NBFC Due Diligence involves evaluating the commercial worth of a Non-Banking Financial Company (NBFC) through a careful analysis of its assets and liabilities. Usually, this evaluation is conducted by investors to assess the viability of investing in the NBFC and to ensure the safety and stability of their investments. It is a proof to the caution exercised by individuals or organisations considering investment in an NBFC.
It's important to emphasise that there's no fixed set of criteria for conducting NBFC due diligence. The approach is personalised based on the market and industry in which the NBFC operates. This customised approach aids in accurately determining the NBFC's true value and facilitates meaningful comparisons within the same market context.
Understanding Concept of NBFC Due Diligence
NBFC Due Diligence is a comprehensive evaluation of different aspects of a Non-Banking Financial Company. This process aims to determine the financial health, legal compliance and overall viability of the NBFC for potential investors.
Legal NBFC Due Diligence
Legal Due Diligence is an important component of NBFC DD and involves a detailed examination of the NBFC's legal standing and operations. This legal scrutiny includes various features, including:
- Incorporation and Business Structure:
Examining whether the NBFC has been incorporated in adherence to the required business structure or legal vehicle.
- Registration Compliance:
Assessing whether the NBFC has been registered in accordance with applicable laws before commencing its activities as an NBFC.
- Compliance with Legal Regulations:
Ensuring that the NBFC has been consistently adhering to the necessary legal compliances, such as maintaining required registers and accounting records in the prescribed format.
- Litigation Status:
Investigating whether there are any pending legal cases against the NBFC and ascertaining the current status of such cases.
- Legal Risk Assessment:
Analysing whether the NBFC is exposed to any significant legal risks that may impact its operations or financial stability.
- Other Legal Matters:
Covering any additional legal issues or concerns related to the NBFC's operations that may be relevant to the due diligence process.
Financial Due Diligence in NBFC Assessment
Financial Due Diligence is an important aspect of evaluating an NBFC and requires a comprehensive analysis of the company's financial health. This scrutiny focuses on assessing various financial elements, including assets, liabilities, cash flow and other factors relating to capital management. The primary financial considerations that an NBFC should address are:
- Accurate and Compliant Financial Records:
Ensuring that the accounts and other financial records of the NBFC are maintained accurately and in compliance with established best practices and regulatory requirements.
- Credibility and Creditworthiness:
Upholding the credibility and creditworthiness of the company by maintaining a strong financial profile and meeting financial obligations.
- Overall Financial Hygiene:
Maintaining general financial hygiene by adopting careful financial management practices plus safeguarding against financial risks.
Commercial Due Diligence for NBFCs
Commercial Due Diligence revolves around treating the NBFC as a business entity and scrutinising its financial viability and soundness. This component of due diligence involves:
- Competitor Performance:
Comparing the NBFC's performance with that of its competitors in the market to measure its competitive standing.
- Customer Relationship:
Assessing the depth and quality of relationships between the NBFC and its customers, as this can significantly impact business sustainability.
- Market Goodwill:
Measuring the goodwill and reputation of the NBFC in the market, which can influence customer trust and business success.
- Sales and Marketing Strategies:
Analysing the strategies employed for business growth and expansion, including current and expected sales targets.
- Business Vision:
Examining the vision and long-term objectives of the NBFC within the market to ensure alignment with investor goals.
- Meeting Targets:
Evaluating the realistic expectations of the NBFC in terms of meeting its financial and operational targets.
Other (Miscellaneous) Due Diligence
Elements not included by the previously discussed categories fall within the scope of Other (Miscellaneous) Due Diligence. This includes critical aspects like taxation, management practices, information technology systems, communication channels, data protection and data management.
Role of Non-Banking Financial Companies
An NBFC in India is a registered financial institution operating under the regulatory framework of the Companies Act, both under the 1956 Act as well as the 2013 Act . These entities are not traditional banks but have become equally Important in the financial sector. NBFCs have many financial activities, which may include:
- Extending Loans and Advances:
Providing loans and advances to individuals and businesses.
- Acquisition of Shares:
Investing in shares of other companies, contributing to capital markets.
- Leasing and Hire-Purchase:
Engaging in lease financing and hire-purchase transactions, enabling clients to acquire assets over time.
- Insurance Services:
Offering insurance products or services, although some specific NBFCs focus solely on insurance operations.
- Chit Fund Business:
Facilitating chit fund operations, which involve a group of individuals contributing to a common fund for periodic disbursements to members.
Under the Reserve Bank of India Act, 1934, NBFCs are legally mandated to register with the RBI as per Section 45-IA. This registration is an important step to subject NBFCs to regulatory supervision by the central bank. This oversight not only contributes to upholding financial stability but also safeguards the rights and interests of depositors and investors.
