NBFC Due Diligence- An Overview

NBFC Due Diligence is the exercise of ascertaining the commercial value of an NBFC by examining its assets and liabilities. This exercise is undertaken usually by and for the investors to find out the feasibility of making investment and also to ensure that the investments made in the NBFC will be safe and sound. This exercise is also a reflection of the due care taken by the organisation / individual who is about to or looking forward to making an investment in an NBFC.

It must be noted that there is no set criteria for the exercise of NBFC due diligence. It is dependent on the basis of the market and industry in which the entity is carrying on its business and accordingly the exercise of NBFC Due Diligence is designed and carried out. Such custom designed exercise makes it easier in ascertaining the actual value of the NBFC and also in making comparisons in the same market.

What are the aspects of NBFC Due Diligence?

NBFC Due Diligence is done for an NBFC with the objective of evaluating the business activities of the NBFC and to ascertain its assets and liabilities from the commercial point of view. Any investor who is thinking about making investment in an NBFC wants to undertake this exercise to ensure that his investment is not being misused and being invested in an economically viable entity.

Every NBFC Due Diligence exercise is undertaken under the following four broad heads:

Legal Due Diligence

The legal due diligence is the scrutiny of an NBFC done on a legal basis. Such scrutiny takes into account contracts entered into by NBFC, property, loans taken, pending litigation, legal structure and the employment compliances of the organisation. Legal due diligence encompasses scrutinising the whole working of an NBFC from a legal point of view and comprises of assessment on the following matters:

1. Whether the NBFC has been incorporated according to the required business structure/ vehicle or not?
2. Whether the NBFC has been registered as per the applicable laws or not before undertaking activities as an NBFC?
3. Whether the NBFC has been complying with the necessary legal compliances such as maintenance of registers, maintenance of accounts in the prescribed format etc. or not?
4. Whether any cases are pending against the NBFC and the status of such cases?
5. Whether the company is at any legal risk or not?
6. Any other legal matter connected to the NBFC.

Financial Due Diligence

Financial Due Diligence involves ascertaining the financial information of the NBFC viz. Financial information pertaining to the assets and liabilities of the company such as debts, cash flow and other financial aspects of the NBFC relating to its capital, management etc. Following are the financial aspects where a company needs to maintain its financial hygiene:

1. The accounts and other financial records should be accurate and genuine based on the prescribed best practices;
2. The credibility and creditworthiness of the company should also be maintained; and
3. Overall financial hygiene should be maintained.

Commercial Due Diligence: Commercial due diligence is undertaken keeping in mind NBFC as a business entity checking the financial viability and soundness of the project. The NBFC is evaluated as a part of the business market where comparison is done taking into account the performance of the competitors, customer relationship of the NBFC, vision of the business, current and expected sales, strategies adopted for growth and the position of the business within the market. To be precise, following practices form part of commercial due diligence:

1. Comparison of the performance of the competitors of the NBFC as per the market conditions;
2. Level of relationship between the customers of NBFC with its customers;
3. Goodwill of the NBFC in the market;
4. Marketing and sales strategies adopted to grow the business in the near future;
5. Reasonable expectations of the NBFC meeting its targets etc.

Other (Miscellaneous) Due Diligence

The facets of scrutiny that did not form part of the above three heads is covered within the ambit of Other (Miscellaneous) Due Diligence. Those aspects which form vital components such as Taxation, Management, Information Technology systems, communication channels, data protection and data management etc. From the above discussion, it can be safely concluded that due diligence of an NBFC is evaluation of each and every material aspect of the NBFC and cannot be restricted under few heads. The scrutiny is with respect to the overall

What is a Non-Banking Financial Company (NBFC)?

A non-banking financial company is a company that has been registered under the Companies Act, 1956 and 2013. It is engaged in the business of extending loans, advances, acquisition of shares, leasing, hire-purchase, insurance, chit business. It is also mandatory for an NBFC under section 45-IA of the Reserve Bank of India Act, 1934.

Collecting information for NBFC Due Diligence  

Before embarking on the process of NBFC Due Diligence, it is important that only accurate and information pertinent to NBFC Due Diligence is only adopted. It is also important that the source who collects the information for the purposes of due diligence should be dependable as the entire exercise of NBFC Due Diligence and the consequent decision of the investment in derived on the basis of information collected.

The information relevant for carrying out the exercise of NBFC Due Diligence should be taken from the financial records of the company, business news, market data, directors of the company etc.

