Project on Indian Financial Market Structure
[Source: RBI Report on Currency and Finance 1999-2000 dated January 29, 2001]

Credit Market Structure Contd.

Financial Institutions

A large variety of financial institutions has come into existence over the years to perform a variety of financial activities. While some of them operate at all-India level, others are state level institutions. All-India financial institutions (AIFIs) consist of all-India development banks, specialised financial institutions, investment institutions and refinance institutions. The state level institutions, on the other hand, comprise 18 State Financial Corporations (SFCs) and 26 State Industrial Development Corporations (SIDCs).

All-India development banks (IDBI, IFCI, ICICI, SIDBI and IIBI) occupy an important position in the financial system as the main source of medium and long-term project finance to industry. Among them, the IFCI (1948), IDBI (1964) and IRBI (presently IIBI-1984) were established under various Acts of the Parliament. The ICICI (1955) was set up as a public limited company under the Companies Act. The SIDBI (1990), a wholly owned subsidiary of IDBI, was set up for promotion, financing and development of industry in the small-scale, tiny and cottage sector. It acts as the chief refinancing institution in this sector. Besides, specialised financial institutions are also operating in the areas of export-import (EXIM Bank-1982), infrastructure (IDFC-1997), tourism (TFCI-1989) and venture capital (IVCF, ICICI Venture). Investment institutions in the business of mutual fund (UTI-1964) and insurance activity (LIC-1956, GIC and its subsidiaries-1972) have also played significant roles in the mobilisation of household sector savings and their deployment in the credit and the capital markets. In the agriculture and rural sector and the housing sector, the NABARD (1982) and NHB (1988) respectively, are acting as the chief refinancing institutions. Both of them are also vested with certain supervisory functions.

18 Besides providing direct loans (including rupee loans, foreign currency loans), financial institutions also extend financial assistance by way of underwriting and direct subscription and by issuing guarantees. Recently, some development financial institutions (DFIs) have started extending short term/working capital finance, although term-lending continues to be their primary activity. Amongst them, the five all-India development banks accounted for 83.9 per cent of the total financial assistance sanctioned during 1998-99. The overall importance of these financial institutions could be judged from the fact that their combined assets estimated at Rs.4,88,516 crore formed about 55.1 per cent of the assets of the banking sector as at end-March 2000.

Historically, the Reserve Bank and the Central Government have played a major role in financing these institutions by subscribing to the share capital, by allowing them to issue Government guaranteed bonds and by extending long-term loans at concessional terms. However, with the financial sector reforms in the 'nineties, concessional lending by the Reserve Bank and the Government was phased out, leaving the financial institutions to rely for financing their needs on the equity capital and the debt markets. Expansion of their equity base through public offers and public issues of long-term bonds has become an important element of their market-based financing. In order to provide flexibility, the Reserve Bank has also allowed FIs to raise resources by way of term deposits, CDs and borrowings from the term money market within the umbrella limit fixed in terms of net owned funds. In order to expand their scope of business, a large number of them have been entering various businesses - venture capital, mutual funds, banking (through subsidiaries) and insurance.

20 Non-banking financial companies (NBFCs) are financial intermediaries engaged primarily in the business of accepting deposits and making loans and advances, investments, leasing, hire purchase, etc. NBFCs are a heterogeneous lot. NBFC sector is characterised by a large number of privately owned, decentralised and relatively small-sized financial intermediaries. NBFCs are of various types, such as, loan companies (LCs), investment companies (ICs), hire purchase finance companies (HPFCs), equipment leasing companies (ELCs), mutual benefit financial companies (MBFCs) also known as Nidhis, miscellaneous non-banking companies (MNBCs) also known as Chit Funds and residuary non-banking companies (RNBCs). Loan companies, investment companies, hire purchase finance companies and equipment leasing companies are defined on the basis of the principal activity of their business. Although NBFCs in India have existed for a long time, they shot into prominence in the second half of the 'eighties and in the first-half of the 'nineties, as deposits raised by them grew rapidly. Total assets/liabilities of NBFCs grew at an average annual rate of 36.7 per cent during the 'nineties (1991-98) as compared with 20.9 per cent during the 'eighties (1981-91). Customer orientation, concentration in the main financial centres and attractive rates of return offered by them are some of the reasons for their rapid growth. Primarily engaged in the area of retail banking, they face competition from banks and financial institutions.

An attempt to regulate NBFCs started in the 'sixties when the Reserve Bank issued directions relating to the maximum amount of deposits, the period of deposits and rate of interest they could offer on the deposits accepted by them. To safeguard depositors' interest, norms were laid down from time to time, inter alia, regarding maintenance of certain percentage of liquid assets, creation of reserve funds and transfer thereto every year a certain percentage of profit, etc. These directions were amended from time to time, and in 1977 the Reserve Bank issued two separate sets of guidelines, viz., NBFC Acceptance of Deposits Directions, 1977 for NBFCs and MNBC Directions, 1977 for MNBCs.

