Essentially, these finance companies are banks, since they perform the basic twin functions of attracting deposits from the public and making loans.

RBI has classified the non-banking sector in the following manner.

• Non-banking finance company: The principal business is receiving deposits from the public under any scheme and lending in any manner.  E.g Insurance, Stock broking, Lease financing, Equipment leasing Hire purchase, Investment company Mutual benefits, Financial company etc.
• Residuary non-banking company: Receives deposits from the public under any scheme but it does not belong to any of the categories mentioned above under NBFC.
• Non- banking non-financial company: Refers to an industrial company as defined in the IDBI Act, 1964 or a company whose principal activity is agriculture, trading, etc. which cannot be called as financial activity.

In May 1992, RBI constituted a working group under the chairmanship of Dr. A.C. Shah to conduct a comprehensive study of finance companies and recommend measures to facilitate their healthy growth. In its report submitted in September 1992, the group recommended specific regulations for companies and prescribe entry norms for new financial companies. It also prescribed capital adequacy standards, prudential norms for income recognition and provisions for bad and doubtful debts.

The failure of Rs 1200 crores CRB capital in May 1997 again focussed the need to regulate the working of NBFCs.

The Government of India enacted the Reserve Bank of India (Amendment) Act, 1997 which confers wide ranging powers on RBI for controlling the functioning of non-banking financial companies.

The act defines a non-banking financial company (NBFCs) as a financial institution which is a company and which has, as its principal business, the receiving of deposits under any scheme or arrangement and lending in any manner. Institutions carrying on agricultural or industrial activity as their principal business are excluded from the definition of NBFC.

Salient Feature of RBI Amendment Act, 1997

As per the Act, no NBFC can commence or carry on business;

• without obtaining from RBI a certificate of registration; and
• having net owned funds of Rs 50 lakhs or such other amount, not exceeding Rs 2 crores.

The existing NBFCs which fulfil the above financial requirements are required to apply for registration to the RBI within six months. The RBI is now entrusted with the numerous powers required to control the NBFCs

To avoid systemic risks and for safeguarding the interest of depositors, in its mid-term review of the annual policy statement for 2004-05, the RBI proposed certain measures to improve the functioning of NBFCs.

These measures include (i) transparency of operations, especially in the connected lending relationships, (ii) corporate governance standards including professionalisation of the Boards and ensuring ‘fit and proper’ criteria in consonance with the standards in banks, (iii) avoiding untenable rates of commission to agents (iv) adherence to ‘know your customer’ rules and (v) customer service in terms of clear indication of the identifiable contact with the field agents so that matters such as unclaimed deposits are appropriately addressed.

Legislative control of NBFCs

NBFCs do not have any specific legislation governing them:

• Being limited liability companies, they are governed by the Companies Act, 1956 which does not even contain the definition of a finance company. Application of general provisions of this Act, perforce, has invited avoidable violations by NBFCs.
• In the matter of deposits, NBFCs are governed by Non-banking Financial Companies (Reserve Bank) Directions, 1997.
• Those engaged in merchant banking and portfolio management services are governed by SEBI.

RBI Customer Guidelines for Nbfcs

The Reserve bank of India in 2004 issued “know your customer (KYC)” guidelines for non-banking financial companies (NBFCs), similar to those existing for commercial banks. The ‘Know Your Customer’ framework is meant to work with two objectives – (i) to ensure customer identification and verifying his identity and residential address and (ii) to monitor transactions of a suspicious nature. The guidelines will be applicable to all NBFCs, including Miscellaneous Non-Banking Companies (chit fund companies) and Residuary Non Banking Companies.