Deposit-taking from public is regulated in most countries. As a matter of fact, there are very few countries which allow manufacturing companies to raise public deposits. This unique feature of the Indian financial system is the relic of the 1950s and 60s when textile companies in Maharashtra and Gujarat used to resort to public borrowings to bridge temporary working capital gaps. In the present-day environment, it is a matter of examination at policy level whether allowing manufacturing companies to source public savings directly is serving any macro-economic purpose. Though the amount of deposits raised by non-financial companies is huge, this amount is shared by a large number of companies and such, the companies suffer from diseconomies of scale whereas the depositors suffer from lack of efficient service which specialised depository institutions can offer.

Banking companies are those which engage in banking business. "Banking" is defined in sec. 5 (b) of the Banking Regulation Act, 1949 as "accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise". The essence of banking business is accepting of deposits for the purpose of lending, and the character of such deposit is their withdrawal on demand. Thus, it is current-account keeping which forms the crux of banking business. Mere accepting of deposits for lending does not amount to banking business.

Banking companies are regulated by the RBI under the Banking Regulation Act. No one can carry the business of banking in India without a license granted by the RBI [sec. 22 of the Banking Regulation Act]. Deposit-taking by banking companies is regulated by various instructions of the RBI from time to time.

Non-banking non-financial companies, that is, those not covered by the definition of "financial institution" as defined in sec. 45I (c) of the RBI Act, are governed by sec. 58A of the Companies Act, 1956. This section debars a company from inviting or accepting any deposits from the public or from its members unless such deposit is in accordance with the rules framed under the section. The rules are Companies (Acceptance of Deposits) Rules, 1975. These rules allow companies to raise deposits upto 25% of their net owned funds. The exclusions from the purview of "deposit" are by and large the same as under the NBFC Directions, 1998.

The Companies (Acceptance of Deposits) Rules do not apply to financial companies. This is by virtue of a Notification dated 18-9-1975 of the Deptt of Company Affairs, which exempts every "financial company", meaning a company which is a financial institution under sec. 45I (c) of the RBI Act from the whole of sec. 58A, except sec. 58A (2) (b), which provides for the form and contents of the advertisement for soliciting deposits.

Non-banking financial companies are covered by the Directions of the RBI. [Click here for full text of the RBI's Directions] The RBI classifies and regulates different financial companies as follows:

• Unregistered financial companies
• Registered financial companies, with net owned funds less than Rs. 25 lacs
• Equipment leasing and hire-purchase companies
• Loan and investment companies
• Not the above, and not an RNBC, but a "financial company"
• Residuary non-banking companies (RNBCs)
• Housing finance companies

 A brief description of each of these categories follows:

As per sec. 45-IA of the RBI Act, no non-banking financial company can commence or carry on the business of a financial institution without obtaining a registration with the RBI. The meaning of a financial institution has already been analysed separately.

Accordingly, there is a sweeping restriction on business rights of unregistered financial companies.

Contrary to what is commonly understood, a financial company may or may not have access to public funds. For example, the NBFC Directions, 1998 provide that NBFCs with net owned funds of less than Rs. 25 lakhs will not be allowed to access any public deposits. The Act takes this much further: such company cannot even be in business. As for companies which were in existence, carrying on financial business as on 9^th January, 1997, a 3-year time frame has been given by the Act within which the company has to shore-up its net worth to Rs. 25 lakhs in the minimum. This transient provision is understandable, but the sweeping restriction on business rights in the Act, though the company does not access any deposits as it is not even allowed to access, sounds unreasonable and seemingly goes beyond the purpose of the law.

Though the RBI (Amendment) Act 1997 had put minimum net worth of Rs. 25 lakhs as a precondition for registration, it allowed existing companies a 3 years time to increase their net worth. The 1998 NBFC Directions have added another dimension to this provision and imposed a straight ban on the deposit-taking powers of these companies. According to these Directions, on and from 2^nd January 1998, a financial company with net worth of less than Rs. 25 lakhs will not be allowed to raise any "public deposit" at all. This ban has been retained in the 31^st January directions as well.

Coupled with the RBI (Amendment) Act, the impact of the new regulation is as follows:

• No company incorporated on or after 9^th January engage in a financial business.
• As for companies incorporated before, they have a 3 years' time to increase their net worth.
• However, they cannot accept any "public deposits" on or after 2^nd January 1998.
• Whatever public deposits they hold as on that date have to be refunded by 31^st Dec. 2000 by reducing the volume of deposits as on 31^st January 1998 by one third at the end of each calendar year upto year 2000.

