial terms to confuse the borrower.
- The application forms must contain all the details which are in the interest of the borrower. This includes details like various terms and conditions related to the loan product as given by the NBFC. This one is to facilitate the borrower to make an informed choice while availing of the loan.
The NBFCs must formulate a system to provide the acknowledgement receipt for the applications accepted by it for evaluation.
2. Conditions for Loan Appraisal
- The NBFC should present in writing and in an easy to comprehend language the details regarding the sanctioned loan amount. It should also contain all the necessary terms including the annual rate of interest and the way of repayment of the loan.
- If the NBFC does not give the loan agreement’s copy to the borrower, it might lead to a dispute between the parties. So, a copy of the loan agreement must be kept by both parties to avoid such a scenario.
The NBFC should keep the acceptance letter of the loan’s terms and conditions by the borrower safe in its records.
3. Change in Loan Disbursement Method
- The NBFCs should always notify the borrower regarding any change in its interest rate, loan disbursement method, any additional charges, or new payment terms.
- The decision to accelerate/recall any payment must be made as per the loan agreement signed by the loan borrower.
It is suggested that for NBFCs, all securities on repayment of dues or realization of the outstanding loan amount of loan amount are subjected to any legitimate right.
4. Fair Practice Code for Gold Loans:
- The NBFC should incorporate adequate KYC procedures to ensure due diligence from the customer’s side.
- To ensure the ownership of the gold to the borrower the NBFC must conduct internal proceedings.
- NBFC must ensure that adequate systems are in place for the corporate to securely store and manage the jewellery. The storage must be inspected periodically by an interior auditor to ensure that the security measures are in place. that has got to be inspected periodically by the interior auditor.
- The gold must be insured by a reputed company.
- The auction process for the gold should be transparent.
- Furthermore, NBFCs should not be part of the auctions.
- The loan agreement should display all the small prints concerning the auction.
- NBFCs cannot interfere with the borrower’s affairs except on points mentioned within the terms and conditions document of the loan agreement.
- The lending NBFC cannot use measures that are threatening or can be termed under harassment for the recovery of debt.
- If the lender NBFC has any objection concerning the receipt of the invitation from the borrower, for the transfer of their loan account, then it should be conveyed within 21 days after receiving the receipt.
- It will be the responsibility of the Board of directors of the NBFC to ensure enforcement of the fair practice code in its operations. It should also put in place an efficient complaints redressal system to address issues related to the non-enforcement of oxygen.
- The Fair Practice Code used by the lender NBFC should be shown in the loan agreement to the borrower. The NBFC must also take the nod of its Board of Directors for incorporation of fair practice code in its operations.
Alternative Business Models of NBFCs
Investment Advisory Services
In this model, the NBFCs can collaborate with fintech’s to give investment advisory services. They can offer advice on the sale of Mutual funds online with the help of small and medium-size fintech companies. These companies have sufficient client support to deliver the investment planning services. The Investment advisors of these NBFCs are required to register with SEBI before delivering these services. As Investment advisory has a margin of 1% on their sale proceeds.
Lead Generation Services for Other NBFC/Banks
This model is extremely popular with the NBFCs and Fintech loan business. In this module, the Fintech’s generate a number of leads using their strong digital presence for other NBFC and Banks. In return, they earn DSA commission ranging from 1% to 5% of the loan amount.
Insurance Web Aggregator Business
Insurance Web Aggregators are often called Insurance Intermediaries as they act as a link between companies and the prospective customers. The web aggregator Fintechs provide a platform through their online portal for varied insurance products for buying & selling operations. As an NBFC-Fintech collaboration one can set up a subsidiary with Rs. 25 lac paid-up capital to get an insurance web aggregator license. As an insurance intermediary, an NBFC can earn up to 15%-40% on insurance products sold from their platform.
Forex Dealer or Full-fledged Money changers
NBFCs can also apply for the license of Full fledge exchanger and may engage in the sale/purchase of forex. The collaborators can simply use their digital presence and innovative technology to give the services related to the sale and purchase of foreign currencies. They can also give services as full-fledged money changers to the investors.
Market and Credit Linked Debentures
There is quite a popular trend in the Indian market of new structured products like Market and Credit Linked Debentures. In this model, the interest is paid at the time of maturity. The amount of Interest depends on the performance of the linked index or stock.
The 2017 Amendment Act for NBFC Housing Finance Companies is one of the most significant changes brought by the MCA in consultation with their CLC. The changes in Section 186 of the Companies Act were much needed. Along with these amendments, RBI also withdrew certain exemptions for the Housing Finance Companies and declared they would be treated in the category of non-banking institutions. We also studied the fair practice codes and the business models for the NBFC Collaboration.
The Fair Practices Codes were introduced as regulatory practices for companies to keep an eye on their operations. It is suggested by the RBI that all financial institutions under its regulations must comply with these codes during loan processing operations. These codes ensure that the financial companies are acting in the common interest of the people. This also ensures transparency in their day-to-day operations. One of the biggest advantages of these codes is that they work to increase the trust of a borrower in these institutions.
The business models suggested in the last part of the blog are becoming quite popular. Many NBFCs are looking to collaborate with Fintechs to diversify their business operations through these companies. These models bring mutual profit to the NBFCs and the collaborating Fintechs.