The NBFC sector is awaiting the Union Budget 2017-18 with high hopes. Non-Banking Finance Companies have been performing well recently. There was a sharp credit growth registered in the Financial year 2015-16. The credit growth for NBFCs was 15.5% compared to a much moderate 9.1% growth in the Non-Food sectors by the commercial banks. Even in comparison to the Non-Performing Assets (NPA), the asset quality has been good compared to commercial banks. It should be noted that the commercial banks have been criticized over the years for the rising NPAs and no solution by the banks in dealing with these issues. The quality of assets of the NBFC sector has also been deteriorating since 2012 though. However, the NPAs of NBFCs remained relatively lower than the NPAs of the banking sector.

NBFCs are categorized into two types on the basis of their liability structure: deposit-taking NBFCs (NBFCs-D) and non-deposit taking NBFCs (NBFCs-ND). As at end-March 2016, there were 11,682 NBFCs registered with the Reserve Bank out of which 202 were NBFCs-D and 11,480 were NBFCs- ND entities. There were 209 systemically important non-deposits taking NBFCs (NBFCs-ND-SI), which are subject to more stringent prudential norms and provisioning requirements. NBFCs-Ds' balance sheet expanded by 29.2% during 2015-16, On the asset side, loans and advances, which constituted close to 90 per cent of the assets, registered significant growth and NBFCs-Ds' investment activities also witnessed an increase during the year. Borrowings from banks still constituted the largest source of funding for NBFCs-D.

The NBFC sector assumes a critical role in financial inclusion as it caters to a wide range of financial activities particularly in areas where commercial banks have limited penetration. NBFCs are expected to play a crucial role in fostering inclusive growth, especially in sectors like MSMEs. Consolidation within the NBFC sector continued during 2015-16. Their assets continued to register substantial growth. The accelerated growth in credit deployment by NBFCs was due to their ability to contain risks and tap demand in niche markets. The profitability of NBFCs was significantly higher as compared to commercial banks.

The NBFC sector continued to raise funds mainly through debentures, borrowings from banks and commercial papers. The Reserve Bank also eased the norms for external commercial borrowings (ECBs) for NBFCs that lend to the infrastructure sector, to raise ECBs with a minimum maturity of five years. In addition, the Reserve Bank also allowed NBFCs to raise funds through rupee denominated bonds overseas. The quality of assets of the NBFC sector has, however, showed steady deterioration since 2012, though their NPAs have remained relatively lower than those of the banking sector. On the policy front, the revised regulatory framework for NBFCs, introduced in 2014 by the Reserve Bank of India, is beginning to be phased in to harmonize the prudential norms.

There are high hopes for NBFCs in the upcoming budget especially in relation to the cost of interest. High costs of interest charges by the banks from the Non-Banking Financial Institutions or the Micro Financial Institutions has been quite high. The end result is the interest charged by these NBFCs from their borrowers become exorbitant ranging from 24 to 26 percent at times.

Several big-ticket reforms and the push by the government of India to create growth opportunities is benefiting the sector. This also replicates in the increased credit growth and opportunities for NBFCs. There are hundred smart cities to be built over five years with more than US $7-8 s billion investment as investment. Under "Housing for All", 20 million houses are to be constructed in urban areas in next 7 years. Under urban development Scheme "AMRUT", 500 cities are to be developed. The crux of the matter is that these reforms would bring opportunities for the NBFCs. Despite the perception of higher cost of funds disadvantage, on an average, NBFCs have outperformed banks on Return on Equity (ROE) by 1.5-2.0%. The growth in terms of NBFCs has been ahead of commercial banks due to the simple reasons that they operate in the unpenetrated or underserved markets. This means that the yield is always on the upside. The service levels are faster compared to banks and there is a strict focus on the operating costs that is kept under control. This means that the return on assets is far ahead when compared to banks.

Payment of Interest Under Section 194A To be Exempted

NBFCs have to face severe hardship in terms of collection of TDS certificates from their customers whose numbers run in thousands. Therefore, payment of interest to NBFCs (including those which have been accorded Public Financial Institution status) should be excluded from the purview of provisions of Section 194A of the Act and tax collections through NBFCs 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.

