Q. Consider the following statements :

  1. In India, Non-Banking Financial Companies can access the Liquidity Adjustment Facility window of the Reserve Bank of India.
  2. In India, Foreign Institutional Investors can hold the Government Securities (G-Secs).
  3. In India, Stock Exchanges can offer separate trading platforms for debts.

Which of the statements given above is/are correct?

  • 1 and 2 only
  • 3 only
  • 1, 2 and 3
  • 2 and 3 only

Answer: (d) 2 and 3 only

Notes:
  • Non-Banking Financial Companies (NBFCs) in India do not have direct access to the Liquidity Adjustment Facility (LAF) window of the Reserve Bank of India (RBI). The LAF is primarily used by banks to manage their day-to-day liquidity mismatches.
  • Foreign Institutional Investors (FIIs) are permitted to invest in Government Securities (G-Secs) within the limits prescribed by the RBI and SEBI. This is part of efforts to attract foreign investment into India’s debt market.
  • Indian stock exchanges like the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) have established separate trading platforms for debt instruments, facilitating the trading of corporate bonds, government securities, and other debt instruments.
Liquidity Adjustment Facility:
  • Liquidity in the banking system refers to readily available cash that banks need to meet short-term business and financial needs.
  • On a given day, if the banking system is a net borrower from the RBI under Liquidity Adjustment Facility (LAF), the system liquidity is said to be in deficit. If the banking system is a net lender to the RBI, the liquidity is said to be in surplus.
  • A LAF is a monetary policy tool used in India by the RBI through which it injects or absorbs liquidity into or from the banking system.
  • It was introduced as a part of the outcome of the Narasimham Committee on Banking Sector Reforms of 1998.
  • LAF has two components – repo (repurchase agreement) and reverse repo. When banks need liquidity to meet its daily requirement, they borrow from RBI through repo. The rate at which they borrow fund is called the repo rate. When banks are flush with fund, they park with RBI through the reverse repo mechanism at reverse repo rate.
  • It can manage inflation in the economy by increasing and reducing the money supply.
  • LAF is used to aid banks in resolving any short-term cash shortages during periods of economic instability or from any other form of stress caused by forces beyond their control.
  • Various banks use eligible securities as collateral through a repo agreement and use the funds to alleviate their short-term requirements, thus remaining stable.
  • The facilities are implemented on a day-to-day basis as banks and other financial institutions ensure they have enough capital in the overnight market.
  • The transacting of liquidity adjustment facilities takes place via an auction at a set time of the day.
Tools under the Monetary Policy:
  • Cash Reserve Ratio (CRR).
  • Statutory Liquidity Ratio (SLR).
  • Bank Rate.
  • Standing Deposit Facility (SDF).
  • Marginal Standing Facility (MSF).
  • Cash Reserve Ratio (CRR).
Non-Banking Financial Company (NBFC):
  • A NBFC is a company registered under the Companies Act, 1956, engaged in the business of loans and advances, the acquisition of shares/stocks/bonds/debentures/securities issued by the Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business.
  • It does not include any institution whose principal business is that of agriculture activity, industrial activity, the purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. 
  • A non-banking institution which is a company and has the principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions, or in any other manner, is also a NBFC (Residuary non-banking company).
  • Generally, these institutions are not allowed to take traditional demand deposits from the public. They can only accept time deposits, and they do not provide savings or current account facilities.
    • They cannot accept deposits for a period less than 12 months and more than 60 months.
    • NBFCs cannot offer interest rates higher than the ceiling rate prescribed by RBI from time to time. The present ceiling is 12.5 per cent per annum.
  • NBFCs also provide a wide range of monetary advice like chit-reserves and advances.
  • NBFCs lend and make investments, and hence their activities are akin to that of banks; however, there are a few differences as given below:
    • NBFCs do not have a banking license;
    • NBFCs cannot accept demand deposits;
    • NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
    • Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not availableto depositors of NBFCs, unlike in the case of banks.
    • Unlike banks, NBFCs are not subjected to stringent and substantial regulations. 
  • Regulation:
    • The functions of the NBFCs are managed by both the Ministry of Corporate Affairs and the RBI.
    • The RBI has the authority to issue licenses to NBFCs, regulate their operations, and ensure that they adhere to the established norms and regulations.
  • NBFCs are categorized
    • In terms of the types of liabilities into Deposit and Non-Deposit accepting NBFCs,
    • Non-deposit taking NBFCs by their size into systemically importantand other non-deposit holding companies (NBFC-NDSI and NBFC-ND) and
    • By the kind of activity, they conduct.
  • What are systemically important NBFCs?
    • NBFCs whose asset size is ₹ 500 crore or more as per the last audited balance sheet are considered systemically important NBFCs.
    • The rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability of the overall economy.
  • Examples of NBFCs include investment banks, mortgage lenders, money market funds, insurance companies, equipment leasing companies, infrastructure finance companies, hedge funds, private equity funds, and P2P lenders.