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When it comes to Non-Banking Financial Companies (NBFC) in India is concerned, it may sometimes be overwhelming to ensure that everything is in place. Whether you’re planning to invest, buy, or work with an NBFC, due diligence is the first step to ensure you’re on the right path.
Consider it as a health check-up for the company—you identify possible threats, determine where the advantages might be, and analyse how favourable the situation is for the company as a whole. In this article, we will examine the problem of due diligence regarding Non-Banking Financial Companies and consider it step by step so that you can carry out your objectives in a clever and reasonable way.
What is NBFC Due Diligence?
NBFC Due Diligence is a clear examination of a company’s legal, financial, and operational housekeeping. Necessary, of course, prior to or concurrent with the intention to engage in significant corporate activities such as, but not limited to, M&As, investments or other corporate bonding because it assists in identifying the risks, and the true value of the corporation. Having proper due diligence in place allows taking next steps without second guessing opportunities as well as threats.
Why is Due Diligence Important for NBFCs?
Due diligence in the case of an NBFC is going through all the available information about its workings and this is important for certain very important reasons:
- Ensuring Compliance: It assists in ascertaining if the NBFC is in compliance with the various policies of the Reserve Bank of India. For example, whether it has maintained prescribed external capital and its assets are managed as required, among others. This refers to doing things by the book.
- Understanding the Overview of the Financial Position: It is similar to the way one repeatedly says, ‘go for a health check-up’. This is because in a rational analysis of balance sheets, a cash flow and so forth, one is able to discern the true extent of stability and profitability of any given NBFC.
- Sensing Potential Risks at An Early Stage: Due diligence is like turning on the spotlight to see underlying issues. Some of these risks can be associated with lending, the state of the economy or the efficiency of the NBFC’s business operations. These are early warning signs, which if sensed very well, will prevent any major surprises later.
- Making Solid investment Choices: Where the investors are concerned, due diligence is a way to compel the managers themselves to ensure the business into which they invest is sound. It raises the assurance that this institution will not disappoint before any drastic decisions are made.
To sum it up, there are no external attributes for due diligence. It is not intended to be mere compliance. It is about clever, prudent, balanced decisions to lay the groundwork for success.
Key Steps in the NBFC Due Diligence Process
The due diligence process for Non-Banking Financial Companies (NBFCs) follows a certain step-wise pattern, which is directed to particular aspects of the company’s functioning and conformance. Below is an elaborated account of each stage:
1. Legal Due Diligence
This segment of the NBFC due diligence process aims at identifying legal issues associated with the company in order to ensure legal compliance. Key areas include:
- Review of Incorporation Documents: Includes obtaining and verifying registration certificates, licenses and articles of association.
- Assessment of Compliance with RBI Regulations: Involves checking compliance with regulations set by RBI which inter alia include minimum net owned funds, capital adequacy ratios and filing requirements.
- Verification of Contracts: Contracts executed with customers, vendors and third party service providers are evaluated for legal viability.
2. Financial Due Diligence
The financial standing of any NBFC is of utmost importance and needs to be clear. This entails:
- Examination of Financial Statements: Reviewing a balance sheet, profit and loss accounts, cash flow statements, etc., for the last three to five years.
- Loan Book Review: The review carried out aims to ascertain the risk quality of the loan book including non-performing loans (NPLs) and provisioning.
- Capital Adequacy and Solvency Analysis: This involves an examination of whether the required capital adequacy ratio (CAR) is being observed by the NBFC and assessment of the ability of the institution to meet its financial obligations.
3. Operational Risk Assessment
Operational capabilities can be a decisive factor for the commercial success of an NBFC. The following aspects are of particular importance:
- Evaluation of Internal Processes: Assessment of the performance of the processes of evaluating the customer, issuing the loan and collecting the amounts due.
- IT Systems and Infrastructure: Review of the level of technology employed to run the business, protect client’s data and ensure service delivery.
- Management & Corporate Governance: Qualifying and examining the members of the executive board, the board of directors and their sustainable governance systems.
4. Tax and Compliance Risk Assessment
The Indian tax laws are as complex as they are strict in the case of NBFCs which makes this stage imperative. It consists of:
- Assessment of Tax compliance – Submission of taxes such as Income tax, Goods and Services Tax, and Tax Deducted at Source in correct amounts and within deadlines.
- Assessment of Existing tax Implications – Detection of any tax implications that are likely to arise in the future because of the existing tax status.
- Compliance with RBI and FEMA – KRA in ensuring compliance with the Non Banking Financial Companies of the Reserve Bank of India Act and Foreign Investment Regulation Act.
5. Customer Due Diligence (CDD)
Understanding the customer profile is crucial to assess the risks associated with the loan portfolio. This step includes:
- KYC Verification: Ensuring proper Know Your Customer (KYC) norms have been followed for all clients.
- Risk Profiling of Borrowers: Evaluating the creditworthiness of borrowers and the due diligence process adopted by the NBFC during lending.
- Assessment of Customer Grievance Mechanism: Reviewing the processes in place for handling customer complaints and disputes.
Common Challenges in NBFC Due Diligence
Though NBFC due diligence services can be beneficial, the entire pursuit is faced with several difficulties, namely:
- Adherence to Guidelines: One is faced with the challenge of having to adhere to the capricious guidelines provided by the RBI.
- Limited Data: Inaccurate due diligence may result from the limited number of impartial statistics regarding the ability to perform as well as the data on customers.
- Assessment of the Loan Book: Accurately determining the quality of the loan book is rather difficult, for instance when NPAs are not sufficiently provided for.
Due Diligence Processes for Non Banking Financial Companies
When performing NBFC due diligence, the following best practices should be followed to avoid hitches.
- Get a Mandated Team: Bring on board individuals who are well-versed with the regulations and finances of NBFCs.
- Carry Out Self-Assessment and Re-Assess: Diligence should also be continuous rather than restricted to assessment only at the beginning of any given period. Conducting such a review helps bring out any possible emerging threats.
- Ensure Complete Opacity: Make sure that the NBFC is open while allowing the access of certain documents and information to the proposed investors during the due diligence phase.
Navigating the NBFC Due Diligence Process
NBFC due diligence is more than a financial assessment — it is about appreciating how the business functions, confirming its adherence to the dictations of the RBI, and most importantly in assessing the business growth or risks. Taking this methodical extends to the investors and other stakeholders as they are able to take risks to seeking out opportunities for growth and taking strategies to mitigate them.
At NBFC Advisory, we understand this well and we shall see to it that the process of evaluation is carried out with utmost ease and efficiency.
We are well acquainted with the Indian market and we have a lot to offer in terms of insight and direction throughout the process to assist with full understanding and adherence. Whether your interests are in an acquisition, a merger of companies or investment in an NBFC, we can provide due diligence and analysis that shall ensure the best decisions are made.
There are some doubts regarding NBFC due diligence or would like to know how we can help you? Comment down below or connect with us at NBFC Advisory.
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