1. Background (what client wants to do, what is an LSP, NBFC, etc.

)
Our client is seeking to set up an Indian entity that shall engage in SME lending activities. In this
respect, they want to first start with a Lending Service Providers (LSP). And subsequently,
transition to a lending Non- Banking Financial Companies (NBFCs).

What is Lending Service Providers (LSP)?

Lending Service Providers (LSPs) are third-part agents that work with Regulated Entities (REs),
such as banks or Non-Banking Financial Companies (NBFCs), to facilitate various stages of the
lending process. They often operate via digital platforms or apps, making loans accessible. RBI
defined an LSP1 as an agent of a Regulated Entity (RE) who carries out one or more of lender’s
functions or part thereof in customer acquisition, underwriting support, pricing support,
servicing, monitoring, recovery of specific loan or loan portfolio on behalf of REs in conformity
with extant outsourcing guidelines issued by the Reserve Bank.

What is Non-Banking Financial Companies (NBFCs)2?

The Reserve Bank of India (RBI) defines NBFCs as companies registered under the Companies
Act of 1956 (now Companies Act, 2013) that are involved in businesses such as loans,
advances, and the acquisition of shares, stocks, bonds, or other securities issued by the
Government or other authorities. Simply put, NBFCs provide similar financial services to banks
but operate under different rules and regulations.3
Unlike banks, NBFCs cannot accept demand deposits (the money you can withdraw anytime,
like a savings account in a bank). Still, they can provide loans, offer leasing services, and even
engage in investment-related activities.

2. What all activities can an LSP do4?

i. Customer Acquisition:
 Marketing of loan products
 Lead generation of potential borrowers
 Collection and preliminary analysis of customer data
ii. Underwriting Support:
 Assisting REs in assessing borrower creditworthiness
 Verification of documents
 Background checks
iii. Pricing Support:
 Helping REs determine appropriate interest rates and fees based on borrower
risk profiles.
iv. Disbursement:
 Facilitation of loan disbursement processes once approval is granted.
v. Servicing:
 Answering borrower questions and managing loan accounts.
 Payment processing
vi. Monitoring:
 Tracking loan performance and borrower behaviour for the RE
vii. Collection and Recovery:
 Management of collections on behalf of the lender.
 Implementation of recovery strategies for overdue or defaulted loans.

3. How LSPs is regulated and its eligibility criteria?

Lending Service Provider (LSPs): An agent of a Regulated Entity who carries out one or more of
lender’s functions or part thereof in customer acquisition, underwriting support, pricing support,
servicing, monitoring, recovery of specific loan or loan portfolio on behalf of REs in conformity
with extant outsourcing guidelines issued by the Reserve Bank.

1
https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12382&Mode=0
2
https://cleartax.in/s/non-banking-financial-company-nbfc
3
https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=1167
4
https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=3413
 The Reserve Bank of India (RBI) has established guidelines to regulate digital lending activities,
which encompass the operations of LSPs.
Eligibility Criteria:
i. Establishing partnerships with REs to facilitate lending services.
ii. Compliance with RBI guidelines: Ensuring adherence to RBI's digital lending guidelines
and outsourcing norms.

4. What is the Key Compliance to be maintained by the LSPs?

i. Nodal grievances redressal officer5: REs shall ensure that they and the LSPs engaged by
them shall have a suitable nodal grievance redressal officer to deal with FinTech/ digital
lending related complaints/ issues raised by the borrowers. Such grievance redressal
officer shall also deal with complaints against their respective DLAs.
ii. Assessing the borrower’s creditworthiness: REs shall capture the economic profile of the
borrowers covering (age, occupation, income, etc.), before extending any loan over
their own DLAs and/or through LSPs engaged by them, with a view to assessing the
borrower’s creditworthiness in an auditable way.
iii. REs shall ensure that any collection of data by their Digital Lending Apps (DLAs) and
DLAs of their LSPs is need-based and with prior and explicit consent of the borrower
having audit trail.
iv. REs shall ensure that LSPs/DLAs engaged by them do not store personal information of
borrowers except some basic minimal data (viz., name, address, contact details of the
customer, etc.) that may be required to carry out their operations.
v. REs shall ensure that their DLAs and LSPs engaged by them have a comprehensive
privacy policy compliant with applicable laws, associated regulations and RBI guidelines.
vi. REs shall ensure that their DLAs and LSPs engaged by them have a comprehensive
privacy policy compliant with applicable laws, associated regulations and RBI guidelines.

5. Is foreign investment allowed in Lending Service Providers (LSPs)?

The Indian Government has taken several steps over the years to encourage foreign investment
into the FinTech sector and make the process of investments less tedious. One of the major
steps was taken in 2016, wherein the Reserve Bank of India (RBI) and the Department for
Promotion of Industry and Internal Trade (DPIIT) liberalised the Foreign Direct Investment (FDI)
regime in relation to the financial services sector, allowing 100% FDI under the automatic route,
i.e., not requiring any prior approval from the Indian Government. 6
Foreign investment in investing companies registered as Non-Banking Financial Companies
(NBFCs) with the Reserve Bank, shall be under 100% automatic route7.

