NBFC Checklist
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Sanjeev MaharNBFC Checklist
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Sanjeev MaharCommon questions
Powered by AIInfrastructure Finance Companies (IFCs) contribute to economic development by facilitating long-term debt flow into infrastructure projects critical for growth, such as roads, power, and water supply systems . They are required to maintain rigorously high regulatory standards including a minimum net owned fund of Rs. 300 crore, a credit rating of 'A' or equivalent, and a CRAR of 15%. Additionally, they must deploy at least 75% of their total assets in infrastructure loans to ensure focus and manage associated risks effectively, thereby ensuring stability and sustainability in their operation .
The business model of Micro Finance Institutions (MFIs) is unique as it focuses on extending credit to borrowers in rural and semi-urban areas with limited access to traditional banking . Loans typically do not require collateral and are designed to be simple, such as short-term, small amounts, and with fixed repayment schedules tailored to the borrowers' income cycles. This client-centric approach strengthens customer relationships and enables financial inclusion, enhancing performance by reducing default rates and fostering community trust. Their emphasis on social impact over profit margins challenges conventional performance metrics, focusing instead on borrower empowerment and economic development .
The primary factors influencing NBFC classification into NBFC-ND (Non Deposit Accepting) and NBFC-D (Deposit Accepting) include their asset size and the nature of their liabilities . NBFCs with assets below a certain threshold are categorized as non-deposit accepting, while those with significant deposit liabilities fall into the deposit-accepting category. This classification impacts their operational approach, as NBFC-Ds must adhere to stricter regulatory guidelines on deposit protection and liquidity management to safeguard depositors’ interests. In contrast, NBFC-NDs may have more operational flexibility but face different risks related to funding and credit exposure .
Robust audit processes, including Product Life Cycle Audits, enable NBFCs to achieve strategic goals such as risk management, operational excellence, and regulatory compliance . These audits evaluate various stages from product policy formulation to credit policy execution, which allows early identification of inefficiencies and potential risks. In turn, they contribute to creating a competitive advantage by ensuring operational efficiency, enhancing customer trust, and maintaining market credibility. Moreover, such comprehensive audits facilitate strategic decision-making, leading to innovative financial products and services tailored to market demands .
The audit process for systemically important NBFCs (NBFC-ND-SI) differs significantly from smaller non-systemically important NBFCs due to the scale, complexity, and regulatory scrutiny involved. Systemically important NBFCs, which hold assets of Rs. 500 crores or more, require more comprehensive audits focusing on financial stability and compliance with strict regulatory norms . Critical elements in these audits include mapping of financial statements, risk exposure analysis, compliance with prudential norms, and evaluation of control environments. In contrast, smaller NBFCs may focus more on operational audits and basic compliance checks due to their limited systemic impact .
The National Housing Board plays a crucial role in regulating Housing Finance Companies by establishing guidelines on deposit acceptance, income recognition, and asset classification . Its oversight ensures that Housing Finance Companies operate within a framework that promotes financial stability and consumer protection. Lapses in adherence to NHB guidelines can lead to serious consequences such as financial penalties, loss of licensing, and diminished market confidence, ultimately affecting their ability to offer competitive housing loans and maintaining client relationships .
Core Investment Companies (CICs) maintain compliance with regulatory requirements by adhering to guidelines on asset size, which must be Rs. 100 crores or more, and structure of investments, ensuring at least 90% of their total assets comprise investments in equity shares, preference shares, or loans to group companies . They must also avoid trading their investments, only allowing for block sales for dilution or disinvestment. Non-compliance can lead to severe consequences such as penalties, restricted operations, or loss of CIC status, impacting their ability to raise funds and invest in group companies .
NBFCs follow stringent valuation guidelines that require marking investments to market standards. Quoted investments are valued at the lower of cost or market value, grouped into categories like equity shares and government securities . Unquoted equities are valued at cost or break-up value, whichever is lower, and government securities are kept at carrying cost. These guidelines make financial reporting more transparent, ensuring stakeholders receive an accurate picture of financial health, influencing strategic decision-making. Misvaluation can lead to distorted financial outcomes, impacting investment strategies and regulatory compliance .
NBFCs are distinct from typical banking institutions primarily because they do not offer demand deposits, a core function of banks. Instead, their business operations are centered around loans and advances, acquisition of shares, leasing, and similar financial activities . Unlike banks, NBFCs do not include activities such as agriculture or sale of goods, which affects their classification. They are also subject to different regulatory oversight, with the Reserve Bank of India (RBI) providing specific prudential norms tailored to their activities . This regulatory environment reflects their unique role in financial markets, emphasizing risk management and liquidity without the safety net of deposit insurance common in banking .
Systematic risk exposure in NBFCs is assessed through careful mapping of financial interactions, stress testing, and monitoring residual risks . This involves evaluating their asset-liability profiles, counterparty risks, and market conditions. NBFCs implement several measures to mitigate these risks, such as maintaining adequate capital buffers, diversifying portfolios, and adhering to prudential norms set by regulatory bodies. They also engage in regular audits to ensure compliance and dynamically adjust strategies to changing market environments to maintain balanced risk exposure .
