Non-banking financial companies ("NBFC") have undergone significant transformation over the past few years. Liberalisation of the legal regime, increasing digitisation and rising financial inclusion have given a boost to innovation, growth and investment in the financial sector.
Regulatory changes
Last year, the government liberalised the financial services sector by permitting 100% foreign direct investment in the financial sector under the automatic route, subject to the relevant entity being regulated by the Reserve Bank of India ("RBI") or other financial sector regulators. Further, the benefit of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 was extended to 196 NBFCs allowing such NBFCs to enforce security interests on assets charged to them, without having to resort to either judicial or arbitral authorities. Now, the government is working towards harmonising the regulations applicable to various categories of NBFCs to facilitate ease-of-doing business in this sector. The government is also taking actions towards a technological revolution in this sector by implementing an information technology framework and promoting FinTech activities.
Operational innovation and growth
With the rising innovation and growth in the sector, newer business models of NBFCs such as 'account aggregators' and 'peer to peer lending platforms' ("P2P Lending") are catching pace. To clarify, account aggregator is a form of NBFC engaged in collecting and providing information on a customer's financial assets, in a consolidated, organised and retrievable manner.
Further, P2P Lending is a form of crowd-funding which uses an online platform to match lenders with borrowers to provide unsecured loans. RBI notified P2P Lending platforms as NBFCs on 24 August 2017 and recently issued the Master Directions to regulate the P2P Lending platforms on 4 October 2017.
The NBFC sector is also seeing a surge of newer structured products like Market and Credit Linked Debentures wherein the principal investment of the debenture holder is protected and the interest payment, to be made at maturity, is linked to the performance of an underlying Index or a stock.
Varied investment strategies
Over the years, NBFC sector has witnessed diverse investment structures ranging from strategic investments, private equity investments to debt funding through NBFC route (including private equity funds establishing their NBFC arms). Strategic investments provide financial and operating synergy and help NBFCs tap new markets and provide expertise in operations. However, private equity investments provide capital infusion which can be utilised for expansion purposes, facilitate technology upgradation and also help in enhancing corporate governance of NBFCs. Debt funding through NBFCs is another investment strategy whereby foreign investors set up or acquire NBFCs in India and use such NBFCs to further lend or invest in Indian companies through structured instruments such as non-convertible debentures (which have an advantage of protected downside and equity upside by way of redemption premium or coupons). While, a number of investments have been structured in such a manner, there are divergent views in the market as to whether such investments through structured instruments could be subject to any issues from the foreign direct investment policy perspective.
Increased market activity with more registrations, approvals and listings
In 2016, RBI introduced a fast track registration process and two categories of applications depending on acceptance of public funds and customer interface. This fast track process increased activity in the sector in the form of registration of new NBFCs. Additionally, the number of approvals granted for foreign investment in investing companies and the number of NBFC listings with the stock exchanges have also increased substantially. The sector has also witnessed a large number of entrepreneurial initiatives and successes, mostly aiming at mid to bottom-of-the-pyramid customers.
Sector to look out for
The government policy of demonetisation acted as a deterrent for the unorganised sector and led to compulsive financial inclusion. The regulatory changes aimed towards promoting foreign investment also provided a boost to the financial sector. This sector has evolved significantly in the past few years and the growth of financial inclusion is expected to be driven further with higher penetration into parts of the economy where public-sector banks are unable to penetrate.
The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com