MODULE-4

NBFCs,Micro Finance,
Leasing and Hire Purchase
Non-Banking Financial Company (NBFC)

A Non-Banking Financial Company (NBFC) is a company

registered under the Companies Act
engaged in the business of loans and advances
acquisition of shares/stocks/bonds/debentures/securities
issued by Government or local authority or other marketable
securities of a like nature
leasing, hire-purchase, chit business housing finance but
does not include any institution whose principal business is
that of agriculture activity, industrial activity, purchase or
sale of any goods (other than securities) or
providing any services and sale/purchase/construction of
immovable property
Non-Banking Financial Company (NBFC)

A non-banking institution which is a company and has

principal business of receiving deposits under any scheme
or
arrangement in one lump sum or in instalments by way of
contributions or in any other manner, is also a non-banking
financial company (Residuary non-banking company).
Difference between banks & NBFCs

NBFC cannot accept demand deposits

NBFCs do not form part of the payment and settlement
system and cannot issue cheques drawn on itself
Mobilizes the savings for investment
Supplying medium and long term loans in financial market.
Deposit money only for economic motive of earning extra
incomes
Deposit insurance facility of Deposit Insurance and Credit
Guarantee Corporation is not available to depositors of
NBFCs, unlike in case of banks.
 Different types/categories of NBFCs  
Asset Finance Company (AFC)
A company which is a financial institution carrying on as its
principal business the financing of physical assets supporting
productive/economic activity
Principal business for this purpose is defined as aggregate of
financing real/physical assets supporting economic activity
and income arising there from is not less than 60% of its total
assets and total income respectively. Some of the examples
are: ( below quoted examples are earlier considered as
different types)
 Equipment Leasing Company
 Hire- Purchase Finance Company
 Housing Finance Company
 Different types/categories of NBFCs  
Investment Company (IC)
Any company which is a financial institution carrying on as its
principal business the acquisition of securities
Loan Company (LC)
Any company which is a financial institution carrying on as its
principal business the providing of finance whether by making
loans or advances or otherwise for any activity other than its
own but does not include an Asset Finance Company
 Different types/categories of NBFCs  
Infrastructure Finance Company (IFC)
IFC is a non-banking finance company
 a) which deploys at least 75 per cent of its total assets in
infrastructure loans
 b) has a minimum Net Owned Funds of ₹ 300 crore
 c) has a minimum credit rating of ‘A ‘or equivalent
 d) and a CRAR of 15%

* Capital to Risky Asset Ratio (CRAR) - capital needed for a bank

measured in terms of the assets (mostly loans) disbursed by the
banks. Higher the assets, higher should be the capital by the bank
 Different types/categories of NBFCs  
Non-Banking Financial Company – Factors (NBFC-Factors)
NBFC-Factor is a non-deposit taking NBFC engaged in the
principal business of factoring – Managing account
receivables
Mortgage Guarantee Companies (MGC)
MGC are financial institutions for which at least 90% of the
business turnover is mortgage guarantee business
 Different types/categories of NBFCs  
 Nidhis or Mutual Benefit Finance Company
Oldest form – Receives deposits and lends only to its members-
savings and investment – for some particular purpose
 Residuary Non Banking Company -
Receiving deposits in any manner – Contributions, Subscriptions, sale
of units, certificates or any other instruments.
Functions of NBFCs
Brokers of loanable funds
• Mobilization of savings
• Provide liquidity
• Channelization of funds into investments
• Stabilize the capital market
 Guidelines for NBFC
1. Compulsory registration
2. Income recognition
3. Issue directions (ICAI)
4. Restrictions on deposits
5. Asset Classification
6. Regulation of liquidity (10% of liquid assets)
7. Appointment of committees
8. To Receive balance sheets, PNL & other
statements
 Microfinance
Microcredit, or microfinance, is
Banking the unbankables
Bringing credit, savings and other essential financial services
within the reach of millions of people who are too poor to be
served by regular banks
In most cases because they are unable to offer sufficient
collateral
In general, banks are for people with money, not for people
without
Microfinance is defined as
 “Financial Services (savings, insurance, fund, credit etc.) provided to
poor and low income clients so as to help them raise their income,
thereby improving their standard of living”.
The proposed Microfinance Regulation Bill defines
Microfinance services as
“Providing financial assistance to an individual or an
eligible client, either directly or through a group
mechanism for:
 (i) An amount, not exceeding rupees fifty thousand in
aggregate per individual, for small and tiny enterprise,
agriculture, allied activities (including for consumption
purposes of such individual) or
 (ii) An amount not exceeding rupees one lakh fifty

