A Complete Checklist for Start a Small Finance Company in India

India is a rapidly developing economy, with a diverse population and a large bank of talent. However, a significant portion of the country’s population resides in rural and semi-urban areas, where the traditional banking services are yet to make a mark. Individuals and businesses belonging to the lower-income group are unable to find secure channels of credit. Due to this shortage, they are forced to rely on informal financial sources that overcharge them significantly. The introduction of Non-Banking Financial Companies (NBFC) has reduced this gap to a large extend, and the introduction of small finance companies has further allowed lower-income groups to access quality credit for their requirements. This guide lays down the complete checklist on how to start a small finance company in India.

What is a Small Finance Company in India?

A small finance company or a microfinance institution is a private institution that extends financial services to businesses and individuals belonging to the lower income levels. Small finance companies provide credit services to individuals and businesses that form the lower levels of the income hierarchy.

Many individuals and business are unable to match the requirements of traditional banking institutions that require a credit background and substantial disposable income. Micro or small finance companies provide financial resources to their customers for their personal or professional financial necessities. Individuals, self-employed professionals and businesses can fulfil their entrepreneurial dream or fulfil a personal financial emergency by availing small-size loan from a microfinance company.

Lending Limitations of Small Finance Company in India

Under the RBI Notifications, small finance companies in India are allowed to provide loans of up to INR 50,000 in rural regions and INR 1,25,000 in urban regions to entrepreneurs, businesses, and individuals/households that belong to the low-income group. It provides loans to small businesses, venturers, self-employed professionals, farmers, etc. without any form of collateral security or marginal money. It can extend credit at reasonable rates as laid down by the central government and Reserve Bank of India.

Benefits of Small/Micro Finance Company in India

The benefits of small or microfinance businesses in India can be summed up under the following points:

• A small finance company provides low-income individuals and MSMEs with quality credit assistance.
• A microfinance company promotes entrepreneurial drive and self-financial reliance among individuals.
• Small finance companies in India have more lenient credit appraisal standards and do not need an elaborate credit history of the borrower.
• Such financial institutions offer flexible and affordable loan repayment rates as compared to traditional banking institutions.
• By offering financial assistance to the lower-income groups, these companies promote better living standards and overall economic growth in the country.

Options for Start A Small Finance Company in India

There are two ways to start a small finance company in India:

• Micro Finance Institution (MFI) Non-Banking Finance Company (NBFC) registered with RBI.
• Small finance Company registered under Section 8 of the Companies Act, 2013.

Starting a Small Finance Company as Non-Banking Financial Company- Micro Finance Institution (NBFC-MFI)

Micro Finance Institutions or MFIs are small finance companies that provide financial services similar to the lending services provided by NBFCs in India. MFIs primarily target the weaker and marginalized segments which are unable to access banking services due to the strict eligibility requirements or inaccessibly in their remote regions.

Generally, an MFI or small finance company extends small-sized loans to individuals and businesses of around INR 20,000-30,000 for an array of financial requirements.

An NBFC MFI is a non-deposit taking NBFC. It is mandatory for such a company to have at least 85% of its assets as qualifying assets. The conditionals applicable over a small finance company established as an NBFC-MFI are as follows:

• Loans provided by an NBFC-MFI can be provided to households with an annual income of INR 1 lakh in rural regions, and to households with an annual income of INR 1,60,000 in urban and semi-urban regions.
• Loans provided by an NBFC-MFI are limited to INR 50,000 in the first cycle and INR 1,00,000 in the following cycles.
• The loans can be extended for a minimum period of 24 hours in case of the amount of loans is more than INR 15,000. Additionally, the borrowers have the option of prepayment without penalty in such cases.
• Loans provided by a small finance company are provided without any form of collateral.
• The loan repayment cycle can be weekly, 15-day or monthly. The borrower has the option to select the EMI cycle as per their repaying capacity.
• The processing fee is limited to 1% of the gross loan amount.
• The company is allowed to different rates of interest from its customers as per their portfolio; however, the minimum and maximum rates of interest cannot exceed 4% for individual loans.
• The NBFC-MFI requires a CIBIL membership mandatorily.

Procedure to Start a Small Finance Company as NBFC-MFI

The following process is followed to start an NBFC-MFI in India:

• Business Registration: The first step to start a small finance company as NBFC-MFI is to register the business as a company under the Companies Act 2013. Once the company registration formalities are completed and the business receives its Certificate of Incorporation from the State ROC, it is required to hold a minimum amount of capital as specified by the RBI.
• Capital Requirement: To start a microfinance company in India, a minimum capital of INR 5 crores is required. However, the requirement to start a small finance company in North-Eastern states is INR 2 crores. The business is required to open a bank account and deposit the capital in the form of a fixed deposit.
• RBI Application: The next step is to file an application with the Reserve Bank of India in the given format for NBFC-MFI registration, along with the requisite documents. The RBI allows a Company Application Reference Number, after which a physical (hard) copy of the documents is submitted.

The RBI performs detailed due diligence on the documents submitted by the applicant company such as the incorporation certificate, Banker’s certificate, MOA and AOA, fixed deposit receipt, etc.

Once the applicant clears the checklist of the RBI, the bank issues a Certificate of Incorporation. After receiving the RBI’s incorporation certificate, the company can launch its lending services in India.