Traditionally, the regulation of NBFCs was confined to deposit-taking activities of NBFCs. Although some attempt was made to regulate the asset side of NBFCs in 1994 in pursuance of the Shah Committee recommendations, the absence of adequate regulatory powers remained a major constraint. In 1997, however, the RBI Act was amended and it was given comprehensive powers to regulate NBFCs. The amended Act made it mandatory for every NBFC to have minimum net owned funds (NOF) of Rs.25 lakhs (subsequently increased to Rs.2 crore for the new companies) and obtain a certificate of registration from the Reserve Bank for commencing or carrying on business. The provisions relating to certificate of registration and minimum NOF were put in place to ensure that only companies with a healthy background and adequate capital were allowed to carry on the business. This was also to reduce the number of NBFCs to a manageable universe for purposes of effective regulation and supervision. As on June 30, 2000, out of the 37,274 companies seeking registration, 679 were approved for registration with permission to accept public deposits, while 8,451 were approved for registration without authorisation to accept deposits. Ceilings were prescribed for acceptance of deposits based on the principal business, capital adequacy, credit rating and NOF. The amended Act also empowered the Reserve Bank to regulate the asset side of NBFCs. Accordingly, in January 1998, the Reserve Bank laid down norms relating to capital adequacy, income recognition, asset classification, credit rating, exposure norms, etc. The Reserve Bank has also developed a comprehensive system to supervise NBFCs accepting/holding public deposits. This involves: (i) on-site inspection; (ii) off-site monitoring through periodic control returns from NBFCs; (iii) use of market intelligence; and (iv) submission of reports by auditors of NBFCs.

Public deposits held by NBFCs (including RNBCs) as at end-March 1999 at Rs.20,429 crore constituted approximately 2.6 per cent of aggregate deposits mobilised by scheduled commercial banks (excluding regional rural banks). Significantly, RNBCs (numbering only nine) held 52.1 per cent of the total deposits held by all NBFCs. Public deposits of large NBFCs (i.e., holding public deposits of Rs.20 crore and above) accounted for about 45 per cent of the total liabilities of the NBFC sector as a whole. Deposits of large size (Rs.10,000 and above) constituted 74.5 per cent of the total deposits of NBFCs. Increased competition in the financial sector, on the one hand, and strengthening of the regulatory requirements, on the other, have resulted in a major consolidation in the NBFCs sector in the recent period.

In India, investment in housing is mainly financed by own sources or from informal credit market. The formal housing finance institutions contribute only 15-20 per cent of housing investments in the country (NSS, 44th Round, 1988-89). However, within the formal housing finance sector, the conventional sources of housing finance in India have been the public sector institutions. Over the years, they were found to be grossly inadequate to meet the requirements of the new investments and maintenance of housing and habitat systems. Accordingly, since the mid-eighties, efforts have been directed at the development of housing finance institutions to meet the large resource gap that exists for housing finance in the country. A policy shift to encourage private and cooperative sectors in housing could be discerned and the necessary legal and regulatory changes are being effected in this regard.

25 The formal segment of housing finance includes funding provided by the Central and State Governments and funds from financial institutions like GIC, LIC, commercial banks and specialised housing finance institutions and cooperative banks. HUDCO was set up in April 1970 as an apex techno-finance organisation in order to provide loans and technical support to state and city level organisations. The State Governments are responsible for implementing social housing schemes. Almost all the States have set up Housing Boards in order to facilitate the implementation of the social housing schemes. Co-operative banks have been financing housing schemes. Co-operative banks cater to economically weaker sections, low and middle income groups as well as co-operative or group housing societies. The first comprehensive guidelines in respect of these banks (other than Urban Co-operative Banks) were issued by the Reserve Bank in December 1984.

The second formal tier of the housing finance consists of insurance corporations, commercial banks and housing finance companies. In 1976, the Reserve Bank issued its first set of housing finance guidelines to scheduled commercial banks for the benefit of weaker sections of the society. At present, banks are required to extend for housing finance 3 per cent of incremental deposits in a financial year. This apart, the financial market for housing includes housing finance companies, which provide the bulk of housing finance. Although there are around 400 HFCs in operation, the market is dominated by a few big players. More than 95 per cent of disbursements are accounted for by only 29 leading HFCs having refinance facility from the National Housing Bank (NHB).

In recognition of the need for developing a network of specialised housing finance institutions in the country, the National Housing Bank was set up in July, 1988 as a wholly owned subsidiary of the Reserve Bank under the National Housing Bank Act, 1987, to function as an apex bank for the housing finance. NHB regulates HFCs, refinances their operations and expands the spread of housing finance to different income groups all over the country, while functioning within the overall framework of the housing policy. It has also helped in diverting increasing proportions of annual provident fund accumulations for housing finance through housing linked savings schemes for provident fund subscribers.

The second major policy in this direction was introduced in 1994 in the form of the National Housing Policy (NHP) that envisaged a major shift in the Government's role from a provider to a facilitator. The policy framework deals with technological, financial and institutional aspects. The market for housing finance really started growing after the NHP was framed. Among the HFCs, while HUDCO dominated in terms of size (paid up capital), HDFC and to an extent LIC performed better in terms of profits and total disbursements. The NHP also recognised the need to strengthen HUDCO through augmenting its resources for meeting the requirements for shelter provisions for lower income groups in a larger measure in rural and urban areas including the shelters and the slum dwellers and for expanding infrastructure facilities in the urban areas.

The NHB, as part of its regulatory measures, announced introduction of major provisions in September 1997 to strengthen the regulatory framework for HFCs. The regulations, inter alia, included compulsory registration of housing finance companies with minimum net-owned fund of Rs.25 lakhs, mandatory transfer of 20 per cent of net profits to a reserve fund, maintenance of 5 per cent of SLR in bank deposits and another 5 per cent in approved securities. The Union Budget for 2000-01 envisaged a 20 per cent tax rebate under section 88 of the Income Tax Act for repayment of housing loans up to Rs.20,000 per year as against Rs.10,000 earlier.

The interest rate structure across HFCs has been similar due to the similarity in their liability structure resulting in similar cost of funds. For the year 1996-97, 55 per cent of the deposits received from the public were collected at rates above 14 per cent.