Provisions of Section 43D to be Made Applicable to NBFC

In accordance with the directions issued by the RBI, NBFCs follow prudential norms and like the above institutions are mandatorily required to defer income in respect of their non-performing accounts. It is accordingly recommended that the provisions of Section 43D of the Act should also be made applicable to NBFCs registered with RBI. Section 43D of the Act recognizes the principle of taxing income on sticky advances only in the year in which they are received. This benefit is already available to Banks, Financial Institutions and State Financial Corporations. Although deferring of income in respect of Non-Performing Accounts under this section of the Act would mean that

Micro Finance Institutions lend the money to the people who are at the bottom of the pyramid. The rate of interest charged by these Micro Finance Institutions (MFIs) from the borrowers varies 24%-26%. The main reason of charging the high rate from the MSMEs is the high cost of interest charges by the Banks from MFIs. MFIs should get funds from the Bank at low interest rates, so that the people belonging to the lower stratum could actually be benefited. Service tax should be waived off from the processing fee on loan sanctioned by MFIs, so that the burden on the poor people can be reduced.

Routing of Funds to be Channelized using Jan Dhan Accounts

It is very difficult for the Lending Bank to monitor the end use of funds. Opening an account is a very easy process under PM Jan Dhan Yojna. Most of the people in remote areas have already opened their Bank Account under PM Jan Dhan Yojna. PMJDY has become a vehicle for channelizing for routing the funds released by MFIs to the needy poor. MFIs should be encouraged to disburse the loans to their borrowers through Bank Account only. Since NBFCs are supplementing banks and are also regulated by the Reserve Bank of India, NBFCs (including those which have been accorded Public Financial Institution status) should be treated at par with banks and the benefit of ‘Nil TDS' should be extended to them as well under Sec. 194A.

Exemptions of Section 194A should be extended to NBFC

Sec.194A provides for TDS at 10% on payment of interest to a resident. Sec.194A (3) provides for non applicability of Sec.194A to, inter alia, banking companies to which the Banking Regulation Act applies. Such exemption has not been extended to NBFCs. As a result, in contrast to the nil TDS rate for banks on their interest payments, NBFCs have to deduct tax at 10%. NBFCs have the option to apply for a lower withholding certificate u/s.197, but in practice, it is difficult to obtain this certificate, given the large number of customers. EMIs on loan instalments receivable by NBFCs also have an interest component subject to TDS. Extensive paper work and administration burden coupled with high collection costs in issuing large number of TDS certificates, filing quarterly returns, etc., make TDS collection cumbersome and costly. Also many a times, TDS estimated for advance tax computations actually turns out to be much lower than what is actually deducted by the customers, resulting in huge refund claims.

While most Banks are unable to reach the MSME sectors for their financing needs, Asset Finance and Infrastructure Finance NBFCs (AFCs & IFCs) bridge the gap and act as an extended arm of the banking system in India. Hence it is very important that these NBFCs are provided level playing field with the Banks. Such differentiation severely constrains these Non-Banking Financial Institutions / Companies in conducting their duties which essentially goes against Government's national goal of financial inclusion & Ease of Doing Business.

Outlook

In the expectations of a level playing field, industry associations and stakeholder have been eyeing for reduction of cost of borrowings and benefits on the taxation front. This will be beneficial that the NBFCs is doing in terms of reaching out to customers in remote areas. The other benefit would be reduction of interest rates charged from the customers. This would mean a win-win situation will be on the cards. The financial system that is the backbone of Indian economy can be improved leaps and bounces if banks and NBFCs function in a efficient manner. The countdown to the budget keeps these hopes on the rise.

Tables and Charts:

Domestic  Liquidity Aggregates
(Rs Billion)
Aggregates	2015-16	2015	2016
		Nov.	Sep.	Oct.	Nov.
	1	2	3	4	5
1 NM3	116,156.4	111,792.4	125,951.7	124,586.4	123,177.8
2 Postal Deposits	2,084.1	1,938.5	2,256.7	2,277.9	2,277.9
3 L1 ( 1 + 2)	118,240.5	113,730.9	128,208.3	126,864.2	125,455.7
4 Liabilities of Financial Institutions	29.3	29.3	29.3	29.3	29.3
4.1 Term Money Borrowings	26.6	26.6	26.6	26.6	26.6
4.2 Certificates of Deposit	0.3	0.3	0.3	0.3	0.3
4.3 Term Deposits	2.5	2.5	2.5	2.5	2.5
5 L2 (3 + 4)	118,269.8	113,760.2	128,237.7	126,893.6	125,485.0
6 Public Deposits with Non-Banking Financial Companies	394.7	..	418.4	..	..
7 L3 (5 + 6)	118,664.5	..	128,656.1	..	..
Note: Financial institutions comprise EXIM Bank, SIDBI, NABARD and NHB.
L1 and L2 are compiled monthly and L3 quarterly.
Source: RBI