6. Does a change of control in a Lending Service Provider (LSPs) require approval from
the Reserve Bank of India (RBI)8?
In September 2022, the RBI issued comprehensive guidelines on digital lending to enhance
transparency and protect borrowers. These guidelines apply to digital lending services extended
by banks and non-banking financial companies (including housing finance companies). The
Guidelines also refer to Digital Lending Apps (“DLA”) and Lending Service Providers (“LSP”). The
Guidelines reiterate that any outsourcing by an RE to an LSP or a DLA does not diminish the
RE’s obligations to conform to the existing RBI guidelines on outsourcing. In addition, REs also
needs to ensure that LSPs and DLAs comply with the Guidelines. A change of control in a
Lending Service Provider (LSP) does not directly require approval from the Reserve Bank of
India (RBI). However, LSPs act as agents of Regulated Entities (REs) like banks and NBFCs, and
these REs are responsible for ensuring that LSPs comply with RBI guidelines on digital lending
and outsourcing.

5
https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12382&Mode=0
6
https://chambers.com/content/item/4317?utm_source=chatgpt.com
7
Schedule 1 of NDI Rule, 2019
8
https://www.nishithdesai.com/fileadmin/user_upload/pdfs/NDA%20In%20The%20Media/News
%20Articles/Digital-Lending-in-India_Analysis-and-Implications.pdf?utm_source=chatgpt.com
7. What additional activities can a lending NBFC do9?
NBFCs are also be categorized into following types based on the kind of activity they are
engaged in:
i. Asset Finance Companies: An AFC is a company which is a financial institution
carrying on as its principal business the financing of physical assets supporting
productive/economic activity, such as automobiles, tractors, lathe machines, generator
sets, earth moving and material handling equipments, moving on own power and
general-purpose industrial machines. Principal business for this purpose is defined as
aggregate of financing real/physical assets supporting economic activity and income
arising therefrom is not less than 60% of its total assets and total income respectively.
ii. Investment Companies: IC means any company which is a financial institution
carrying on as its principal business10 the acquisition of securities.
iii. Loan Company (LC): LC means any company which is a financial institution carrying
on as its principal business the providing of finance whether by making loans or
advances or otherwise for any activity other than its own but does not include an Asset
Finance Company.
iv. Infrastructure Finance Company: IFC is a non-banking finance company a) which
deploys at least 75 per cent of its total assets in infrastructure loans, b) has a minimum
Net Owned Funds of ₹ 300 crore, c) has a minimum credit rating of ‘A ‘or equivalent d)
and a CRAR of 15%
v. Core Investment Company: It is an NBFC carrying on the business of acquisition of
shares and securities which satisfies the following conditions: -
a) it holds not less than 90% of its Total Assets in the form of investment in equity
shares, preference shares, debt or loans in group companies;
b) its investments in the equity shares (including instruments compulsorily
convertible into equity shares within a period not exceeding 10 years from the
date of issue) in group companies constitutes not less than 60% of its Total
Assets;
c) it does not trade in its investments in shares, debt or loans in group companies
except through block sale for the purpose of dilution or disinvestment;
d) it does not carry on any other financial activity referred to in Section 45I(c) and
45I(f) of the RBI act, 1934 except investment in bank deposits, money market
instruments, government securities, loans to and investments in debt issuances
of group companies or guarantees issued on behalf of group companies
e) Its asset size is ₹ 100 crore or above and
f) It accepts public funds
vi. Infrastructure Debt Fund: It is a company registered as NBFC to facilitate the flow of
long-term debt into infrastructure projects. IDF-NBFC raise resources through issue of
Rupee or Dollar denominated bonds of minimum 5 years maturity.
vii. Micro Finance Institution: It is a non-deposit taking NBFC having not less than 85%
of its assets in the nature of qualifying assets which satisfy the following criteria:
a) loan disbursed by an NBFC-MFI to a borrower with a rural household annual
income not exceeding ₹ 1,00,000 or urban and semi-urban household income
not exceeding ₹ 1,60,000;
b) loan amount does not exceed ₹ 50,000 in the first cycle and ₹ 1,00,000 in
subsequent cycles;
c) total indebtedness of the borrower does not exceed ₹ 1,00,000;
d) tenure of the loan not to be less than 24 months for loan amount in excess of ₹
15,000 with prepayment without penalty;
e) loan to be extended without collateral;
f) aggregate amount of loans, given for income generation, is not less than 50 per
cent of the total loans given by the MFIs;

9
https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=1167
10
The concept of 'principal business' was laid down by India's central bank, the Reserve Bank of India
(RBI), to determine which companies / entities will be considered as an NBFC. A company will be treated
as an NBFC if its financial assets are more than 50% of its total assets (netted off by intangible assets),
and income from financial assets is more than 50% of the gross income.
 g) loan is repayable on weekly, fortnightly or monthly instalments at the choice of
the borrower
viii. NBFC Factors: It is a non-deposit taking NBFC engaged in the principal business of
factoring. The financial assets in the factoring business should constitute at least 50
percent of its total assets and its income derived from factoring business should not be
less than 50 percent of its gross income.
ix. Mortgage Guarantee Companies: It is financial institutions for which at least 90% of
the business turnover is mortgage guarantee business or at least 90% of the gross
income is from mortgage guarantee business and net owned fund is ₹ 100 crore.
x. Non-Operative Financial Holding Company: It is financial institution through which
promoter / promoter groups will be permitted to set up a new bank. It’s a wholly-owned
Non-Operative Financial Holding Company (NOFHC) which will hold the bank as well as
all other financial services companies regulated by RBI or other financial sector
regulators, to the extent permissible under the applicable regulatory prescriptions.

