Conversion Of NBFC Into Bank

What is Conversion Of NBFC Into Bank?

NBFC have a phenomenal role to play in Indian economy to have sound sources of funding. As said by PN Vasudevan, Bank is like a marriage; NBFC is like a bachelor’s life; you enjoy it and have a lot of freedom but at the end of the day, that’s not life.NBFCs, once they get converted into banks, will get access to lower-cost deposits and improved leverage.

How Bank is different as compared to Non-Banking Finance Company

The Bank and NBFCs function comparable to each other but there are some allowances given to only Banks. i.e following activities can only undergo by Banks

• Acceptance of Deposits;
• Issue of cheques drawn and being a part of the payment and settlement system;
• Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation

Legal norms for converting NBFC into Bank

While non-banking financial companies (NBFCs) are seen as one of the key contenders to receive the banking regulator's green signal to foray in the banking space but some of them may face a challenge to meet the criteria to convert themselves into a bank.

Following conditions to be fulfilled before Conversion Of NBFC Into Bank

• The minimum paid-up capital for a new bank shall be Rs.200 crore. The initial capital shall be raised up to Rs.300 crore within three years of commencement of business.
• The minimum promoters’ contribution shall be        40 percent of the paid-up capital of the bank.
• The initial capital, other than the promoters’ contribution, may perhaps be raised through public issue or private placement.
• While expanding capital to Rs.300 crore within three years of commencement of business, the promoters will have to bring in additional capital, which would be at least 40 percent of the fresh capital raised.
• Capital will be locked in for a minimum period of 5 years from the date of receipt of capital by the bank.
• The new bank should not be sponsored by a large industrial house. Though, individual companies, directly or indirectly connected with large industrial houses may be allowed to participate in the equity of a new private sector bank up to a maximum of 10 percent who will not have controlling interest in the bank.
• The proposed bank shall maintain an arm’s length relationship with business entities in the promoter group and the individual company/is investing up to 10% of the equity as stipulated.
• The relationship among business entities in the promoter group and the proposed bank shall be of like between two independent and unconnected entities.

Conversion of NBFCs into private sector banks

NBFC who has good track record wishing to convert into a bank should satisfy the following criteria

• The NBFC should have a minimum net worth of Rs.200 crore in its latest balance sheet which shall increase to Rs.300 crore within three years from the date of conversion.
• The NBFC should not have been promoted by a large Industrial House or owned/controlled by public authorities, which includes Local, State or Central Governments also.
• The NBFC shall acquire a credit rating of not less than AAA rating (or its equivalent) in the previous year.
• The NBFC should have an impeccable track record in compliance with RBI regulations/directions and in repayment of public deposits and no default should have been reported.
• The NBFC wishing to convert into the bank should have a capital adequacy of not less than 12 percent and net NPAs of not more than 5 percent.
• The NBFC on conversion to a bank will have to comply with Capital Adequacy Ratio and all other requirements such as lending to priority sector, promoters' contribution, lock-in period for promoters' stake, dilution of promoters' stake beyond the minimum, NRI and foreign equity participation, arm's length relationship, etc. as applicable to banks.

Other Requirement to be followed for Conversion Of NBFC Into Bank

• The bank shall maintain a minimum capital adequacy ratio of 10 percent on a continuous basis.
• The new bank will have to witness priority sector lending target of 40 percent of net bank credit as applicable to other domestic banks.
• The new bank will be required to open 25 percent of its branches in rural and semi-urban areas.
• The new bank shall not be permissible to set up a subsidiary or mutual fund for at least three years from the date of commencement of business.
• The headquarters of the proposed new bank could be in any location in India as decided by the promoters.
• The new bank shall be governed by the provisions of the Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, other relevant Statutes and the regulations of SEBI regarding public issues and other guidelines applicable to listed banking companies.

Procedure for Application for Conversion Of NBFC Into Bank

• The application shall be prepared and submitted in the prescribed form.
• The applications shall be accompanied with a project report covering business potential and viability of the proposed bank, the business focus, the product lines, technology capability and other information as may be required.
• The detailed information on the background of promoters, their expertise, the track record of business and financial worth, details of promoters’ direct and indirect interests in various companies/industries, details of proposed participation by foreign banks/NRI/OCB shall be furnished.
• Licences will be issued on a selective basis to those who conform to the requirements stated by RBI and who are likely to conform to the best international and domestic standards of customer service and efficiency.
• After receiving an application, same will be screened by RBI to ensure prima facie eligibility of the applicants and will be referred to a high-level Advisory Committee to be set up by RBI.
• The Committee will screen the applications by the procedure set up by them.
• The decision to issue an in-principle approval for setting up of a bank will be taken by RBI which will be final.
• The in-principle approval issued by RBI is valid for the period of one year from the date of granting in-principle approval and subsequently would lapse automatically.
• After issue of the in-principle approval issued by RBI for setting up of a bank in the private sector, if any contrary features are noticed subsequently regarding the promoters or the companies/firms with which the promoters are related and the group in which they have interest, the Reserve Bank of India may impose additional conditions and if warranted, it may withdraw the in-principle approval.

Discussion Paper issued by Finance Minister on Entry of new banks in the private sector

• The discussion paper touches conversion of NBFCs into Bank. RBI has given NBFCs who have a good track record and low-NPAs an option to enter the banking sector.
• The discussion paper, instead of giving recommendations, has discussed the pros and cons of various options out of one option discussed for NBFCs is their conversion into banks and the second is to allow only standalone NBFCs (with no industrial house as its promoter) to convert into a bank.
• The advantages NBFCs would enjoy once they convert into the bank, which is access to lower-cost deposits and improved leverage. Currently, only a few NBFCs are allowed to access public deposit.

Conclusion

Conversion may not be a wise idea as it depends on the business model of individual NBFCs. Thus, considering the long-term strategy NBFC shall go for the conversion.

Despite the threat of increased competition, the impact will be low.NBFCs are presently not of a scale to intimidate existing banks.

In addition, NBFCs will also forego the advantages of operating in an unregulated turf with concentrated exposures. However, Bank will get to enter the markets serviced by NBFCs.