Collecting Information for NBFC Due Diligence: Best Practices
In the process of Due Diligence for NBFCs, the collection of accurate and relevant information is vital to make informed investment decisions. The source of information gathering should be reliable and trustworthy, as the entire due diligence exercise and investment decisions are based on this data. Given below are key steps and considerations for collecting information effectively:
- Checklist Preparation:
Develop a comprehensive checklist that outlines all the types of information required for conducting NBFC Due Diligence. This checklist should cover legal, financial, commercial, and miscellaneous aspects. For a properly detailed NBFC due diligence, availability of all such data is essential for the process.
- Identifying Information Sources:
Identify and locate the sources from which the necessary information will be collected. These sources may include:
- Financial Records: Reviewing the financial statements, annual reports, and audit reports of the NBFC.
- Business News: Monitoring news articles and reports related to the NBFC's activities and industry trends.
- Market Data: Utilizing market research and data on the financial sector and the specific market in which the NBFC operates.
- Directors and Management: Examining the backgrounds and qualifications of the company's directors and key management personnel.
- Engaging Professionals:
Appoint experienced professionals like StartupFino to collect the relevant information and oversee the entire Due Diligence process. These experts are important because they possess the knowledge and expertise to extract vital information from complex financial documents. They are skilled in assessing the authenticity of information and determining whether it is reliable.
The appointment of professionals is essential as they can ascertain the accuracy of the information gathered, which forms the foundation of the Due Diligence process. Their expertise aids in making well-informed investment decisions and mitigating potential risks. In essence, professionals ensure that Due Diligence is conducted on a solid foundation of reliable information.
Key Legal Compliances to Verify in NBFC Due Diligence
In the process of Due Diligence of NBFCs, it is imperative to scrutinise various legal compliances to ensure that the NBFC operates within the boundaries of the law and adheres to regulatory requirements. Here are the significant legal compliances that need to be checked during the Due Diligence:
- Creation of Statutory Reserves:
Under section 45-IC of the Reserve Bank of India Act, 1934, every NBFC is mandated to establish a reserve fund and transfer a minimum of 20 percent of its net profit annually, as disclosed in the profit and loss account, before declaring any dividends.
- Registration with KYC Portal:
NBFCs are required to register with the KYC portal and provide the prescribed information as part of their due diligence process.
- Registration with the Financial Intelligence Unit-India:
NBFCs must adhere to the guidelines of the Prevention of Money Laundering Act, 2002, and the Rules made thereunder. This includes verifying the identity of their clients, maintaining records, and sharing information with the Financial Intelligence Unit-India.
- Appointment of Nominated Counsel in Delhi High Court:
As per guidance from the Securities and Exchange Board of India, NBFCs authorized to invoke Sections 13 and 14 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act are obligated to appoint nominated counsels in the High Court and report their names to the Central Registry of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest.
- Membership in Credit Information Company:
All NBFCs are required to obtain membership with one of the four Credit Information Companies, as stipulated by the Reserve Bank of India. This compliance ensures that the NBFC contributes to the credit information ecosystem.
- Auditor’s Report and Statutory Auditor Certificate:
NBFCs must comply with the directions outlined in various circulars released by the RBI. Part of this compliance includes reviewing the auditor's report and the statutory auditor certificate as part of the due diligence process to ensure transparency and adherence to financial standards.
It has become very essential to comply with these legal compliances during Due Diligence of NBFCs so that investors can gain a clearer picture of the NBFC's commitment to regulatory standards and overall operational integrity. This scrutiny helps in making well-informed investment decisions while minimizing legal and regulatory risks.
Major Areas in NBFC Due Diligence Process
The Due Diligence process for Non-Banking Financial Companies is a complete assessment wherein it involves scrutinizing various areas to ensure transparency, compliance, and overall business viability. These given areas are very important for the Due Diligence process:
- Corporate Matters:
Reviewing corporate governance, organizational structure, and legal standing, including the company's incorporation and registration.
- Foreign Direct Investment:
Examining FDI-related matters, if applicable, to assess compliance with foreign investment regulations.
- Financial Matters:
Analyzing financial statements, annual reports, etc., as well as other important pieces of financial documents to gauge the financial health and performance of the NBFC.
- Property and Real Estate Assets:
Assessing the assets, including real estate holdings, owned or utilized by the NBFC.
- Human Resource (HR) Capabilities:
Evaluating the HR capabilities and ensuring compliance with labor laws and regulations, as well as understanding the workforce's composition and capabilities.