thousand in aggregate per individual for housing

purposes, or
 Such other amounts, for any of the purposes mentioned

at items (i) and (ii) above or other purposes, as may be

prescribed.”
It is an essential part of rural finance.
It deals in small loans.
It basically caters to the poor households.
It is one of the most effective and warranted Poverty
Alleviation Strategies.
It provides an incentive to grab the self employment
opportunities.
It is more service-oriented and less profit oriented.
It is meant to assist small entrepreneur and producers.
In India, the beginning of microfinance movement could be
traced to Self Help Group (SHG) – Bank Linkage Programme
(SBLP) started as a pilot project in 1992 by NABARD.
 In India, the institutions which provides microfinance services
includes
 NABARD
 Small Industries Development Bank of India (SIDBI)
 RashtriyaMahilaKosh
 Commercial Banks, Regional Rural Banks, Cooperative Banks and
 Non Banking Financial Companies (NBFCs)
Microfinance services are provided mainly by two models
 Self Help Group - Bank Linkage Programme (SBLP) Model and
 Micro-Finance Institutions Model (MFI)
ROLE AND IMPORTANCE OF MICROFINANCE
 Credit To Rural Poor
 Micro financing has been successful in taking institutionalized
credit to the doorstep of poor and have made them economically
and socially sound.
 Poverty Alleviation
 Due to micro finance poor people get employment. It also helps
them to improve their entrepreneurial skills and encourage them to
exploit business opportunities
  Women Empowerment
 Normally more than 50% of SHGs are formed by women. Now they
have greater access to financial and economical resources
 Economic Growth
 Due to microfinance, production of goods and services increases
which increases GDP and contributes to economic growth of the
country.
Mobilisation Of Savings
Microfinance develops saving habits among people. Now poor
people with meagre income can also save and are bankable
Development Of Skills
Micro financing has been a boon to potential rural
entrepreneurs. SHGs encourage its members to set up business
units jointly or individually
Mutual Help And Cooperation
Microfinance promotes mutual help and cooperation among
members. The collective efforts of group promotes economic
interest and helps in achieving socio-economic transition
Social Welfare
With employment generation the level of income of people
increases. They may go for better education, health, family
welfare etc
Os/MFI
Objectives of Microfinance
Promote socio-economic development at the grass
root level through community-based approach
Develop and strengthen people’s groups called Self-
Help Groups and facilitate sustainable development
through them
Provide livelihood training to disadvantaged
population
Promote activities which have community
participation and sharing of responsibilities
Promote programs for the disabled
Os/MFI
Cont.....
Empower and mainstream women
Promote sustainable agriculture and ecologically
sound management of natural resources
Organize and coordinate networking of grass root
level organization
Get benefits by reducing expenditure and making use
of local resources as inputs for livelihood activities
Increase the number of wage days and income at
household level
Challenges faced by Micro finance Institutions
Over Indebtedness
Higher Interest rates as compare to commercial banks
Higher dependence on Indian banking system
Lack of investment validation
Lack of awareness of available financial services
Choice of Appropriate Model
Regional Imbalances
SHG - Bank Linkage Programme (SBLP)
A Self Help Group (SHG) is a small group of 10 to 20 persons
of rural poor who come together to mutually contribute to
common fund for meeting their emergency needs
Model I
 SHGs promoted, guided and financed by banks.
Model II
 SHGs promoted by NGOs / government agencies and financed by
banks.
Model III
 SHGs promoted by NGOs and financed by banks under NGOs /
formal agencies as financial intermediaries
FUNCTIONS OF SHGs
 Group Formation
Members voluntarily form groups for generating employment
and reducing poverty.
Savings
SHG encourages its members to save a part of their income on
regular basis. Savings are transferred to groups.
Lending
After saving for a minimum period, the funds are used for
lending to its own members
Meetings
Group meetings are conducted regularly to solve the problems
and difficulties of its members.
Record
SHG keeps record of accounts.
Advantages of financing through SHGs
 An economically poor individual gains strength as part of a
group.
Financing through SHGs reduces transaction costs for both
lenders and borrowers.
While lenders have to handle only a single SHG account
instead of a large number of small-sized individual accounts,
borrowers as part of an SHG cut down expenses on travel (to
and from the branch and other places) for completing paper
work and on the loss of workdays in canvassing for loans.
SHGs have significantly empowered poor people, especially
women, in rural areas.
Disadvantages of financing through SHGs

