The Viewpoint: Liberalizing FDI in Financial Services: Need of the hour?

The Viewpoint: Liberalizing FDI in Financial Services: Need of the hour?

Bar & Bench

 – Shradha Sachdev (With inputs from Satyajit Gupta)


Traditionally, India has had a bank-dominated financial services sector. However, the importance of non-banking financial companies (NBFCs) has been recognized, not only as a supplement to mainstream banking in meeting the increasing financial needs of the corporate sector but also for delivering credit to the unorganized sector and to small local borrowers.

The RBI Act broadly defines a NBFC as a financial institution that is into lending or investment or collecting monies under any scheme or arrangement but does not include any institutions which carry on agricultural activity, industrial activity, trading and purchase or sale of immovable properties as their principal business.

Contribution of NBFCs to the economy has grown in leaps and bounds from 8.4% in 2006 to above 14% in March 2015[1]. In terms of financial assets, NBFCs have recorded a healthy growth – a compounded annual growth rate (CAGR) of 19% over the past few years – comprising 13% of the total credit and expected to reach nearly 18% by 2018–19[2].

The Indian government understands that industrial growth is impossible in an environment where banks are reluctant to finance new businesses. The Pradhan Mantri Mudra Yojana (PMMY) was launched for the benefit of bottom of the pyramid entrepreneurs. Banks and NBFC-Micro Finance Institutions have reported that the amount sanctioned under PMMY had reached about INR 100,000 crore to over 2.5 crore borrowers by early February 2016, while the target next year is raised to INR 180,000 crore[3].

To complement various initiatives like Make in India, Start-up India, Smart Cities, and Housing for all, the government has announced a significant change for NBFCs by liberalizing the existing foreign direct investment (FDI) regime in India[4].

In addition to the restricted ambit of activities open to FDI earlier[5], there were other challenges. For example, asset management activity, even though technically a fee based activity, was treated as a ‘fund-based’ activity for the purpose of capitalization, thereby attracting prohibitively high capitalization norms linked to foreign ownership.

Further, since the list of permitted activities under the current list did not specifically include ‘investment activities’, regulatory ambiguity existed for FDI in a NBFC engaged in any investment activity. Separately, whenever a majority foreign-owned NBFC created a step down joint venture or a subsidiary, it attracted additional capitalization requirements; this additional capital would have to be brought in through fresh infusion in the parent, thereby further disturbing the foreign investment at the parent entity level.

Expansion of Eligible Activities

Foreign Direct Investment in NBFCs are no longer restricted to the 18 stipulated activities but have been permitted across all regulated activities. This means that as long as the NBFC is subject to a regulatory authority such as the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Pension Fund Regulatory and Development Authority (PFRDA) etc., it is permitted to raise 100% FDI under the automatic route, irrespective of the activity it performs.

For example, once a commodity broking license is approved by SEBI, a commodity broking company will not require any further approval from the Foreign Investment Promotion Board (FIPB) for bringing in foreign direct investment.

Prior government approval will be required for bringing in foreign investment only in such NBFCs that are not regulated or where only part of the financial services activity is regulated or where there is doubt regarding regulatory oversight[6].

Until now, one of the major difficulties faced by NBFCs while inviting foreign funds was regarding the interpretation of the permitted 18 activities. Financial services being a dynamic sector, the nature of financial services has been evolving and there was no definition or basis for ascertaining the services from which these 18 activities evolved.

Further, there was also no practical or reliable mechanism for investors to ask questions relating to whether or not a certain activity is covered within the permitted 18 activities. It would not be incorrect to say that this ambiguity, at times, restricted highly potential businesses from accessing foreign funds.

With permission for inflow of foreign investment in “Other Financial Services” on automatic route, the sector is poised to witness remarkable diversity of players and businesses being intermediaries between mainstream banking and unorganized sectors.

 Capitalization Norms

The Government has also done away with the minimum capitalization requirements under the FDI policy[7].

While NBFCs undertaking non-fund based activities[8]were required to comply with a minimum capitalization of USD 0.5 million upfront, those undertaking fund based activities were required to comply with the following requirements;

  • USD 0.5 million for FDI upto 51%, to be brought upfront;
  • USD 5 million for FDI more than 51% and upto 75%, to be brought upfront;
  • USD 50 million for FDI more than 75% out of which USD 7.5 million to be brought up front and the balance to be brought in within 24 months.

