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How to start a small finance company in India?

Legal Raasta
30th May 2019
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A Finance Company is set up with the basic purpose of providing loans to individual and commercial customers. Similarly, a Small Finance company fulfil the financial needs of individuals and businesses, on a smaller level. Basically, they serve those poor people who cannot access mainstream banking and financial services. Thus, you can deduce that a Small Finance Company acts as a bank for the poor. If your priorities are clear, the process of how to start your Small Finance Company in India may not be a daunting task.


Your customers may include small and marginal businesses/farmers/entities belonging to the unorganized sectors. In general, they don't get served by other larger banks. The reasons for taking the loan may be different for each of your customer.


More about Small Finance Companies


As of now, India is one of the largest emerging markets for Small Finance Companies or Micro-Finance Institutions (MFI). With a huge part of our population based in villages and rural areas, where the traditional banking assistance is out of reach. People in the lower income group take the informal channel of financial assistance like moneylenders and pawnbrokers. Generally, this means paying high-interest rates and be forever under debt. Such debtors are not able to benefit from the economic development of the country.


In such areas, the Small Finance Banks prove to be useful. After obtaining a license from the Reserve Bank of India, they can provide three basic services i.e. savings, credit and insurance. Primarily, the amount of loans is less than Rs. 50,000. Such entities provide loans without demanding any collateral or marginal money. Moreover, the borrowers get much easier repayment facilities. And these Small Financing Entities, although charging higher interest rates than those in the urban areas, still charge much less as compared to the private moneylenders.


The government has realized the importance of such entities for the development of rural and backward sectors. In recognition of the same, RBI has released detailed guidelines related to how to start a Small Finance Company, applicable in India.


The goal of MFI in Indian Context


With MFIs, the communities have better access to capital and funds. Thereby, MFIs assist in all of the development goals through various financial services, programs, and resources.


  • Strengthening women’s participation in activities of generating livelihood and decision-making at the household and community levels.
  • Providing access to health care insurance and protection.
  • Reduction in the economic need to keep children working and out of school.
  • Providing access to more environmentally friendly agricultural inputs.
  • Educating the public about better resource management. which can enhance the sustainability of income-generating activities and natural resources.
  • Increasing the modes of earning a livelihood for poor people and creating opportunities for self-employment. This way the impact of natural calamities gets reduced.
  • Training rural in simple skills so they make better use of the available resources.


How to start a Small Finance Company in India


Starting any business requires an in-depth knowledge of the needs of the customer. Additionally, you need to have a solid business plan in place outlining the path to success. Likewise, you need to have a step-by-step process for how to start and make your Small Finance Company, success in India. For this, the first prerequisite is to comply with the strict regulations and meet initial funding requirements.

Before setting up your Finance Bank, you need to decide whether you want to set your MFI as a Profit Institution or as a Non-Profit Institution.


Starting a Non-Profit Micro Finance Business


An MFI under Non-Profit Organization is registered as Trusts/Societies/Companies under the relevant acts. Those are Indian Trust Acts 1882/Societies Registration Act 1860/Companies Act 2013, respectively. Micro-Finance, generally termed as Micro-Credit, need to take Section 8 Company Registration of Companies Act 2013.


How to start a Small Profit-Making Finance Company in India


A Profit Making MFI can be registered either as a Non-Banking Financial Company (NBFC) or as a Co-operative Society. Incidentally, an unregulated Non-Profit NGO can be transformed into a regulated, For-Profit Institution, as well.


This commercializing the entity would attract market investors. The supervising and regulatory authority is RBI, where they are registered. Their performance and other standards need to be maintained and, if possible, improved, to assure good investment for the investors.


In fact, today’s big MFIs started as Non-Profit Entities. For instance, India’s two largest, Swayam Krishi Sangam (SKS) and Spandana Microfinance, both of Hyderabad, also started as Non-Profits. Later they turned into For-Profit Finance Companies.


Just remember, investors would want to ensure that their investments earn higher returns.


Registration Process


For Non-Profit Micro-finance Business through Section 8 Company


You can start Small Finance NGO registered as a Society, Trust or a Company, in India. Another name for NGO registered as a Company is Section 8 Company.


Such Section 8 Companies have higher credibility amongst Government departments, Donors, and another stakeholder. Therefore, it is an advisable path to your Small Finance Business. Listed below are some of the benefits and ease of doing business as a Section 8 Company:


  • The registration process, under Section 8 of the Companies Act, is much cheaper and easier,
  • RBI approval is not mandatory. Only required to comply with its guidelines concerning Interest Rates and Processing Charges,
  • Number of Compliances required is much lesser as compared to other MFI,
  • There is no Minimum Ceiling for Fund-Raising,
  • Can grant Unsecured Loans of an amount up to Rs. 50,000, to Small Businesses. Limit to grant a loan for Dwellings and Residences is Rs. 1,25,000,
  • Loans can be granted following the guidelines under the relevant Sections,
  • The Average Interest Rate should not be more than 26%. 
  • The Processing Charge should not be over 1% of the Gross Loan Amount.
  • In the case of Insurance, the Premium charged must be the Actual Cost of the Insurance of the Group/Life/Health and nothing extra.
  • Not allowed to accept public deposits.


