Some thoughts on the NBFCs Auditors Report Directions 2008 – II (concluded)

(second and concluding part)

Having considered some basic concerns, let us consider a few areas relating to the 2008 Directions.

Essentially, the requirements are just a few if one groups them. The Auditors are required to report on compliance generally relating to registration. For example, has the NBFC registered itself with the Reserve Bank of India if it is required to do so? The reverse question to be also answered is, does the NBFC holding a Certificate of Registration still an NBFC? And so on.

Then there are reporting requirements relating to eligibility relating to acceptance of deposits and whether the applicable limits to the particular NBFC on deposits have been exceeded.

There are requirements on whether the Directions relating to Prudential Norms have been complied with generally and specifically with regard to certain matters.

Also, whether the specified reporting requirements have also been complied with?

And so on.

These are the reporting requirements for the report to the Board of the NBFC. However, there are two situations under which the Auditors has to make, what is called an “exception report”, directly to the Reserve Bank of India. Firstly, if, in the report to the Board of the NBFC as discussed earlier, there are any statements that are unfavorable or qualified, then the exception report in respect of such statements has to be made. Secondly, if the NBFC has not complied with any of the specified provisions of law relating to NBFCs – a review of the list shows that practically all the provisions under the RBI Act or which the RBI has notified are to be covered – such non-compliance has also to be so reported directly to the Reserve Bank of India.

The Directions has thus put the onus of checking on compliance of all such laws on the Auditors. Auditors normally check on accounting requirements or a few provisions of laws that affect such accounting requirements. The onus placed on the Auditors under these Directions relate to intricate issues of law most of which are not connected with accounting. And these laws are often not clear and have ambiguities. Nevertheless, the Auditors would be obliged to interpret and take a view on them and report to the Reserve Bank of India on non-compliances.

Consider a very basic requirement relating to NBFCs. When is a company an NBFC? The Act gives a fairly convoluted definition but it boils down mainly on what the “principal business” of the company is. What is the “principal business” and how does one decide what is the “principal” business? The law does not give any guidance. The Reserve Bank of India has given some indicative specific requirements under certain circumstances in a press release but one wonders whether it has any legal status. In fact, whether a company is or is not an NBFC is a question that requires consideration of many factors but surprisingly, the Public Deposits Directions state that if there is any doubt as to whether a company is a NBFC or not, the Reserve Bank of India will decide the issue in consultation with the Central Government and its view would be final. But for the purposes of the report, still, the Auditors will have to form his own opinion. Mind you, this question has to be answered not just for NBFCs but for every company because the Auditors have to question every company’s facts as to whether it is an NBFC.

Further, taking a view as to whether a company is an NBFC or not has serious repercussions. If a company is an NBFC and it has not registered, the punishment for non-registration is a minimum and mandatory imprisonment of one year.

Criticisms apart, these Directions do put a check on the NBFC itself. It knows that, though a little later after maybe a year, someone is going to check on compliance of the law by it and if there are non-compliances, there would be a direct report to the Reserve Bank of India.

NBFCs have always been considered to be sensitive entities by the Reserve Bank of India since they can accept deposits from the public without the rigorous discipline applicable to banks. The many investments banks that failed in the US recently are comparable to the NBFCs here despite certain conceptual and legal differences. Even these entities there used Other People’s Money and lost them in trillions of dollars. The loss obviously is not restricted to those who gave monies to such entities but there were system wide – even global – repercussions. In this context, NBFCs in India are obviously bound to face strict regulations and these 2008 Directions are just some more of such controls.

Jayant Thakur, CA

(Concluded)