- Intellectual Property Rights:
Examining the IPR that is held by the NBFC, which includes within itself patents, trademarks, etc.
- Minutes of Meetings:
Scrutinizing the minutes of meetings held by the NBFC to understand decision-making processes and governance.
- Secretarial Compliances:
Verifying that the NBFC adheres to all secretarial compliances and regulations, including those related to record-keeping, disclosure, and reporting.
- Major Agreements:
Reviewing significant agreements entered into by the NBFC, such as loan agreements, lease agreements, or partnership agreements.
- RBI Prescribed Compliances:
Ensuring that the NBFC complies with the regulations as given by the RBI that are relevant to its operations.
- Pending Litigation:
Identifying and assessing any ongoing legal disputes, cases, or litigation involving the NBFC.
- Insurance Claims:
Evaluating the status of insurance claims made by the NBFC and the company's overall risk management practices.
- Taxation Compliances:
Verifying that the NBFC is in compliance with all taxation regulations, including IT, GST, etc.
Ensuring Authenticity of Documents in Due Diligence
In conducting Due Diligence of NBFCs, an important responsibility of the evaluators is to verify the authenticity of each and every one of the documents being examined. The following documents must be carefully validated:
- Certificate of Incorporation of the NBFC:
Validate the Certificate of Incorporation issued to the NBFC to ensure its authenticity and compliance with relevant regulatory requirements.
- GST Registration:
Verify the authenticity and current status of GST registration to ascertain its legitimacy.
- TAN Registration:
Confirm the validity and accuracy of the Tax Deduction and Collection Account Number registration in accordance with tax regulations.
Validate the authenticity and compliance of the Permanent Account Number with tax laws.
- Documents Submitted to Regulatory Bodies:
Thoroughly review and authenticate all documents submitted to regulatory bodies such as the Reserve Bank of India and the Ministry of Corporate Affairs for NBFC operations. Ensure that these documents are accurate and comply with regulatory requisites.
In addition to these core documents, the evaluator should also ascertain the authenticity of various registrations and permissions obtained by the NBFC from regulatory bodies. These documents should be retained throughout the Due Diligence process until its conclusion.
Other Documents for NBFC Due Diligence
Furthermore, there are other essential documents that the NBFC must maintain during its regular operations, and these documents should be scrutinized as part of the Due Diligence process:
- Board Resolutions:
Review all board resolutions up to the date of the Due Diligence exercise to understand key decisions made by the company's leadership.
- Minutes of Meetings:
Scrutinize minutes of meetings held by the NBFC up to the conclusion of the Due Diligence process to gain insights into discussions and decisions.
- Statutory Audit Reports:
Verify the authenticity of statutory audit reports to assess the financial health and compliance of the NBFC.
- Record of Total Net Worth:
Examine records that provide insights into the total net worth of the company to assess its financial stability.
The authentication of documents is a fundamental aspect of Due Diligence to ensure the reliability and accuracy of information. This thorough examination helps minimize risks and facilitates well-informed decision-making in investments and business engagements.
Expert Opinion on NBFC Due Diligence
NBFC Due Diligence is a complex and time-intensive procedure that requires attention to every detail. Its importance cannot be emphasized enough, as a poorly informed investment choice in the NBFC sector can have wide consequences, not only for the investor but also for the overall economy. Hence, it is strongly recommended to seek the assistance of professionals with substantial experience and a sharp eye for detail like at StartupFino.
The process of Due Diligence involves a blend of various skills and expertise, making it a multidisciplinary task. It cannot be effectively executed by a single category of professional. Instead, it demands a collaborative effort involving professionals from various fields, including lawyers, Chartered Accountants, Company Secretaries, and more. The areas to be assessed in NBFC Due Diligence are distinct and unique, each demanding specialized expertise.
An ideal Due Diligence evaluation team comprises a mix of these professionals who collectively bring their unique skills and knowledge to the table. This guarantees a comprehensive examination and evaluation of every facet of the NBFC operations, including legal and financial compliance, as well as regulatory and operational considerations.
Why Choose StartupFino for NBFC Due Diligence?
NBFCs serve as major participants in India's financial sector, engaging in a diverse range of financial activities. The RBI's regulation of their operations is for guaranteeing transparency, accountability, and the overall soundness of the financial system. NBFC Due Diligence is a comprehensive evaluation of every significant component of the company. It includes legal, financial, commercial, and miscellaneous dimensions, ensuring that potential investors have a thorough understanding of the NBFC operations and risks. This complex scrutiny is essential for making well-informed investment decisions.
StartupFino specializes in offering comprehensive services on NBFC Due Diligence, assisting you from initial advice to ensuring full compliance with essential requirements.