Law Overview: Non-Banking Financial Companies (NBFCs)

Table of Content

1. Background

2. RBI is regulatory authority and has overriding powers

3. Types of NBFC

4. Systemically important and non-systemically important NBFC

5. Residuary Non-Banking Company [RNBC]

6. Core Investment Companies (CIC-ND-SI)

7. Mortgage guarantee company

Check out Taxmann's Statutory Guide for NBFCs which  is an authentic & updated compendium of RBI's Directions & Guidelines governing NBFCs, Residuary NBFCs, Miscellaneous Non-Banking Companies, and Mortgage Guarantee Companies

1. Background

NBFC is a company registered under the Companies Act and is engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by the Government or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business.

As per section 45-I(f) of RBI Act, NBFC means

(i) financial institution which is a company

(ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner

(iii) such other non-banking institutions or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify.

NBFC means only the non-banking institutions which a loan company or investment company or asset finance company or mutual benefit financial company or a factor registered with RBI under section 3 of Factoring Regulation Act – Clause 3(xiv) of NBFC Acceptance of Public Deposits (Reserve Bank) Directions, 2016 issued on 25-8-2016.

A deposit insurance facility is not available for deposits with NBFC.

1.1 Mere holding fixed deposits in Banks in not NBFC business

Many NBFCs obtain Certificate of Registration (CoR) as NBFC and put their funds in fixed deposits with commercial banks, without carrying out NBFC activities. The fixed deposits are not financial assets. There is only near money and can be used only for temporary parking of funds or till the commencement of business. If such NBFCs do not commence NBFC business in six months, their CoR will stand withdrawn automatically – RBI circular No. DNBS (PD) CC NO. 259/03.02.59/2011-12 dated 15-3-2012.

1.2 NBFCs/Nidhis are not mutual funds

The NBFCs and nights are not ‘mutual funds’. – PIB Press release dated 14.2.2000.

2. RBI is regulatory authority and has overriding powers

Chapter IIIB of the RBI Act [Sections 45H to 45QB to RBI Act] gives powers to RBI to control and supervise NBFCs. As per section 45Q of the RBI Act, these provisions override provisions of any other law.

In the case of Non-banking Financial Companies (NBFC) like hire purchase companies, leasing companies, housing finance companies, loan companies, investment companies, etc., RBI restrictions and guidelines have to be followed.

Nidhi Company and chit fund company are also ‘NBFCs’ but they are regulated by different authorities.

If a company is engaged in industrial activities or agricultural operations as its principal business, it is not an ‘NBFC’.

NBFCs have to be registered with RBI. A list of NBFCs registered is available on www.rbi.org.in. RBI has clarified that deposits with NBFC are not guaranteed by RBI. These are unsecured.

RBI is the sole regulatory authority for NBFCs, State Money Lenders Act does not apply to NBFC – State Money Lenders Act does not apply to NBFCs, as they are solely and entirely regulated by RBI. Section 45Q of RBI Act confers overriding effect upon Chapter III-B of RBI Act, 1934  – Nedumpilli Finance Co Ltd. v. State of Kerala (2022) 7 SCC 394 = 138 taxmann.com 191 = 138 taxmann.com 191 (SC).

Housing Finance Companies regulated by RBI – Housing Finance Companies (HFC) were earlier regulated by National Housing Bank. However, HFCs are now regulated by RBI as per sections 29A to 52A of the National Housing Bank Act, 1987 amended vide Finance (No. 2) Act, 2019 w.e.f. 9-8-2019.

As per Notification No. DOR.047/CGM (MM)-2019 dated 19-11-2019, all provisions of Chapter IIIB of the RBI Act will apply to NBFCs which are Housing Finance Companies (HFC), except section 45-IA of RBI Act.

Provisions of sections 45-IA, 45-IB, and 45-IC of RBI Act shall not apply to NBFC, a housing finance company – RBI Notification No. DOR.049/CGM (MM)-2020 dated 18-11-2020.

A company must have minimum net owned funds of Rs. 20 crores to commence housing finance as its principal business or carry on business of housing finance as its principal business. Existing companies must have at least Rs. 15 crores net owned funds before 1-4-2022 and Rs. 20 crores before 1-1-2023 – RBI Notification No. DOR.048/ED(SS)-2020 dated 18-11-2020.

2.1 RBI master directions

Various master directions issued by RBI summarise policy in respect of registration, prudential regulations (of income recognition, asset classification, provisioning), norms for acceptance of public deposits, capital adequacy, and restrictions on investments) Asset Liability Management (ALM), returns to be submitted to RBI, etc.

RBI has started issuing Master Directions on all regulatory matters beginning in January 2016. The Master Directions consolidate instructions on rules and regulations framed by the Reserve Bank under various Acts including banking issues and foreign exchange transactions. These are updated from time to time. RBI has issued the following Master directions. These can be seen on the RBI website www.rbi.org.in.

• Fit and Proper Criteria for Sponsors – Asset Reconstruction Companies (Reserve Bank) Directions, 2018
• Non-Banking Financial Company – Peer-to-Peer Lending Platform (Reserve Bank) Directions, 2017
• Information Technology Framework for the NBFC Sector
• Mortgage Guarantee Companies (Reserve Bank) Directions, 2016
• Non-Banking Financial Company Returns (Reserve Bank) Directions, 2016
• Non-Banking Financial Companies Auditor’s Report (Reserve Bank) Directions, 2016
• Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016
• Non-Banking Financial Company – Account Aggregator (Reserve Bank) Directions, 2016
• Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016
• Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016
• Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016
• Core Investment Companies (Reserve Bank) Directions, 2016
• Exemptions from the provisions of the RBI Act, 1934
• Miscellaneous Non-Banking Companies (Reserve Bank) Directions, 2016
• Standalone Primary Dealers (Reserve Bank) Directions, 2016
• Residuary Non-Banking Companies (Reserve Bank) Directions, 2016.

