FOREIGN DIRECT INVESTMENT IN NBFC
Non-Banking Financial Company (NBFC) is a type of company which is engaged in the business of loans and advances, acquisition of shares, stock, bonds hire-purchase, insurance business or chit business but does not include any institution whose principal business includes agriculture, industrial activity or the sale, purchase or construction of immovable property. Continuing with the liberalization of the overseas investments regime government has allowed 100% foreign direct investment (FDI) in ‘other financial services’ carried out by non-banking finance companies (NBFCs). The government has liberalized its policy for Foreign Direct Investment in NBFC.
Other financial services will consist activities which are regulated by any financial sector regulator such as RBI, SEBI, IRDA, Pension Fund Regulatory and Development Authority, National Housing Bank or any other financial sector regulator as may be notified by the government in this regard. However, the investment would be subject to conditions such as minimum capitalization norms specified by the regulator or government agency concerned. Finance Minister Arun Jaitley in the Budget 2016-17 speech had announced that “FDI will be allowed beyond the 18 specified NBFC activities in the automatic route in other activities which are regulated by financial sector regulators,”
LAW GOVERNING THE FOREIGN INVESTMENTS IN NBFC
Foreign exchange provisions are regulated by the FEMA, 2000 and NBFCs operations are regulated by the Reserve Bank of India within the framework of the RBI Regulation Act 1934. 100% FDI is allowed in NBFCs subject to the minimum capitalization norms as issued by the Government.
The Foreign Exchange Management Act, 1999 and Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulation, 2000 and the RBI regulations govern the provisions relating to foreign loans.
FOREIGN LOANS AND NBFC
Loans from foreign institutions are referred as External Commercial Borrowings (ECB). These loans could be obtained from foreign banks or foreign financial institutions. ECB can also be obtained in the form of bonds, preference shares, and debenture. ECB will also include a loan from a foreign shareholder who owns at least 25% of the shares of the borrower company.
Only in some specific sectors, RBI allows ECBs to be obtained after fulfilling necessary requirements. There is a requirement of complying with the procedural requirements to obtain foreign loans in a Non-banking financial company. While availing the loans no RBI approval is required.
FOREIGN INVESTMENTS MODES
In a Non-Banking Financial Company, foreign investment can be obtained not only in liquid currency but also by way of exchange of shares, conversion of loans to share, exchange of some skill sets etc.
MATURITY PERIOD AND INTEREST
Regarding the External Commercial Borrowing, there are certain rules and restriction mentioned in Foreign Exchange Management Regulation. There are some specific rules mentioned regarding the maturity period and the amount of interest to be paid. ECB cost includes the interest charged by the bank, other fees and expenses paid in foreign loans. It must be within the limit which is measured with respect to a reference rate called the LIBOR or London Interbank Offered Rate.
- For a loan whose average maturity period is 3-5 years, its interest would be 3.5% over six months the LIBOR and
- For the loan which will be matured after more than 5 years its interest ceiling would be plus 5% over the six month LIBOR.
PROCEDURE OF TAKING FOREIGN LOANS
NBFCs are required to submit Form 83 to the Authorized Dealer bank to obtain the LRN number for taking foreign loans under the automatic route. The Loan Registration Number (LRN) must be certified by a company secretary or chartered accountant.
After this, AD bank must forward a copy of from 83 to the Department of Statistics and Information Management of RBI. Only after the allotment of the LRN number, a loan can be taken.
CONVERSION OF LOANS INTO EQUITY
In the case when the non-banking financial company is unable to repay its debts then after obtaining the consent of the lender it can convert some or all of its debts into equity. Provided that, it must be ensured that the shares are issued under the FEMA pricing guidelines when a company wants to convert the loan into equity.
CONSEQUENCES OF VIOLATION OF ECB REGULATIONS
If anyone contravenes the provisions of the ECB regulation punishment will be up to thrice of the amount involved according to the section 15 of the Foreign Exchange Management Act.
Corporate entities which are under the investigation by RBI can only avail foreign loans under the approval route. In case of violation is continuous then an additional penalty of INR 5000 will be payable per day. In case of unintended violation, it can be further rectified by compounding with RBI, which may help in getting a much lower penalty.
FDI POLICY FOR NBFC
In NBFC foreign investment is permitted under the automatic route as per the FDI Policy. Under automatic route, before making the proposed investment there is no requirement of Foreign Investment Promotion Board or RBI approval. Under automatic route up to 100%, foreign investment is allowed without the prior approval of foreign investment promotion board.
Each foreign transactions are required to be routed only through entities licensed by the RBI as per section 10 of FEMA.
Foreign investment was permitted under automatic route only in the following 18 prescribed non-banking financial service activities.
- Merchant Banking
- Portfolio Management Services
- Stock Broking
- Asset Management
- Venture Capital
- Custodial Services
- Leasing & Finance
- Housing Finance
- Credit Card Business
- Micro Credit
- Rural Credit
Non-fund based activities
- Investment Advisory Services
- Financial Consultancy
- Forex Broking
- Credit Rating Agencies
- Money Changing Business
In these specified activities foreign investment in non-banking sectors is permitted under the automatic route subject to compliance with the minimum capitalization norms.
After the establishment of NBFC with the requisite capital under the Foreign Exchange Management Regulation, subsequent diversification either through the existing company or through downstream NBFCs could be undertaken without any further authorization.
Foreign Investments Subject To Minimum Capitalization Norms
- The US $0.5 million for foreign capital up to 51% to be brought up front.
- The US $5 million for foreign capital more than 51% and up to 75% to be brought up front.
- 50 million for foreign capital more than 75% out of which $7.5 million to be brought up front and the balance in 24 months.
- The NBFCs having foreign investment more than 75% and up to 100%, and with a minimum capitalization of $50 million, can set up step down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without bringing additional capital.
- Joint Venture operating NBFCs that have 75% or less than 75% foreign investment can also set up subsidiaries for undertaking other NBFC activities, subject to the subsidiaries also complying with the applicable minimum capitalization norm mentioned above.
- Non- Fund based activities: The US $0.5 million to be brought upfront for all permitted non-fund based NBFCs irrespective of the level of foreign investment.
Subject to certain conditions
For such company it would not be permissible to set up any subsidiary for any other activity, nor can participate in the equity of an NBFC holding company. Above mentioned capitalization norms apply to each downstream subsidiary engaging in NBFC activities except where its parent entity already has more than 75% foreign investment.
CHANGES MADE IN FDI POLICY
In RBI notification dated 9 September 2016 following key relaxations have been introduced:
- In NBFC 100% FDI through the automatic route is now permitted in “Other Financial Services” beyond the 18 specified activities.
Provided that the activities are regulated by financial sector regulators such as RBI, SEBI, Pension Fund Regulatory Authority of India (IRDA) etc.
- Under FDI Policy, additional capitalization norms linked to foreign ownership has been removed, and thereby the capitalization norms have been aligned with those prescribed by the relevant regulators regulating these activities. Under FDI Policy, minimum capitalization norms have been eliminated as most of the regulators have already fixed minimum capitalization norms.
- Unregulated NBFCs which are not regulated by any financial sector regulators will require prior government approval.
Due to the relatively easier and faster sanction of loans with favorable interest rates, increasing FDI will be beneficial for the business. This move of the government is expected to provide a much-needed boost to this sector.