8. How is an NBFC regulated? Explain Base Layer and Mid layer focused aspects
A Non–Banking Financial Corporation is a company incorporated under the Companies Act 2013,
and its operations are regulated by the Reserve Bank of India (RBI) under the framework of
Chapter III -B (Provisions Relating to Non-Banking Institutions Receiving Deposits and Financial
Institutions). According to section 45-I (c) of the RBI Act, a Non–Banking Company carrying on
the business of a financial institution will be an NBFC. In a nutshell a Non-Banking Financial
Company means and includes any business of financial institution referred under Section 45 I(c)
and Section 45 I (f). In addition to RBI guidelines, NBFCs are regulated by NHB, SEBI, MCA IRDAI
and State Government.
Regulatory structure for Non-Banking Financial Companies (NBFCs) shall comprise of four layers
based on their size, activity and perceived riskiness. NBFCs in the lowest layer shall be known
as NBFCs-Base Layer (NBFCs-BL). NBFCs in middle layer and upper layer shall be known as
NBFCs-Middle Layer (NBFCs-ML) and NBFCs-Upper Layer (NBFCs-UL), respectively.

Middle Layer11: The Middle Layer shall consist of:

a) All deposit taking NBFCs, irrespective of asset size;
b) Non-deposit taking NBFCs with asset size of Rs. 1000 crore and above
c) NBFCs undertaking the following activities:
I. Standalone Primary Dealers;
II. Infrastructure Debt Fund – Non-Banking Financial Companies;
III. Core Investment Companies;
IV. Housing Finance Companies
V. Infrastructure Finance Companies

Base Layer: The Base Layer shall comprise of:

a) Non-deposit taking NBFCs below the asset size of Rs. 1,000 crore and
b) NBFCs undertaking the following activities-
I. NBFCs- Peer to Peer Lending Platform
II. NBFC- Account Aggregator
III. Non- Operative Financial Holding Company
IV. NBFC not availing public funds and not having any customer interface 12

9. NBFC - Eligibility criteria

a) A company should first be registered under the Companies Act 2013.
b) The minimum net owned funds of the Company should be Rs. 2 Crore.
c) One-third of the Directors must possess finance experience.
d) The CIBIL records of the Company should be clean.
e) The company must have a detailed business plan for five years.

11
https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12179&Mode=0#F1
12
Public Funds and Customer Interface as defined in RBI Master Direction on Non- Banking Financial
Companies dated September 01, 2016- https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?
id=10586
 f) The company must comply with the requirements for capital compliances and FEMA.

Annual filings required to be made by an NBFC in India: An NBFC, being a company, is

required to submit its annual returns in form MGT-7, financial statements in form AOC-4,
interest of directors in form MBP-1 with the concerned Registrar of Companies (RoC). Apart from
RoC compliances, all NBFCs are required to submit a certificate by statutory auditor relating to
its business at end of March every year. A company holding public deposits, whose application
for certificate of registration has been rejected, is required to submit critical parameters in form
NBS-4 by 1 May of each year.

Documents required for registration of NBFC:

a. Certified copy of certificate of incorporation and certificate of commencement of

business in case of a public limited company;
b. Certified copy of only the main object clause of the memorandum of association;
c. Board resolution stating that:
I. The company is not carrying on/has stopped and will not carry on/ commence
NBFC activity before getting registration from RBI;
II. The unincorporated body in the group, in which the director holds substantial
interest, has not accepted any public deposit till date and will not accept the
same in future;
III. The company has formulated a 'Fair Practice Code' as prescribed by RBI;
IV. The company has not accepted public funds in the past and does not hold public
funds as on date. Further that, the company will not accept public funds without
the prior approval of RBI; and
V. The company does not have customer interface and will not have any in future
without the prior approval of RBI;
VI. Copy of fixed deposit receipt;
VII. Banker’s certificate of non-lien with respect to net owned fund;
VIII. Audited balance sheet and profit & loss account for companies which are
already in existence. Such documents should be furnished for the lesser of the
entire period of existence of the company or for the last 3 (Three) years; and
IX. Banker's report in respect of the applicant company, dealings of its
group/subsidiary/associate/holding company/related parties and directors of the
applicant company having substantial interest in other companies.

10. Foreign Ownership perspective in NBFC

Foreign investment in investing companies registered as Non-Banking Financial Companies
(NBFCs) with the Reserve Bank, shall be under 100% automatic route13.

13
Schedule 1 of NDI Rules, 2019