Explained: NBFCs in India and RBI guidelines for NBFCs

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956. The companies predominantly engaged in financial activity are only getting registered with RBI as NBFCs. In other words,  when a company’s financial assets out of the total assets are more than 50 percent and the company’s gross income from financial assets constitutes more than 50 percent, then such a company is known as predominantly engaged in financial activities.

NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:

i. NBFC cannot accept demand deposits;

ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;

iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in the case of banks.

The Non-banking financial companies (NBFCs) may raise money through deposits under any scheme or arrangement either in one lump sum or in installments by way of contributions or in any other manner. However, they cannot accept demand deposits for the above purpose. Further, NBFCs cannot issue cheques drawn on them, as they do not form part of the payment and settlement system. The depositors who made deposits with NBFCs are not eligible for the insurance facility of DICGC unlike in the case of banks.

The business of NBFC is largely in the field of leasing, hire-purchase, and bill discounting facilities. They also engage in the business of loans and advances, acquisition of shares, bonds, debentures, securities issued by the Government or local authority, or other marketable securities such as insurance business, chit business, etc. However, the business of NBFC does not include agriculture activity, industrial activity, purchase or sale of any goods other than securities, or providing any services and sale /purchase /construction of immovable property.

Key RBI guidelines for NBFCs
The Reserve Bank has been given the powers under the RBI Act 1934 to register, lay down policy, issue directions, inspect, regulate, supervise, and exercise surveillance over NBFCs that meet the 50-50 criteria of principal business. The Reserve Bank can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by RBI under the RBI Act. The penal action can also result in RBI canceling the Certificate of Registration issued to the NBFC prohibiting them from accepting deposits and alienating their assets or filing a winding-up petition.
In terms of Section 45-IA of the RBI Act, 1934, no Non-banking Financial company can commence or carry on business of a non-banking financial institution without a) obtaining a certificate of registration from the Bank and without having a Net Owned Funds of ₹ 25 lakhs (₹ Two crore since April 1999).
A company incorporated under the Companies Act, 1956 and desirous of commencing the business of a non-banking financial institution as defined under Section 45 I(a) of the RBI Act, 1934 should comply with the following:

i. It should be a company registered under Section 3 of the Companies Act, 1956

ii. It should have a minimum net owned fund of ₹ 200 lakh. The minimum net owned fund (NOF) required for specialized NBFCs like NBFC-MFIs, NBFC-Factors, and CICs was Rs 2 crores previously, but effective from October 1, 2022, the RBI has increased it to Rs 10 crores.

NBFCs whose asset size is ₹ 500 cr or more as per the last audited balance sheet are considered systemically important NBFCs. The rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability of the overall economy.

Housing Finance Companies, Merchant Banking Companies, Stock Exchanges, Companies engaged in the business of stock-broking/sub-broking, Venture Capital Fund Companies, Nidhi Companies, Insurance companies, and Chit Fund Companies are NBFCs but they have been exempted from the requirement of registration under Section 45-IA of the RBI Act, 1934 subject to certain conditions.
Regulators:
The following NBFCs are regulated by other regulators, not by RBI.

• Housing Finance Companies are regulated by the National Housing Bank,
• Merchant Banker/Venture Capital Fund Companies/stock exchanges/stock brokers/sub-brokers are regulated by the Securities and Exchange Board of India, and
• Insurance companies are regulated by the Insurance Regulatory and Development Authority.
• Chit Fund Companies are regulated by the respective State Governments.
• Nidhi Companies are regulated by the Ministry of Corporate Affairs, Government of India.                                                       Companies that do financial business but are regulated by other regulators are given specific exemptions by the Reserve Bank from its regulatory requirements to avoid duality of regulation.
  Note: The Mortgage Guarantee Companies have been notified as Non-Banking Financial Companies under Section 45 I(f)(iii) of the RBI Act, 1934. Core Investment Companies with asset size of less than ₹ 100 crore, and those with asset size of ₹ 100 crore and above but not accessing public funds are exempted from registration with the RBI.

‘Companies that do financial business but are regulated by other regulators are given specific exemptions by the Reserve Bank from its regulatory requirements to avoid duality of regulation.

‘Owned fund’ and ‘net owned fund’ about NBFCs:

‘Owned Fund’ means the aggregate of the paid-up equity capital, preference shares which are compulsorily convertible into equity, free reserves, balance in share premium account, and capital reserves representing surplus arising out of sale proceeds of asset, excluding reserves created by revaluation of asset, after deducting therefrom accumulated balance of loss, deferred revenue expenditure, and other intangible assets. ‘Net Owned Fund’ is the amount as arrived at above, minus the amount of investments of such company in shares of its subsidiaries, companies in the same group, and all other NBFCs and the book value of debentures, bonds, outstanding loans, and advances including hire purchase and lease finance made to and deposits with subsidiaries and companies in the same group, to the extent it exceeds 10% of the owned fund.

In case of defaults by NBFCs:

If an NBFC defaults in deposit repayment, the depositor can approach the Company Law Board or Consumer Forum or file a civil suit in a court of law to recover the deposits. Further, at the level of the State Government, the State Legislation on Protection of Interest of Depositors (in Financial Establishments) empowers the State Government to take action even before the default takes place or complaints are received from depositors. If there is the perpetration of an offence and if the intention is to defraud, the State Government can even attach properties. ( Read the below articles on the NBFC ombudsman scheme and Fair Practice code for NBFCs).

Originally posted August 25, 2017, edited and updated on 07.06.2024

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