The following things should be kept in mind while collecting the information:

• Prepare a checklist of all kinds of information required for carrying out the exercise of NBFC Due Diligence;
• Locating the sources where the information is being collected;
• Appointment of professionals for collecting the relevant information and for conducting the entire NBFC Due Diligence process.

The importance of appointment of professionals for carrying out the exercise of NBFC Due Diligence cannot be ignored because these people hold the experience in undertaking the exercise of Due Diligence, and have the requisite know-how to cull out the important information from complicated texts of financial data. These professionals are also proficient in finding out whether the information is authentic or not. To sum up, these professionals can help in determining whether the information collected is correct or not and the exercise of Due Diligence can be conducted based on this information or not.

Legal compliances to be checked for NBFC Due Diligence   

For the purpose of NBFC Due Diligence, following legal compliances need to be checked by the auditor:

• Creation of Statutory Reserves-

According to section 45-IC of the Reserve Bank of India Act, 1934, every NBFC has to create a reserve fund and transfer a sum not less than 20 per cent of its net profit every year as disclosed in the profit and loss account and also before any dividend is declared.

• Registration of the NBFC with the KYC portal-

Every NBFC is supposed to get it registered with the KYC portal and provide the prescribed information.

• Registration with the Financial Intelligence Unit- India (FIU-Ind)-

The NBFCs are supposed to verify the identity of their clients, maintain records and furnish information to the Financial Intelligence Unit-India according to Prevention of Money Laundering Act, 2002 and Rules made thereunder.

• Appointment of nominated counsel in Delhi High Court-

According to one of the guidance note released by SEBI, all the NBFCs empowered to invoke section 13 and 14 of the SARFAESI Act are required to appoint nominated counsels in the High Court and convey their names to the Central Registry of Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest.

• Obtain the membership of a Credit Information Company (CIC)-

All the NBFCs are required to obtain the membership of one of the four Credit Information Companies as per RBI.

• Auditor's Report to Directors and Statutory Auditor Certificate-

As per the directions of various Circulars released by RBI, the auditor's report and statutory auditor certificate need to be checked for due diligence purpose.

Key Areas forming part of NBFC Due Diligence process  

Scrutiny of the following documents forms part of the exercise of NBFC Due Diligence:

• Corporate matters
• Foreign Direct Investment (FDI)
• Matters related to the financials of the NBFC
• Property and Real Estate assets held by the NBFC
• Human Resource (HR) capabilities and all the HR compliances
• Intellectual Property Rights held by the NBFC
• Scrutiny of the minutes of the meetings held so far
• All the secretarial compliances
• All the major agreements entered into by the NBFC
• Compliances prescribed by RBI under various regulations
• Pending litigation of NBFCs
• Insurance claims of the NBFCs
• All the taxation compliances

Ensure Authenticity of the documents

Whenever a due diligence activity is being carried out, the first thing the evaluator must be assured about is that the documents which are being scrutinised are not fake and it becomes the duty of the hired professionals undertaking the activity of Due Diligence to check the authenticity of the following documents:

• Certificate of Incorporation of the NBFC
• GST registration
• TAN registration
• PAN

All the documents submitted to the RBI, MCA and other regulatory bodies for carrying out the business of NBFC.

The evaluator also needs to be assured about the authenticity of all other registrations and permissions obtained by the NBFC from various regulatory bodies. These documents need to be maintained by the evaluator till the conclusion of the Due Diligence exercise.

There are some other vital documents that an NBFC needs to maintain as part of its ongoing operations till the exercise of Due Diligence is concluded. Following are the documents:

• Board Resolutions till the date of the exercise of Due Diligence
• Minutes of meetings of all the meetings held till the conclusion of Due diligence
• Statutory audit reports
• Record of the total net worth of the company

Opinion of the Expert on NBFC Due Diligence

Considering NBFC Due Diligence is a time consuming process detail oriented work, its importance cannot be overlooked or ignored in any manner as a wrong decision with the investment may lead to serious repercussions for the investor and economy as a whole. Therefore, it is always suggested to engage the services of a professional who has years of experience and an eye for detail. The practice of Due Diligence cannot be carried by a single category of professional; it requires the expertise of a battery of professionals such as lawyers, Chartered Accountants, Company Secretaries etc. as the areas to be evaluated are distinct and require a separate skill set. An ideal evaluator is one which comprises of a team of such professionals.