Open Access Research Article
FOREIGN DIRECTION INVESTMENT IN NBFC SECTOR
Published Paper
Article Details
FOREIGN DIRECTION INVESTMENT IN NBFC
SECTOR
AUTHORED BY - ZEBA DARVESH
Abstract
This research paper conceptualizes
the intermix of Foreign Direct Investment in the Non-Banking Financial Company
with respect to Indian legislation regime which is governed primarily by
“Foreign Exchange Management Act, 1999 (FEMA)”[1].
Furthermore, the accord of Foreign direct investment and Non-Banking Financial
Company has undergone changes over the years such as the additional capitalization
rules which is associated with foreign ownership has been eliminated and
further changes with respect to minimum capitalization have been improvised to
keep up with the global economy. The Reserve Bank of India has introduced
changes in the FDI Policy with respect to NBFC vide its notifications to
attract overseas investment. Lastly, FDI policy is governed by other
legislations apart from the “Foreign Exchange Management Act, 1999 (FEMA)”
namely the “Reserve Bank of India Regulation Act, 1934”[2], “Foreign
Exchange Management (Non-Debt Instruments) Rules”, 2019[3]
and Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt
Instruments) Regulations, 2019[4]
and the important provisions have been discussed forthwith.
Keywords: Foreign Exchange Management
Act, 1999, Foreign Direct Investment, Reserve Bank of India, capitalization
rules, non-Banking financial Company, Indian legislations.
Introduction
Foreign Direct Investment (FDI) is a
stake in a foreign company or any project undertaken by a foreign investor,
company, or government. This is a type of investment in which a party in one
country makes a substantial and long-term investment in a business or
corporation in another country. A long-term interest is generally considered to
be established when an investor obtains at least 10% of the voting power in a
company.
The presence of the element of
control is required in order to establish a Foreign Direct Investment. Control
is defined as the intent to actively manage and influence the operations of a
foreign firm, highlighting the distinction between FDI and a passive foreign
portfolio investment. FDI can take many forms, including acquiring voting stock
in a foreign company, mergers and acquisitions, joint ventures with foreign
corporations, or establishing a subsidiary of a domestic firm in a foreign
country.
In India, the Foreign Direct
Investment is governed by the Foreign Exchange Management Act, 1999 (FEMA) as
the primary legislations along with the applicable rules and regulations
prescribed including the “Foreign Exchange Management (Non-Debt Instruments)
Rules, 2019 (NDI Rules)”[5]
and the “Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt
Instruments) Regulations, 2019”[6]
which function and operate under the guidance of the RBI.
A Non-Banking Financial Company (NBFC) is a company
registered under the Companies Act, 2013 and is engaged in providing services
pertaining to financial sector extending to acquisition of shares, stocks,
debentures and providing loans and advances. These institutions have gained
importance over the recent years for being able to fill the gap and the lacunae
created by the traditional banks in providing credit and advances with respect
to certain sectors of the economy pertaining to Small and medium-sized
enterprises (SMEs).
The co-relation between NBFC’s and Foreign Direct Investments
is closely linked as FDI inflows have played a crucial in the NBFC sector which
led to the overall development and growth of NBFC sector. The sector has been
able to attract Foreign Direct Investment because of the sector being able to
offer potential with respect to the growth and opportunities available to offer
for investors to participate in the Indian Financial System along with
complying with the regulatory bodies, primarily involving Securities Exchange
Board of India (SEBI), 1992.
Foreign Direct Investment has various positive impacts on the
NBFC sector such as capital infusion as Foreign direct investment (FDI) allows
NBFCs to raise capital from foreign investors, providing them with an
additional source of funds. This capital infusion assists NBFCs in expanding
their operations, improving their product offerings, and increasing their
market share. FDI brings advanced technology and
best practises, which can assist NBFCs in improving their operations and
increasing their efficiency. This can result in cost savings, better customer
service, and higher profitability. Foreign
direct investment enables NBFCs to diversify their business and product
offerings. For example, an NBFC that specialises in lending can use FDI to
diversify into insurance or wealth management, providing its customers with
more comprehensive financial solutions. FDI
brings risk management expertise, which can help NBFCs better assess and manage
credit risk, market risk, and operational risk. This can result in more
cautious lending practises and a reduction in non-performing assets.