Documents Required for Small Finance Company Registration as NBFC-MFI

The following documentation is required to file an application to start a small finance company in the form of NBFC-MFI in India:

• Certified copy of Certificate of incorporation and certificate of commencement of the business.
• Certified copy of the latest Memorandum of Association and Article of Association of the company.
• Certified copy of the Board Resolution allowing the registration of the company as a small/microfinance company.
• Declaration laying down that the company would comply with the rules, regulation and notifications provided by Reserve Bank of India for non-banking financial companies in India.
• Bankers’ report mentioning their dealing with the company.
• Auditor’s report specifying that the applicant fulfils the minimum capital requirements.
• A detailed 5-year business plan that lays down the company’s operational strategies and financial projections.
• Certified copies of educational and professional qualification of all directors and experience certificate in the sector of Financial Services if any.

Starting a Small Finance Company as Non-Profit Micro Finance Business

Another option to start a small finance company in India is by way of establishing a Non-Profit microfinance business or a Section 8 company. As per the RBI regulations, financial activities by a private institution can only be carried by a company registered as a Non-Banking Finance Companies (NBFC).

However, the Reserve Bank of India has granted certain exemptions for businesses to extend financial services up to a limit without getting registered as an NBFC. The RBI issued its master circular: RBI/2015-16/15 DNBR (PD) CC.No.052/03.10.119/2015-16 dated July 01, 2015 allows companies registered under Section 8 of the Companies Act to undertake microfinance activities.

The circular further states that under Para 2 (iii) of the circular, Sections 45-IA, 45-IB, and 45-IC of the Reserve Bank of India Act, 1934 are not applicable over any non-banking financial company which is involved in the following activities:

• Company engaged in microfinance activities, extending credit for up to INR 50,000 to a business enterprise.
• Company engaged in microfinance activities extending credit for up to INR 1,25,000 to fulfil the costs of a housing unit to any poor person and allowing such individuals to elevate their level of income and standard of living.
• A Company registered under Section 8 of the Companies Act, 2013 (section 25 of the Companies Act, 1956).
• A company which is not taking any public deposits as described in paragraph 2(1) (xii) of Notification No. 118 /DG (SPT)-98 dated January 31, 1998.

Under this notification of the Reserve Bank of India, a microfinance company can be started in the form of a trust, society or company. An MFI can, therefore, be registered under any of the following acts to run as a non-profit business:

• As a Trust under the Indian Trust Acts, 1882
• As a Society under the Societies Registration Act, 1860
• As a Section 8 Company under the Companies Act, 2013

Key Features of Section 8 Small/Micro Finance Company

A small finance company registered as a Section 8 company has the following unique features:

• A section 8 Company can be established only for the purposes of promoting commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment or any such other charitable goals.
• Any forms of profits earned by a Section 8 company can only be used to fulfil its charitable objectives.
• A company registered under Section 8 of the Companies Act cannot declare or pay any form of dividend to its members.
• The small finance company can grant a maximum loan amount up to INR 50,000 for business purposes and INR 1,25,000 for residential dwelling.

Benefits of Small Finance Company Registered Under Section 8

Registering a small finance company under section 8 of the Companies Act, 2013 comes with the following benefits:

• A Section 8 company does not require any separate approvals or registrations from the RBI.
• A Section 8 company does not need to maintain a minimum capital deposit of INR 5 crores.
• The process to start a Section 8 company is fairly simple as compared to an NBFC-MFI.
• The cost of Section 8 company registration is lower than the cost of registering an NBFC.
• The post-registration compliances of a Section 8 company are fewer than a small finance company registered as an NBFC-MFI.

Procedure for Start a Section 8 Small Finance Company in India

The registration process to start a small finance company in the form of a Section 8 company is fairly simple. It includes the following easy steps to start a Section 8 small finance business in India:

• Minimum Requirements: There must be at least two individuals to register a Section 8 company.
• DSC and DIN: Each Director of the company must have a Digital Signature Certificate (DSC) and Directors Identification Number (DIN) for application filing and compliance requirements.
• Naming the Section 8 Company: The application to get the name approval of the company must be filed, mentioning a unique name for the company. The name of Section 8 small finance company must include the words such as foundation, Forum, Association, Federation, Chambers, Confederation, council, Electoral trust or Micro Credit. This makes the nature of the business transparent for the general public.
• Central Government License: Once the name approval is received, the company must obtain the license to operate as a Section 8 company. The license is obtained by submitting the details of the company’s detailed documentation.
• Company Incorporation: Once the documents are submitted and the government approval is received, the company incorporation application must be filed. Upon approval of the documents and application, the company incorporation certificate is issued.
• PAN and TAN: The PAN and TAN of the company must be obtained once the company incorporation is done.

Documents Required for Section 8 Small Finance Company Registration

The following documents are required to obtain the Section 8 company registration in India:

• Latest passport size photographs of all directors or promoters.
• Copy of PAN of all directors or promoters.
• Identity Proof of the Directors such as voter ID card, driving license, passport or Aadhar Card.
• Address Proof of the Directors such as the Bank Statement or the latest Utility Bills such as telephone bill, landline bill or electricity bill.
• Property ownership documents of Registered office such as rent agreement or lease deed, property documents, or electricity bills, etc.
• Certificate by a practising Chartered Account or Company Secretary.

Starting a Small Company: Which Option is Better?

While starting and running a small finance company as a Section 8 company is relatively easier, it is advised by the most experienced finance experts that starting a small finance company in the form of an NBFC-MFI. Starting an NBFC-MFI provides the RBI’s^[1] backing to the business to carry out its lending activities securely in the country.

Also, with the RBI’s backing, the chances of default are lesser than the defaults in the case of Section 8 companies. Since registering an NBFC-MFI requires a Banker’s involvement in the Board, the lending activities are executed and backed by subject matter experts. Starting a small finance company in the form of NBFC-MFI if the business has the correct support and guidance of business experts who have prior experience in NBFC registrations at the RBI. Swarit connects you with a team of NBFC experts who can guide you at each step of your business registration and help you establish and operate a successful small finance company in India.