Availability of fund is limited

Limited working hours and seasons for the operations of
the facilities
Dominated by males
New members can influence the functioning of a group
People may misuse the money given to them
May not work on their own and be completely dependent
on the grants
Microfinance Institution (MFI) Model
The MFI model is a commercial model where institution
borrows funds or raise equity for lending for various purposes
through the concept of JLG.
Not-for-profit MFIs – Societies, public trusts and non profit
companies
Mutual Benefit MFIs – Co-operatives and mutual co operative
societies
For profit MFIs – NBFCs and local area banks
 Features :
o Short term loans
o High transaction cost
o Absence of collaterals
o Higher frequency of repayment
What is a Lease ?
A lease transaction is a commercial arrangement whereby an equipment
owner or Manufacturer conveys to the equipment user the right to use the
equipment in return for a rental.

Lease is a contract between the owner of an asset (the lessor) and its user
(the lessee) for the right to use the asset during a specified period in return
for a mutually agreed periodic payment (the lease rentals). The important
feature of a lease contract is separation of the ownership of the asset from its
usage.
Essential Elements of Lease
 Parties to the contract
 Asset
 Ownership separated from user
 Term of lease
 Lease Rentals

Modes of terminating lease:

 Renewal : The lease is renewed on a perpetual basis or for a definite
period.

 Return to Lessor :The asset reverts to the lessor.

 Selling equipment to Third party : The assets reverts to the lessor and
the lessor sells it to a third party.

 Selling equipment to lessee : The lessor sells the asset to the lessee.
Steps in Leasing
1) The lessee chooses the equipment and the equipment supplier
2) The supplier provides a quotation to lessee
3) The lessee submits an application to the lessor
4) The lessor evaluates the application
5) The lessor and lessee sign a lease contract
6) The lessor orders the equipment from the supplier
7) The supplier delivers the equipment to the lessee and presents the bill to
lessor
8) The lessor registers and insures the equipment
9) The supplier provides after-sales services as per contract
10) The lessee maintains the equipment (routine maintenance)
11) The lessor monitors the lease operation
12) The lessee pays instalments as per contract
13) At the end of the lease period, the lessee either returns the equipment or
exercises the option of purchase
14) If the option is purchase, the lessee pays the agreed final sum and the
lessor transfers the ownership of the equipment to the lessee
Legal aspects of Leasing
The lessor has the duty to :

 Deliver the asset to the lessee

 Authorize the lessee to use the asset
 Leave the asset in peaceful possession

The lessee has the obligation to:

 Pay the lease rentals periodically

 Take reasonable care of the asset
 Return the leased asset
 Types of Leasing
Lease agreements are basically of three types:

1.Financial lease
2.Operating lease
3.Leveraged Lease

The other variations in lease agreements are:

Sale and lease back

Direct leasing
Financial Lease
 Long-term, non-cancellable lease contracts are known as financial leases.
 The lease agreement is irrevocable.
 The essential point of financial lease agreement is that it contains a
condition whereby the lessor agrees to transfer the title for the asset at the
end of the lease period at a nominal cost.
 At lease it must give an option to the lessee to purchase the asset he has
used at the expiry of the lease.
 Under this lease the lessor recovers 90% of the fair value of the asset as
lease rentals and the lease period is 75% of the economic life of the asset.
 Practically all the risks incidental to the asset ownership and all the
benefits arising there from are transferred to the lessee who bears the cost of
maintenance, insurance and repairs.
 Only title deeds remain with the lessor.
 Financial lease is also known as ‘Capital Lease or Full Payout Lease’
 It is suitable for Ships, Aircraft, Railway Wagons, Engines, Land Buildings
and, Heavy Equipment
Operating Lease
 An operating lease stands in contrast to the financial lease in
almost all aspects.
 This lease agreement gives to the lessee only a limited right
to use the asset.
 The lessor is responsible for the upkeep and maintenance of
the asset.
 The lessee is not given any uplift to purchase the asset at the
end of the lease period.
 The primary lease period does not cover the cost of the asset
 Normally the lease is for a short period and even otherwise
is revocable at a short notice.
 Office equipment, Computers hardware, trucks and
automobiles are found suitable for operating lease because the
rate of obsolescence is very high in this kind of assets.
Operating lease is further categorized into:
•Domestic lease- a lease transaction is classified as domestic if all parties to the
agreement , namely, equipment supplier, lessor and the lessee, are domiciled in the
same country.
•International lease- if the parties to the lease transaction are domiciled in different
countries, it is known as international lease. It is sub- classified into:-