Foreign Direct Investment and NBFC’s
FDI in NBFCs can come
in a variety of forms, including equity investments, debt investments, or a mix
of the two. A stake in an NBFC is purchased through equity investments, giving
the investor ownership rights and the chance to get involved in the management
of the business. Contrarily, debt investments entail lending money to an NBFC
in exchange for a predetermined interest rate and the repayment of the
principle at a later time. FDI has been crucial in enabling NBFCs to grow their
businesses and boost the amount of money they can lend. The introduction of new
technologies, management techniques, and access to global markets by foreign
investors has aided NBFCs in diversifying their loan portfolios and
strengthening their risk management capacities. Owing
to the understanding of the significance of these organisations in providing
lending to SMEs and other underserved sectors of the economy, the Indian
government has also been supportive of FDI in the NBFC industry. The government
has put in place a number of initiatives to promote FDI inflows, including loosening
rules on foreign ownership of NBFCs and allowing 100% FDI in specific NBFC
sectors, such housing finance.
The potential of foreign investors to inject long-term
capital, which can assist stabilise the financial system and lower volatility,
is one of the major advantages of FDI in NBFCs. This is crucial in the context
of India, where the banking industry has historically been vulnerable to crises
because of high rates of non-performing loans and poor governance. FDI can also assist NBFCs in expanding their international
markets and diversifying their funding sources. This is critical for NBFCs as
well because they rely heavily on domestic funding sources like bank loans and
commercial paper. Diversifying funding sources can help NBFCs reduce their reliance
on volatile sources of funding while also improving their liquidity profiles.
FDI can also help NBFCs improve their risk management capabilities because
foreign investors bring expertise and knowledge from other markets. This can
help NBFCs implement best practises in credit risk management, operational risk
management, and regulatory compliance.
However, there are risks associated with FDI in NBFCs, such
as the possibility of foreign investors exploiting regulatory flaws or engaging
in predatory lending practises. As a result, the Indian government must closely
monitor and regulate FDI inflows to ensure that they do not pose a systemic
risk to the financial system.
Changes made in the FDI structure in NBFC’s in the recent
years vide RBI notifications
Foreign direct investment is regulated by the Foreign
Exchange Management Act, 2000 and has been governed by the Reserve Bank of
India. FDI in NBFC sector vide RBI notification[7]
has been allowed through either the government route or FDI automatic route.
The 100% automatic FDI route refers to an Indian government policy that allows
for 100% FDI in certain sectors or industries without prior government approval
or permission. Foreign investors can invest up to 100% of their equity capital
in an Indian company or sector under this route, with no restrictions or prior
approval from the government. The Indian government specifies the sectors or
industries that are eligible for 100% automatic FDI on a regular basis. Sectors
such as information technology, construction, manufacturing, and wholesale
trading are currently eligible for 100% automatic FDI. Although the 100%
automatic FDI route eliminates the need for prior government approval, foreign
investors must still adhere to certain regulatory requirements such as
sector-specific regulations, reporting requirements, and investment
restrictions, if any. Whereas, the Reserve Bank's approval is required for the
Government route, whereas the Authority's approval is not required for the
Automatic route. Foreign Direct Investment involves various procedures and
compliances therefore has always been regarded as a complicated procedure
because there has always been a regulatory apprehension in allowing foreign
direct investment above the minimum capitalization norms.
Furthermore, “The Foreign Exchange Management (Transfer or
Issue of Security by a Person Resident Outside India) Regulations, 2000” have
been amended, according to a Reserve Bank of India Notification[8].
