The decision by the Securities and Exchange Commission of Pakistan (SECP) to increase the capital requirement for non-banking finance companies (NBFCs), and to categorize them into two distinct groups, will go a long way towards streamlining this sector, which has been rather chaotic in the past.
Informed sources have told Business Recorder that the Non-Banking Finance Companies (Establishment and Regulation) Rules 2003 have been amended under the Non-Banking Finance Companies and Notified Entities Regulations, 2007, to ease out functional overlapping that had often created conflict of interest, as all NBFCs tried to perform all the functions under the old rules.
The new regulatory framework has been divided into two parts, ie NBFC Rules 2003 (amended) and NBFC Regulations. The Rules spell out the parameters for forming NBFCs, while the Regulations address all operational aspects and issues of NBFCs and their notified entities.
In order to facilitate new entities, all existing Prudential Regulations for NBFCs, issued on January 21, 2004 along with appropriate amendments, have been merged into one set of Regulations.
The new rules specifically forbid NBFCs' involvement in money laundering or any other illegal trade. Secondly, it has been made mandatory for all NBFCs to make all efforts to determine the true identity of the customer before extending their services.
The first group will cover asset management companies (mutual funds) while the second group will handle leasing, investment banking and housing finance units under the new NBFC Rules. For instance, if an NBFC wants to operate an asset management company, it will have to confine itself to its specified role without taking on other functions.
Likewise, if an NBFC wishes to work in deposit banking, leasing or investment sector, it will have to confine itself strictly to its core business. Another fundamental change brought about under the new regulatory framework is the enhancement of capital requirement for NBFCs. (The existing weak entities have been given three years to meet the revised capital requirement/benchmark limits).
Under the revised operational parameters set by SECP, an NBFC seeking licence for investment advisory or assets management services or both will not be eligible for seeking licence for any other form of business. The Commission has also notified the minimum equity requirement for each category of business.
For instance, the minimum equity requirement for obtaining a fresh licence for investment finance services has been set at Rs 1,000 million; for leasing at Rs 700 million; for asset management services at Rs 200 million; and for investment advisory services at Rs 50 million; for obtaining a new licence for housing finance services it is Rs 700 million, while the capital requirement for venture capital investment has been fixed at Rs 50 million.
These equity requirements are in sync with the best practices followed in 35 countries of the world. The new regulatory framework, devised by SECP, also takes into account the augmented powers of the Commission (including the powers to make regulations) which were incorporated in the Finance Act of 2007. These powers are specified in Section 282 of the Companies Ordinance.
Under the new rules particular care will be exercised to identify ownership of all accounts and those using safe custody facilities. The rules also lay down that the NBFC will establish procedures for ascertaining customer status and for monitoring the borrower accounts on a regular basis for checking the bona fides of the remitters and the beneficiaries of transactions for future reference.
Transactions, which are out of character with the normal operations of the account, ie high deposits or transfers will be thoroughly investigated. The SECP has also notified restrictions on certain types of transactions.
For instance, an NBFC will not take exposure against the security of shares/TFCs issued by it; will not provide unsecured credit to finance subscription towards floatation of share capital and the issue of TFCs; provide facilities against the non-listed TFCs or the shares of companies not listed on the stock exchange; provide facilities to any limited company against the shares/TFCs of that company or its group of companies; or provide facilities to any limited company against the shares/TFCs of the listed companies that are not members of the Central Depository System.
The regulatory mechanism framed by SECP relating to the functioning of NBFCs is quite timely, as the demand for capital investment in the country is expected to witness a sharp rise in future under the compulsion to introduce new technology. This means that our capital market will undergo considerable expansion. Incidentally, many NBFCs have in the past indulged in questionable practices, which resulted in heavy distortions.
The entire structure and growth of the corporate sector depends on a transparent and prudent financial system, while the financial resources of the corporate sector are determined by the performance, and strength of the financial markets of the country. SECP has taken a laudable initiative to regulate the functioning of NBFCs, particularly the increase in the minimum equity requirement for obtaining licence.