The Non-Banking Finance Companies (NBFC) sector is an integral part of Indian Financial System, providing large infrastructure financing to small microfinance, while innovating over time to address the debt requirements of every segment of the economy. For a large and diverse India, the NBFC is a key contributor to the financial inclusion program, as the banking penetration continues to be low, despite implementation of various social sector such as Pradhan Mantri Jan Dhan Yojana (PMJDY).

The sector has evolved from being fragmented and informally governed to being well regulated and in many instances, adopted best practices in technology, innovation and risk management as well as governance. NBFCs in India have recorded marked growth in recent years.

NBFCs are today passing through a very crucial phase where RBI has issued a revised regulations such as NPA norms, capital requirements, provisioning requirements with the objective to harmonize it with banks and Financial Institutions and address regulatory gaps and arbitrage. The asset classification norms have been made more stringent so as to be at par with banks. With a view to strengthening the early warning system for recognising incipient financial stress, NBFCs were directed in March 2014 to create a sub-asset category ‘Special Mention Accounts' (SMAs). They were also directed to report relevant credit information to the Central Repository of Information on Large Credits (CRILC).

The scheme for encouraging banks to extend long-term loans (known as the 5/ 25 structure) to infrastructure with a flexible structuring/ tenure to absorb potential adverse contingencies has also been extended to NBFCs from January 2015.

The revised regulatory framework for NBFCs issued in November 2014 aligns NPA norms for NBFCs with that of banks in a phased manner. Accordingly, the time limit for classifying a loan account as NPA will be progressively reduced to 90 days by March 2018. Furthermore, to bring parity in the regulation of NBFCs with other financial institutions (FIs) in matters relating to recovery of bad loans, NBFCs registered with the Reserve Bank and having asset size of Rs 5 billion and above will be considered for notification as FIs in terms of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002.

TDS exemption: NBFC's have to face severe hardship in terms of collection of TDS certificates from its customers whose numbers run in thousands. Therefore, payment of interest to NBFC's should be excluded from the purview of provisions of Section 194A of the Act and tax collections through NBFC's should be made by way of advance tax. This will provide level playing field to NBFCs similar to banking companies, LIC, UTI, public financial institution etc., which are also exempted from the purview of this Section.

Allow tax deduction for Provision for NPAs: The provisions for bad and doubtful debts made by banks are allowed as a deduction to the extent of 7.5% from the gross total income and 10% of aggregate average rural advances made by them. NBFCs are now subject to directions of RBI as regards income recognition and provisioning norms. Accordingly, NBFCs are also compulsorily required to make provisions for NPAs. However, the deduction is not available to NBFC. It is essential that such discriminations between NBFCs and banks be eliminated.

Deduction for Reserves to NBFC-MFIs (Micro Finance Institutions): The deduction in respect of special reserve created and maintained by a specified entity, to the extent of 20% of the profits derived from eligible business. The deduction is available to a reserve created by a financial corporation engaged in the business of providing long-term finance for industrial or agricultural development in India or by a public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes. NBFC-MFIs also provide long-term finance for agricultural and industry in the form of micro-credit/small loans but are not eligible for deduction. It is, therefore, suggested that NBFC-MFIs should also be included as specified entity eligible for claiming deduction.

Tax benefits on interest and principal repayment: the housing finance companies are expecting increase in tax benefit limit for home loan repayment from Rs 2 lakh principal paid under sec 80C. The segment is also expecting more announcements on Housing for all by 2022 scheme.

Key stocks to watch

HDFC, LIC Housing Finance, L&T Finance Holding, Bajaj Finance, Shriram Transport Finance

Outlook

The NBFCs sector is in desperate need of an on par treatment with the banking system. The sector is expecting resolutions to the various problem in Union Budget 2016-17. With NPA recognition norms turning more stringent, the sector would require the deduction benefit for NPA provisions on priority basis. The higher tax benefit for home loans and further clarity on Housing for All by 2022, would benefit housing loans sector NBFCs. Any allowance of deductions for NPA provisions for tax purposes, would improve profitability of all NBFCs and thus would lead to higher capital available for lending and reduce regulatory arbitrage.