The 1998 Directions have, thus, added to the strain created on small finance companies by the RBI Amendment Act of 1997. While the 1997 Act required the company to bring in capital, the Directions require the company to pay out deposits. Understandably, with the two requirements together, small financiers do not have the option of even downsizing their operations to pay off their liabilities: they have to bring in additional capital to pay off the liabilities. In other words, it is not a case of liabilities substituting liabilities, or assets being cut down to pay off liabilities, but capital coming in to pay off liabilities. This would be a particularly difficult proposition for most small companies.

The Directions also contain a ban on deposit-taking by an unrated company or a company rated below the minimum investment grade rating. The minimum rating, by any one of the rating agencies, is A- or equivalent for leasing and hire-purchase companies and A for loan and investment companies. If a company has sought rating from more than one agency,, the company is free to choose the rating that favours it.

 The rating agencies approved for the time being in India, and their minimum ratings, are as under:

The discrimination created between leasing and loan companies is understandable except by historical evolution. The 2^nd January Directions provided A as the minimum rating for all financial companies. However, in the mass-scale resentment that followed, the RBI relented as far as leasing and hire-purchase companies are concerned. Loan companies were not well-represented; therefore, the relaxations were limited to leasing companies alone. As far as loan companies are concerned, adequate safety is inadequate safety, and therefore, such companies are not allowed to access "public deposits" .

One must not dismiss the case of loan companies lightly. With 60% income and investment criteria, many asset-based financing companies might slip into the category of loan companies because, for purely technical reasons, they might have chosen loan as their instrument modality. Sales-tax is one of such technical reasons that might force a company to choose loan as the modality. The instrument changes; not the substance, but this change of instrument changes the character, and hence the deposit-raising ability of the company seriously.

With the criteria of minimum investment grade rating, the minimum net worth condition seems to be superfluous. The rating agencies rate the credit of a company based on CAMEL, that is, capital, assets, management, earnings and liquidity. That is to say, capital is the first and perhaps the most significant of all elements in analysing credit. Though there is no document by any of the rating companies on what they consider to be the minimum capital for a safe credit, the minimum size for an investment grade rating is nowhere near Rs. 25 lakhs, the statutory meaning. In fact, with every other factor appreciably strong, many companies have been given below investment grade rating merely because their capital strength is not good. It would be doubtful whether even with a Rs 2 crore net worth, a company would get the minimum rating of investment grade which is the least required.

Here again, the true impact of the law would be far more restrictive than what it appears on the surface. Not Rs. 25 lakhs is the minimum net worth required for accepting deposits, it is such capital as would qualify a company in the eyes of the rating agencies for a minimum A rating. This fact misses the eye on a prima facie reading.

In order to be classed as an equipment leasing or hire-purchase company, the Directions require that the company should be principally engaged in the business of leasing and hire-purchase. The two businesses, leasing and hire-purchase, can be seen together from the point of view of principality.

An administrative circular issued on 2^nd January clarifies that the RBI has decided that to be classified as an equipment leasing or hire-purchase company, the company should have not less than 60 per cent of its assets, and shall derive not less than 60 per cent of its income, from equipment leasing and hire-purchase activities taken together.

If a company is not classified as an equipment leasing and hire-purchase company, and it is not an investment company, it will then be treated as a loan company.

Having satisfied the test of being a leasing company as per the above definition, an equipment leasing company has to satisfy the following 3 tests, common for all deposit-seeking companies:

• Minimum net worth Rs. 25 lakhs
• Minimum credit rating
• Must be complying with prudential norms

Equipment leasing companies which have the minimum rating as above have been given the following freedom as per the 31^st January Directions:

• They can accept fresh deposits, and renew existing deposits even after 31^st January, even if they are in excess of the ceilings as on that date.
• They must now, however, exceed their balance on as on 31^st January 1998.
• They have to bring down their volume of deposits so as to eliminate the excess, in instalments of 1/3^rd each year, and clear the excess by 31^st December 2000.
• Companies having net worth of less than Rs 25 lacs, or those not having the minimum rating, cannot accept any fresh deposits with effect from 31^st January 98.

In order for a company to be classified as a financial company, it has to be a company as also a "financial institution". "Financial institution" is defined in the RBI Act.

As per sec. 45I (c) of the RBI Act, a financial institution is a non-banking company which carries on as its business or part of its business any of the following activities:

1. financing whether by way of making loans or advances or otherwise;
2. acquisition of marketable securities;
3. letting of goods on hire-purchase;
4. insurance
5. managing or conducting of chits or kuries;
6. prize or gift schemes by sale of units etc.

A financial institution does not include an institution which carries on as its principal business any agricultural operation, industrial activity, trading or purchase and sale of immovable properties. 

• Click here for full text of the RBI Directions
• Click here for full text of the Prudential Norms Directions (latest as amended on 12^th May 1998)

• Click here for write-up on accounting for non-performing assets as per Prudential regulations.