Having a single regulator for nidhi companies is beneficial, says R. Anand

R. Anand

THE origin of nidhi companies can be traced back to the early 20th century. These institutions were set by philanthropic and public-spirited individuals in towns to deal with the credit requirements of that area. The concept of nidhi is built on the principle of mutuality. Inherently, nidhi companies function for the common benefit and mutual advantage of their members/shareholders, where the "haves" provide necessary financial support to the "have-nots".

Like several other modes of financing, including organised non-banking financial companies (NBFCs), nidhis were set up mainly for rescuing the middle class from the clutches of usurious moneylenders.

Nidhis encourage thrift and savings among their members who are committed to the cause of service to the membership at large. Nidhi companies have had a chequered history right from the time they got legal recognition through Section 620A of the Companies Act, 1956. The deposit acceptance norms of nidhis are similar to those for non-banking finance companies (NBFCs). Nidhi companies, therefore, have two regulators: The Department of Company Affairs (DCA); and the Reserve Bank of India (RBI).

As is the case with institutions controlled by multiple regulators, nidhis face problems of supervision and buck-passing. The Irani Committee has devoted some attention to this aspect in the functioning of nidhis.

The Irani report

The report basically traces the origin of nidhis and points out that over time these institutions, on account of their financial and administrative strength, opened branches outside the local territory even as the concept of mutual benefit remained fundamental. Once they started spreading out, monitoring and supervision became difficult, leading to failures and lakhs of depositors being left in the lurch.

The Irani Committee Report advocates better regulation and has come to the following conclusion:

"Nidhi companies are effectively non-banking financial companies and are engaged in the business of accepting deposits and making loans to their members. The recent failures in the NBFC sector also extended to the nidhi companies compelling the Government to introduce strict prudential norms for such companies. The deposit- taking activities of nidhis are governed by the RBI Act and guidelines made thereunder.

"The power to give exemptions to the nidhi companies in the administration of nidhis is with the Ministry of Company Affairs. This dual control leads to confusion in the administration of the provisions of the RBI Act and the Companies Act, 1956. Since, RBI is the regulator of all the NBFC incorporated under the Companies Act, the Committee felt that nidhi companies should also be controlled by the RBI through close supervision."

A regulator is said to play its role well if it blows the whistle before a problem erupts. In the case of NBFCs, the fiasco of 1990s can in no small measure be attributed to the inability of the regulator to come to grips with the expansion spree that NBFCs embarked on in that period that is, by diverting funds to non-core areas. Whistle blowing came much after the depositors lost their money. In 1997, the RBI Act was amended to bring in the required safeguards. As in the case of NBFCs, the decision to shift the regulation of nidhis to the RBI is welcome since it recognises the need for a single regulator. But, in the process, the lessons of the past should not be forgotten and an effective monitoring system must be put in place.

The inputs of the Irani Committee will help zero in on the ideal regulatory system even if there is only one regulator.

(The author is a Chennai-based chartered accountant.)

(This article was published in the Business Line print edition dated August 4, 2005)
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