Prior to the aforementioned notification, 100% FDI was permitted under the
automatic route but the NBFC’s are only permitted to engaged in 18 activities, which
were further bifurcated into fund-based and non-fund-based activities with a
minimum capitalization norm. Furthermore, the notification, permitted 100% FDI
through the automatic route under the heading 'other financial services,' with
no other restrictions. It has a comprehensive coverage under the said
notification for financial service activities regulated by financial sector
regulators and governed by the Reserve Bank of India, Securities Exchange Board
of India, Insurance and Regulatory Development Authority of India or any other
ancillary financial sector regulator as may be notified by the Government of
India. There have been changes introduced with respect to the conditions for
minimum capitalization norms which have been eliminated prescribing a greater
ceiling limit to the capitalization requirements from INR 20 million to INR 20
billion which was aimed at attracting long-term and serious foreign investors
to boost Indian economy[9].
In October, 2020, the Government along with the RBI has permitted 100% foreign
investment in the debt-restructuring sector under the automatic route which is
subject to regulatory approvals of the particular industry or sector.
On account of the changes made vide notifications of the
regulatory bodies, foreign banks and venture capitalist are now permitted to
invest in the Indian lending business and promote the growth and expansion of
the Financial Market allowing NBFC to make long-term loans to the
infrastructure sector in particular. Foreign loans, which are governed by the
Foreign Exchange Management (Borrowing and Lending in Foreign Exchange)
Regulation, 2000, the Foreign Exchange Management Act, 1999, and the RBI
regulations, are another aspect of foreign direct investment in non-banking
finance companies. However, NBFCs are only permitted to make loans for working
capital, loan repayment for capital expenditure, or loan repayment for other
than capital expenditure.
Lastly, the Single Master Form introduced in April, 2018 by
the RBI[10]
for reporting foreign investments in India which aimed at providing for a
simplified reporting mechanism and for consolidating and replacing the obsolete
method of multiple reporting forms for foreign investment, The SMF mechanism is
a mandate upon the NBFCs to follow in order to report the requirements for
foreign investment.
Legislations governing FDI in NBFC sectors
The Foreign Exchange Management Act (FEMA) of 1999 governs
foreign exchange transactions in India. The Reserve Bank of India (RBI) is the
regulator for foreign exchange transactions in India, and FEMA provides the
legal framework for them. The provisions of FEMA, along with the RBI's
regulations, establish the guidelines and regulations for foreign investment in
NBFCs in India. It is critical for NBFCs to follow these regulations in order
to avoid legal action or penalties.
The Consolidated Foreign Direct Investment Policy, 2020[11]
establishes a comprehensive framework for FDI in India. It is updated annually by the Department for Promotion of
Industry and Internal Trade (DPIIT) and lays out the various regulations and
conditions for foreign investment in various sectors, including NBFCs. The policy establishes the maximum allowable foreign
investment in various types of NBFCs. For example, under the automatic route,
the maximum permissible foreign investment limit for an NBFC engaged in
infrastructure finance is 100%. However, under the automatic route, the maximum
permissible foreign investment limit for an NBFC engaged in microfinance
activities is 74%.
Regulations of the Reserve Bank of India (RBI) is India's
NBFC regulator, and it has issued several regulations regarding FDI in the
sector. The key RBI regulations governing FDI in NBFCs as prescribed by the
NBFC Master Direction which establishes the guidelines and regulations for
NBFCs in India. It contains provisions concerning foreign investment in NBFCs.
Foreign Exchange Management Act, 1999 (FEMA) Master Direction
on Reporting specifies the reporting requirements for foreign investments in
India. Other FDI in NBFCs Notification which the RBI has issued notifications
regarding FDI in NBFCs, including minimum capitalization requirements and
sectors eligible for FDI.
Foreign direct investment (FDI) in Non-Banking Financial
Companies (NBFCs) is permitted under FEMA in various ways, firstly, FEMA allows
100% FDI in the NBFC sector through the automatic route for certain activities[12].
These include investment advisory services, stock brokerage, merchant banking,
and underwriting. FDI is not permitted in certain activities, such as chit
funds, Nidhi companies, and agricultural or plantation activities. Secondly,
the Investment Route which enumerates that FDI in NBFCs can be made via the
automatic route or the government route. Foreign investors can invest up to
100% of their equity capital in an Indian company under the automatic route
without obtaining prior government approval. Investments made through the
government, on the other hand, require prior approval from the Foreign
Investment Promotion Board (FIPB). Thirdly, the reporting Requirements provide
that all NBFCs that receive foreign investment must comply with FEMA reporting
requirements. The Reserve Bank of India (RBI) has introduced the Single Master
Form (SMF) for reporting foreign investments in India. SMF reporting
requirements for foreign investments apply to all NBFCs[13].