This was in addition to and irrespective of the minimum capitalization requirements fixed by the relevant sector regulatory authority. Moreover, it was unfair to subject merchant banking and custodian services to similar capitalization norms without taking the market and investment environment into consideration.

To eliminate the vexatious requirement of complying with multiple capitalization norms, the FDI policy does not stipulate any minimum capital requirements anymore. This means that an NBFC would need to comply with capital requirements fixed, if at all, by the relevant sectoral regulatory authority only. The minimum capitalization requirements shall be decided by the government for NBFCs when raising FDI is falling under approval route.

Interestingly, in view of Foreign Exchange Management (Transfer or Issue of Security by the Person Resident Outside India) (Thirteenth Amendment) Regulations, 2016, for activities that are regulated by a specific act, the foreign investment limits shall be restricted to such limits as may be set out under the relevant act[9].

The impact of this change may be appreciated better by analyzing the capitalization norms stipulated by the relevant regulator for some common financial sector services:

S. No.Financial ServiceRegulatorCapitalization Norms
1.Merchant bankingSEBI

Net worth of not less than INR 50 million.

“Net worth” means the sum of paid-up capital and free reserves of the applicant at the time of making application


Net worth of not less than INR 2 Million.

However, every stock-broker, who acts as an underwriter shall fulfil the capital adequacy requirements specified by the stock exchange of which he is a member.

“Net worth” means,— (a) in the case of an applicant being a proprietary concern or a firm or an association of persons or anybody of individuals, the value of capital contributed to such business by the applicant and the free reserves of any kind belonging to the business of the applicant; and (b) in the case of a body corporate, the value of the paid-up capital and the free reserves as disclosed in the books of account of the applicant at the time of making the application under sub-regulation (1) of regulation 3.

3.Portfolio Management ServicesSEBINet worth of INR 30 Million;

Provided that a portfolio manager, who was granted a certificate under these regulations prior to the commencement of the Securities and Exchange Board of India (Portfolio Managers) (Amendment) Regulations, 2008, shall raise its net worth to not less than one crore rupees within six months from such commencement and to not less than two crore rupees within six months thereafter;

Provided further that the portfolio manager shall fulfill capital adequacy requirement under these regulations, separately and independently, of capital adequacy requirements, if any, for each activity undertaken by it under the relevant regulations.

“Net worth” means the aggregate value of paid up equity capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not written off, including miscellaneous expenses not written off.

4.Custodian ServicesSEBINet worth of a minimum of INR 500 Million. Explanation-For the purposes of this regulation, the expression “net worth” means the paid-up capital and the free reserves as on the date of the application.
5.Investment AdvisorySEBI

Net worth of not less than INR 2.5 Million.

“Net worth” means the aggregate value of paid up share capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses, deferred expenditure not written off, including miscellaneous expenses not written off, and capital adequacy requirement for other services offered by the advisers in accordance with the applicable rules and regulations.

Further, Investment advisers who are individuals or partnership firms shall have net tangible assets of value not less than rupees one lakh. Provided that existing investment advisers shall comply with the capital adequacy requirement within one year from the date of commencement of these regulations.

6.Credit Rating agenciesSEBI

Net worth of not less than INR 50 Million.

Provided that a credit rating agency existing at the commencement of these regulations, with a net worth of less than rupees five crores, shall be deemed to have satisfied this condition, if it increases its net worth to the said minimum within a period of three years of such commencement.

7.Collective Investment SchemeSEBI

Net worth of not less than INR 50 Million.

Provided that at the time of making the application the applicant shall have a minimum net worth of rupees three crores which shall be increased to rupees five crores within three years from the date of grant of registration;

8.Stock Broker and Sub-brokerSEBI

Base Minimum Capital stipulated by SEBI[10] as applicable for NSE:

(a) Only Proprietary trading without Algorithmic trading (Algo) – INR 1 Million

(b) Trading only on behalf of Client (without proprietary trading) and without Algo – INR 1.5 Million

(c) Proprietary trading and trading on behalf of Client without Algo – INR 2.5 Million

(d) All Trading Members/Brokers with Algo – INR 5 Million

For MCX, Base Minimum Capital requirements are:

(a) A Member with Algo Trading – INR 5 Million

(b) A Member without Algo Trading – INR 1 Million[11]

9.Angel FundSEBI

Net worth of at least INR 10 Million; or


10.Non-Banking Financial CompaniesRBI

INR 20 Million as the net owned fund (NOF) required for a non-banking financial company to commence or carry on the business of non-banking financial institution, except wherever otherwise a specific requirement as to NOF is prescribed by the Bank;

(1) Every applicable NBFC shall maintain a minimum capital ratio consisting of Tier I and Tier II capital which shall not be less than 15 percent of its aggregate risk weighted assets on-balance sheet and of risk adjusted value of off-balance sheet items.