Import lease- here the lessor and the lessee are domiciled in the same
country but the equipment supplier is located in a different country. The lessor
imports the asset and leases it to the lessee.
Cross-border lease- when the lessor and lessee are domiciled in different
countries, the lease is classified as cross-border lease. The domicile of the supplier is
immaterial.

The international lease transaction is affected by country risk and currency risk. The
country risk arises from the need to structure the lease transaction according to the
political and economic climate and a knowledge of the tax and regulatory
environment governing them in the foreign country concerned.
Difference Between Financial Lease and
Operating Lease
Meaning
Ownership risk
Transferability
Term of lease
Nature of contract
Maintenance cost
Running cost
Risk of obsolescence
Cancellation
Purchasing option
Tax advantage
 Leveraged Lease
 Under leveraged leasing arrangement, a third party is
involved beside lessor and lessee.

 The lessor borrows a part of the purchase cost (say 80%) of

the asset from the third party i.e., lender and the asset so
purchased is held as security against the loan.

 The lender is paid off from the lease rentals directly by the
lessee and the surplus after meeting the claims of the lender
goes to the lessor.

 The lessor, the owner of the asset is entitled to depreciation

allowance associated with the asset.
 Sale and Lease Back
• Here, the owner of an asset sells the asset to a party (the buyer), who in
turn leases back the same asset to the owner in consideration of lease rentals.

• However, under this arrangement, the assets are not physically exchanged
but it all happens in records only.

• This is nothing but a paper transaction.

• Sale and lease back transaction is suitable for those assets, which are not
subjected depreciation but appreciation, say land.

• The advantage of this method is that the lessee can satisfy himself
completely regarding the quality of the asset and after possession of the asset
convert the sale into a lease arrangement.
 Direct Lease
• Under direct leasing, a firm acquires the right to use an asset
from the manufacturer directly.
• The ownership of the asset leased out remains with the
manufacturer itself.
• The major types of direct lessor include manufacturers, finance
companies, independent lease companies, special purpose
leasing companies etc

Direct Lease is of 2 types:

• Bipartite Lease: In such lease, there are two parties in the lease
transaction namely equipment supplier cum lessor and lessee
• Tripartite Lease: In such lease, there are three parties in the
lease agreement namely equipment supplier, lessor and lessee
 NET LEASE
In commercial real estate, a net lease requires the tenant to pay, in addition to
rent, some or all of the property expenses which normally would be paid by
the property owner (known as the "landlord" or "lessor").

These include expenses such as real estate taxes, insurance, maintenance, repairs,
utilities and other items.
The precise items that are to be paid by the tenant are usually specified in a
written lease.
For properties that are leased by more than one tenant, such as a shopping centre,
the expenses that are "passed through" to the tenants are usually prorated among
the tenants based on the size (square footage) of the area occupied by each tenant.
The term "net Lease" is distinguished from the term "gross lease".
In a net lease, the property owner receives the rent "net" after the expenses that
are to be passed through to tenants are paid.
In a gross lease, the tenant pays a gross amount of rent, which the landlord can
use to pay expenses or in any other way as the landlord sees fit.
 Types of Net Lease
Single net lease
In a single net lease (sometimes shortened to Net or N), the lessee or tenant is
responsible for paying property taxes as well as the base rent.
Double- and triple-net leases are more common forms of net leases because all or the
majority of the expenses are passed on to the tenant.

Double net lease

In a double net lease (Net-Net or NN) the lessee or tenant is responsible for property
tax and building insurance.
The lessor or landlord is responsible for any expenses incurred for structural repairs
and common area maintenance.
"Roof and structure" is sometimes calculated as a reserve, per square foot.