Furthermore, the Investment Restrictions have been imposed upon foreign
investment in NBFCs. Foreign investors, for example, are not permitted to
invest in companies engaged in agricultural or plantation activities, or in
real estate activities, except in the development of integrated townships and
affordable housing projects.
The Foreign Exchange Management (Mode of Payment and
Reporting of Non-Debt Instruments) Regulations, 2019[14]
are a set of regulations issued under the governance of RBI oversee the
reporting and the payment mechanism for non-debt instruments. The Regulations
prescribe for a specific mode of payment that is through inward remittance[15]
(transfer of funds from a foreign account to an Indian account through a
banking channel). The NBFC’s that receive such FDI’s are required to comply
with the aforementioned regulations as per the Single Master Form (SMF) for
reporting of foreign investments. Furthermore, these regulations also provide
for pricing guidelines which must not be less than the fair market value of the
shares and securities and prescribe for a lock-in period of 3 years. Foreign
investment in the NBFC sector is subject to sectoral caps under the NDI
Regulations. The sectoral caps differ depending on the NBFC's activity. For
example, under the automatic route, foreign investment in investment advisory
services, stockbroking, and merchant banking is permitted up to 100%, while
foreign investment in asset reconstruction companies is permitted up to 74%.
Conclusion
The relationship between NBFCs and
FDI in India is one which is mutually beneficial, as FDI has played an
important role in the development of the NBFC sector, allowing these
institutions to expand their operations and improve their risk management
capabilities. However, foreign direct investment inflows must be carefully
monitored and regulated.
Thereby, allowing 100% FDI in the
NBFC sector is a game changer for the Indian economy because it allows the sector
to grow on a larger scale and contributes significantly to economic growth.
Non-banking finance companies contribute more to economic growth than any other
sector. Foreign direct investment has increased capital inflows to the
Non-Banking Finance sector, allowing NBFCs to invest in large projects or meet
day-to-day business needs. Foreign direct investment has also aided in the
dismantling of domestic monopolies held by large investors, giving NBFCs a
competitive advantage in a market. It is correct to say that FDI in the NBFC
sector has become the backbone for Non-Banking Finance companies, assisting
them in efficiently achieving their vision and objectives.
[1] Foreign Exchange Management Act,
1999
[2] Reserve Bank of India Regulation
Act, 1934
[3] Foreign Exchange Management
(Non-Debt Instruments) Rules, 2019
[4] Foreign Exchange Management (Mode of
Payment and Reporting of Non-Debt Instruments) Regulations, 2019
[5] Foreign Exchange Management
(Non-Debt Instruments) Rules, 2019
[6] Foreign Exchange Management (Mode of
Payment and Reporting of Non-Debt Instruments) Regulations, 2019
[7] Reserve Bank of India Notification
dated September 09, 2016.
[8] Reserve Bank of India Notification
dated September 9, 2016.
[9] Foreign Exchange Management
(Non-Debt Instruments) Rules, 2019 (NDI Rules) Notification dated October
29, 2020.
[10] Reserve Bank of India Notification
dated June 07, 2018
[11] Department for Promotion of
Industry and Internal Trade “Consolidated FDI Policy Circular of 2020”
[12] Reserve Bank of India Notification
dated October 04, 2021.
[13] Reserve Bank of India Notification
dated June 07, 2018
[14] Notification No FEMA. 395/2019-RB
on October 17, 2019
[15] The Foreign Exchange Management
(Mode of Payment and Reporting of Non-Debt Instruments) Regulations Rule
3
Article Information
FOREIGN DIRECTION INVESTMENT IN NBFC SECTOR
Authors: ZEBA DARVESH
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/04/11
- Volume 2
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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