(2) The Tier I capital in respect of applicable NBFCs (other than NBFC-MFI and IDF NBFC), at any point of time, shall not be less than 8.5% by March 31, 2016 and10% by March 31, 2017.

(3) Applicable NBFCs primarily engaged in lending against gold jewellery (such loans comprising 50 percent or more of their financial assets) shall maintain a minimum Tier l capital of 12 percent.

Needless to say, downstream investment by NBFCs having FDI will be subject to the relevant sectoral regulations and provisions of Foreign Exchange Management (Transfer or Issue of Security by the Person Resident Outside India) Regulations, 2000, as may be applicable[12].

 Interpretational Issues Remain?

There seems to be a lack of clarity as to whether the financial services activity needs to be ‘regulated’, or whether the entity needs to be licensed by a regulator for it to avail the automatic route. For e.g. an AIF manager is regulated by SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012 even though the entity itself is not licensed by SEBI.

Further, questions arise as to whether the above conditions could be seen as ‘FDI-linked performance conditions’, thereby making LLPs engaged in financial services ineligible for receiving FDI. It is not clear if an AIF manager incorporated as an LLP can have any foreign investment.

Additionally, there is no uniformly accepted definition of ‘financial services’ in the Indian context. The RBI definition of NBFCs covers certain entities and a number of other activities are regulated by SEBI and other regulators. Traditional Indian financial services entities such as ‘nidhis’, chit funds etc. are restricted rather than regulated by general regulators such as the Ministry of Corporate Affairs.


While the above questions remain to be conclusively answered, a number of financial services such as mutual funds, collective investment schemes, infrastructure debt funds, that have remained largely inaccessible by foreign investors precisely due to lack of clarity on the services included in the 18 stipulated activities, are now open for FDI.

With this recent liberalization of FDI norms, India seeks to truly fuel economic growth and development by allowing greater financial services sector penetration to support small and micro businesses. Even businesses with low net worth would be able to take advantage of well-funded NBFCs.

In the uncertain global economy emanating from ‘Brexit’, the results of the US Presidential elections and the slow-down in the Chinese economy, the financial services sector of India ought to get the attention of global investors who will be lured by the liberalized FDI regime.


[4] RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016 (published in the Official Gazette of Government of India – Extraordinary – Part-II, Section 3, Sub-Section (i) dated 09.09.2016- G.S.R.No.879 (E))

[5] Previously FDI was permissible for (1) Merchant Banking, (2) Under Writing, (3) Portfolio Management Services, (4) Investment Advisory Services, (5) Stock Broking, (6) Asset management, (7) Venture capital, (8) Custodian Services, (9) Factoring, (10) Credit Rating Agency, (11) Leasing & Finance, (12) Housing Finance, (13) Forex broking, (14) Credit Card Business, (15) Money Changing Business, (16) Micro Credit (17) Rural Credit and (18) Financial Consultancy.

[6] Paragraph F.8.1, sub-clause (ii) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016

[7] Paragraph F.8.1, sub-clause (i) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016

[8] Non- fund based activities are (a) Investment Advisory Services, (b) Financial Consultancy, (c) Forex Broking, (d) Money Changing Business and (e) Credit Rating Agencies.

[9] Paragraph F.8.1, sub-clause (iii) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016

[10] SEBI Circular No. CIR/MRD/DRMNP/36/2012 dated December 19, 2012

[11] Circular No. MCX/MEM/138/2013 dated April 11, 2013

[12] Paragraph F.8.1, sub-clause (iv) of RBI Notification No. FEMA.375/2016-RB, dated September 9, 2016

Shradha Sachdev (l) is an Associate and Satyajit Gupta (r) is a Principal in the Corporate/ M&A team at Advaita Legal.

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