Triple net lease

•A triple net lease (Net-Net-Net or NNN) is a lease agreement on a property where the
tenant or lessee agrees to pay all real estate taxes, building insurance, and
maintenance (the three "Nets") on the property in addition to any normal fees that are
expected under the agreement (rent, premises utilities, etc.).
•In such a lease, the tenant or lessee is responsible for all costs associated with the
repair and maintenance of any common area.
•This form of lease is most frequently used for commercial freestanding buildings.
•However, it has also been used in single family residential rental real estate
Wet Lease Agreement
A wet lease agreement means one airline, called the lessor, supplies a
complete aircraft package to another airline, called the lessee.
This complete package includes the aircraft, a crew, maintenance for the
aircraft and insurance.

Lessee's Financial Obligations

•The lessee pays for fuel, airport fees, crew meals and transportation, crew
visa fees and other taxes.

By the Hour

•The lessor charges the lessee by the hour and usually requires a minimum
number of hours.
•These hours are paid for even if they are not used.
Short Term
•A wet lease agreement is for short-term leasing.
•Most wet lease agreements are for at least one month, and some extend
up to two years.
•A longer term of leasing is called a dry lease.

Why a Wet Lease?

•A lessor airline decides to do a wet lease agreement for a variety of

reasons.
•Some airlines are not permitted to fly into certain countries.
•Using a wet lease agreement, the airline can still offer service to those
countries.
•If an airline has particularly a busy season, it can use another airline via
the wet lease agreement to continuing offering service to customers.
•Airlines find it is also a good way to try out new service routes.
Problems of Leasing Industry
Unhealthy Competition
Lack of Qualified Personal
Tax Consideration
Stamp duty
Delayed payment and bad debts
Asset Liability mismatch
Bad Economic environment
Poor and premature credit decisions taken in the
past
Leasing -Tax Provisions
Lessor:

• The depreciation can be claimed by the lessor and not the lessee.

• Depreciation can be charged as a tax deductible expense item by

lessor.

• The lease rentals received by lessor are taxable as profit & gain
from business

Lessee:

• The lease rentals and Insurance, repairs, maintenance charges

paid by lessee are tax deductible items of expenses for the lessee
37
Hire Purchase
Hire purchase is used to buy expensive items which
a person cannot afford to payout right: e.g. a car
A down payment is usually paid and the balance is
paid over several months (monthly instalments).

What is hire purchase ?

Here possession of goods is transferred
immediately, but payment is made in installments.
Ownership is transferred after all the installments
have been paid
Definition
According to hire purchase act of 1972, “An agreement
under which goods are let on hire under which the
hirer has an option to purchase them in accordance
with the terms of agreement and include an
agreement under which
 Possession of goods is delivered by the owner thereof to a
person on the condition that such person pays the amount in
periodic payments
 The property of the goods is to pass to such a person on the
payment of the last installment.
 Such a person has a right to terminate the agreement any
time before the property so passes.
HP agreements must be in writing and signed by both the
parties.

They must clearly lay out the following information:

 A clear description of the goods

 The cash price for the goods
 The HP price
 The deposit
 The monthly installments
 Rights to parties
41
 Possession of goods

 Each installment is treated as hire charges.

 Ownership

 Default in the payment

 Terminate the agreement

42
Operation of HP transaction
Goods are let out on finance by a finance company to the
hire purchaser customer
Buyer is required to pay an equal amount of periodic
installments during a given period
Ownership transfers at the payment of the last
installment
The hirer is required to make a down payment of 20-
25% of the cost and pay the balance amount along with
interest in advance or arrears over a time period of 36-
48months
Alternatively, instead of the down payment, the hirer as to
deposit an equal amount as a fixed deposit with the
finance company which provides entire finance on hire
purchase terms, repayable with interest in EMI over 36-48
months.
Cont……
Deposits and the accumulated interest is returned
to the hirer upon the payment of last installment.
The interest on each hire purchase installment is
computed on the basis of flat rate of interest is
applied to the declining balance of original loan
amount to determine the interest component of
installment for a given flat rate of interest, the
equivalent effective rate of interest is higher.
 Process of Hire Purchase
The Dealer, contracts with finance co. for financing his hire
purchase deals.
The customer selects the goods for HP, and dealer arranges
for the complete set of documents.
Down payment by customer on completion of proposal
form.
Dealer sends documents to finance co. with request to
purchase the goods, and accept the HP transaction.
The finance co. signs the agreement and sends copy
along with EMI details to dealer.
Dealer delivers the goods to the customer, property passes
on to the finance co..
Hirer pays EMIs, and on last payment , the ownership
passes on to him, with loan completion certificate by the
finance co.
 Spread the cost of finance