Documents Required:


⇒ Directors/Shareholders are to submit Copies of PAN Card, Adhaar Card, Address Proof (Utility Bill, Bank Statement, Rent Agreement etc.).

⇒ Address proof for the Registered office of the Company would include Ownership Proof (Utility Bill etc.), NOC.


Step-by-Step:


To start your Finance Company as a Section 8 Company, the minimum number of Directors is 2, in India.


  1. Obtain their DSC and DIN.
  2. Choose and get the Name approved from the ROC. The name has to be unique, that reflects your brand. A maximum of 6 names can be filed at one time.
  3. Apply for a License to do the social work in India, from the Central Government.
  4. On receipt of License approval, apply for Incorporation. The application has to be enclosed with all the important attachments like MOA, AOA, Declarations etc. Wherein, your Company will be issued a Certificate of Incorporation.
  5. Obtain PAN and TAN for your Section 8 Company.


For Small Finance Company as NBFC


An NBFC-MFI is allowed to provide the Micro-Loans only to a special type of clients/borrowers. Other essential features are:


  • At least one of the director or the company itself must be experienced in the financial services of not less than 10 years.
  • Small Finance Company, as NBFC can use Self Help Groups (SHG) to intermediate the financial transactions.
  • MFI is a Non-Deposit taking NBFC.
  • The License to operate an NBFC is to be applied from RBI, subjected to the fund capital.
  • An NBFC-MFI has to have a paid-up capital of Rs. 5 Cr.
  • It has to be a member of the Credit Information Companies (CICs).
  • Additionally, it has to be a member in at least one Self-regulatory Organisations (RBI, SEBI, IRDA, NABARD or SIDBI, to name a few).
  • The Small Finance Company, for registration as an NBFC, shall have CIBIL membership.
  • Any borrower cannot be lent an amount over Rs. 50,000 at first borrowing. The upper limit for all subsequent borrowings is Rs. 1 lakh.
  • However, a particular borrower shall not have loans exceeding Rs. 1 lakh, at one time.
  • The loans would be provided to borrowers having an annual income of less than Rs. 1 lakh (for rural areas) or Rs. 1,60,000 (for semi-urban areas).
  • The Interest charged would be lower of: (a) [Cost of Funds + 12% Margin], or (b) [Average Base Rate x 2.75].
  • At least 10% of the total assets of the small finance company should be loans.


Documents Required:


⇒ Director's/Shareholder's KYC and income proof

⇒ Director's Education/Professional qualification proof, along with proof of the work experience in the field of the financial services sector.

⇒ Net-Worth Certificate of the Directors, Shareholders and the Company.

⇒ Latest Credit Report of the Directors and the Shareholders.

⇒ MOA & AOA of the NBFC depicting the Financial/Investment/Lending business.

⇒ Company Incorporation Certificate.

⇒ Obtain a Banker's Certificate of No Lien supporting Net Owned Funds (NOF) of Rs 5 Cr.

⇒ Banker's Report about the Company and its group.

⇒ A detailed action plan about the Loan Products, Fair Practice Code, Credit and Risk Assessment Policy.

⇒ Organization's Structure Plan.

⇒ Decision-making process for Approval or Rejection of a Loan Application.

⇒ Board Resolution passed in favour of NBFC formation.


Step-By-Step:


  1. Register the Company: The first step involves getting your Financing Bank registered as a Company. You can start by getting your Finance Company registered as a Private Limited Company or a Public Limited Company, India.
  2. Raising Capital: As having a minimum authorized and paid-up capital of Rs. 5 Cr is mandatory for an NBFC Registration. So you must arrange to raise the NOF up to this amount at least, once your Company has been registered.
  3. Certificate of No Lien: Deposit Rs. 5 Cr as Fixed Deposit and obtain the Certificate of No Lien from the bank.
  4. Register with RBI: File an Online Application with RBI to get your NBFC started as a Small Finance Company in India. This Application is to be filed along with the other documents, as may be required. Once the Application has been successfully submitted, Your Company will get a Company Application Reference Number (CAR number). This CAR number must be used in all further communications with the RBI. 
  5. Filing with the RBI: Once the Application has been filed, a physical copy of the Application, along with all the necessary documents, are to be sent to the Regional Office of the Reserve Bank of India.


With Automated systems now available, the growth rate of the Micro-Credit Sector has accelerated. Automation has worked to improve efficiency. The Sector providing Micro-Finance has to focus on understanding the needs of the poor. They need to proactively devise better ways of delivering services in line with the requirements. To start a Small Finance Company in India would involve developing an efficient and effective mechanism to deliver credit to the poor. 

 

This article has been shared by Reema, in recruitment with LegalRaasta. We are in the business of providing well-informed Legal, Registration and Financial Services related to Professions and Companies.

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