 Interest-free credit

 Higher acceptance rates

 Sales

 Debt solutions

43
 Personal debt

 Final payment

 Bad credit

 Creditor harassment

 Repossession rights
44
59
LEASING HIRE PURCHASE
Ownership
 In lease, ownership lies  In hire purchase, the hirer
with the lesser. The has the option to purchase.
lessee has the right to The hirer becomes the
use the equipment and owner of the
does not have an asset/equipment
option to purchase the immediately after the last
asset payment of installment
amount
Purchase Method of Financing
 Hire Purchase is a method
 Leasing is a method of
of financing both business
financing business assets
assets and consumer
only.
articles. 60
LEASING HIRE PURCHASE
Depreciation
 In Leasing, depreciation  In Hire Purchase
and investment allowance depreciation and investment
can be claimed by the allowance can
Lessor. be claimed by the Hirer.

Tax Benefits
 The entire lease rental is tax  Only the interest
deductible expense. components of the Hire
Purchase installment are
tax deductible.

61
LEASING HIRE PURCHASE
Salvage Value
 The lessee, not being the  The hirer, in purchase being
owner of the assets and the owner of assets and
does not enjoy the enjoy the salvage value of
salvage value of the the assets.
assets.
Deposit
 In Leasing the Lessee is not  In Hire Purchase, the Hirer
required to make any is required to deposit 20%
deposit. of the cost.

62
LEASING HIRE PURCHASE

Rent -Purchase
 In Leasing, the Lessee In Hire Purchase the asset is
take the asset on a rent purchased by the Hirer.
basis.

Extent of finance or Down Payment

 Lease financing is In Hire Purchase, a
invariably 100% financing. margin equal to 20-25%
It does not required any of the cost of the assets to
immediate down payment be paid the Hirer.
or margin money by the
Lessee. 63
 LEASING HIRE PURCHASE

Maintenance
 In Leasing, the maintenance In Hire Purchase, the
of leased asset is the cost of maintenance of
responsibility of the Lessee hired assets is to be
in case of financial lease and borne by the Hirer
the lessor in case of operating himself
lease.

Reporting
 The leased assets are shown The assets on hire purchase
by way of footnote only. is shown in the balance
sheet of the Hire.
64
 LEASING HIRE PURCHASE

Income
.
 Income declines as the Equally allocated income in
investment outstanding in the periodical installments. So
the lease declines same income will be received
by vendor

Suitability
It is not suitable for low It is suitable for low
capital enterprises where capital enterprises where
they desire to show strong they desire to show strong
asset position in their asset position in their
balance sheet balance sheet
64
Questions from P.Y. Question Papers
Sl.No Questions Marks Year

1 Explain various functions of NBFC's. 10 or 7 2018/19,2017/18,2

017
2 Write a note on NBFC. 3 2016

3
Compare and contrast lease financing and hire purchase 7
2019/20,2018/19,2
017/18,2017,2016,2
financing. 014/15,2012

4 What is Hire Purchase Service ? 3 2017

5 What is Leasing ? 3 2016

6 Discuss the advantages and disadvantages of microfinance 10 2017

7 What are the 2 micro finance delivery mechanism ? 3 2016/17

8 Problem facing leasing industry 7 2017
2019/20,2016,2014
9 What are the types of NBFC's ? Explain. 10 /15

10 Distinguish between operating lease and financing lease. 7 or 10 2015/16,2014/15

2019/20,2017/18,2
11 What are the types of lease financing ? Explain. 10 016
12 Write a note on Micro finance 7 2016/17

13 What is Leveraged lease ? 3 2015/16,2014/15

14 What are the advantages and limitations of leasing ? 7 2014/15

15 Define Micro Finance. Explain its challenges 7 2019/20