2.2 Directions issued by RBI have statutory force

Directions issued by RBI have statutory force and can be termed as law in force – Central Bank of India v. Ravindra (2001) 107 Comp Cas 416 (SC) – quoted with approval in Sudhir Shantilal Mehta v. CBI (2009) 96 SCL 403 (SC).

2.3 NBNFC companies are not under RBI control

Companies engaged in manufacturing, mining, trading, etc. are Non-Banking Non- Financial Companies. Such companies are governed by provisions under the Companies Act. They do not have to submit any return to RBI in respect of public deposits accepted by them.

3. Types of NBFC

NBFCs are broadly classified by RBI as systemically important NBFCs and systemically important NBFCs.

NBFC-D is an NBFC accepting public deposits.

NBFC-ND is an NBFC not accepting public deposits. These fall under the following categories – NBFC-MEI, NBFC-FACTOR, and NBFC-IDF.

3.1 NBFC-D

NBFC accepting deposits are termed NBFC-D. Instructions are contained in RBI Master Direction No. DNBR.PD.008/03.10.119/2016-17 dated 1-9-2016.

3.2 Infrastructure Finance Company

IFC is a non-deposit-taking NBFC with net owned funds over Rs. 300 crores. A minimum of 75% of its total assets should be deployed in infrastructure loans. It should have a minimum credit rating A.- para 3(xvi) of RBI Master Direction No. DNBR.PD.008/03.10.119/2016-17 dated 1-9-2016.

3.3 NBFC – Factor

NBFC – Factor means an NBFC having financial assets in the factoring business at least to the extent of 75% of its total assets and the income from the factoring business should be not less than 50% of its gross income and factoring business should constitute at least 50% of its total assets.- para 3(xviii) of RBI Master Direction No. DNBR.PD.008/03.10.119/2016-17 dated 1-9-2016.

Factor (Reserve Bank) Directions, 2012 have been issued by RBI. Such companies should have registration under section 3 of the Factoring Regulation Act, 2011.

This Act i.e. Factoring Regulation Act (except sections 19, 20, 21, and 32) has been brought into force w.e.f. 1-2-2012 vide Notification No. SO 1399(E) dated 1-2-2012.

3.4 MNBC

Miscellaneous Non-Banking Companies (MNBC) are mainly financial institutions, which collect money and utilize it for investments or giving loans to members. The foreman organizes collection and distribution. He collects his commission and the balance surplus is distributed among members.

These are similar to chit funds or kukri or bhishi. [Technically, bhishi (by whatever name called) collected by ladies in kitty parties is the same type of transaction, but it is not MNBC as their group is not registered as a company].

They can accept deposits only from shareholders.

The instructions are contained in RBI Master Direction No. DNBR.PD.005.10.119/2016-17 dated 25-8-2016.

However, chit funds are out of the purview of RBI control.

4. Systemically important and non-systemically important NBFC

RBI has made a distinction between systemically important NBFCs and non-systemically important NBFCs.

Non-deposit-taking NBFC with asset size of Rs. 500 crores or more as per the last audited balance sheet is defined as systematically important NBFCs (NBFC-ND-SI).

RBI Master Direction No. DNBR.PD.008/03.10.119/2016-17 dated 1-9-2016 contains detailed instructions in respect of systemically important NBFC.

RBI Master Direction No. DNBR.PD.007/03.10.119/2016-17 dated 1-9-2016 contains detailed instructions in respect of non-systemically important NBFC.

Miscellaneous instructions to NBFC-ND-SI have been given in RBI Master Circular No. DNBR(PD) CC NO 055/03.10.119/2015-16 dated 1-7-2015.

Dive Deeper:
Updated Instructions applicable to NBFC-ND-SI (Systemically Important Non-Deposit Non-Banking Financial Companies)

5. Residuary Non-Banking Company [RNBC]

A non-banking institution that is a company and has its principal business of receiving deposits under any scheme or lending in any manner is a Residuary Non-Banking Company [RNBC].

The instructions are contained in RNBC (Reserve Bank) Directions, 2016 issued on 25-8-2016.

The principal business of RNBC is receiving deposits under any scheme or arrangement, and which are not Investment, Asset Financing, or Loan NBFC. Prudential regulations apply to them also. However, there is no ceiling on deposits raised by them.

RNBC has to ensure that the amounts deposited and investments made are not less than the aggregate amount of liabilities of depositors. The interest cannot be less than 5% if the amount is deposited on a monthly basis and 3.5% if the amount is deposited on a daily basis. The deposit can be for minimum of 12 months and maximum 84 months.

6. Core Investment Companies (CIC-ND-SI)

Core Investment Companies (CIC) are those which have assets predominantly as investments in shares for holding stake in group companies. The holding is not for trading and the CICs do not carry any other financial activity and do not accept any deposits.

These are NBFCs but need a separate treatment. Hence, Core Investment Companies (Reserve Bank) Directions, 2016 have been made operational w.e.f. 25-8-2016.

These apply to every NBFC carrying on the business of acquisition of shares and securities and which satisfies the specified conditions.

Core Investment Company (CIC) means an NBFC carrying on the business of acquisition of shares and securities and which satisfies the following conditions – (i) It holds not less than 90% of its net assets in form of investment in equity shares, preference shares, bonds, debentures, debts or loans in group companies (ii) Its investment in group companies is not less than 60% of its net assets (iii) It does not trade in investments in shares, bonds, debentures, debt or loans in group companies except through block sale for dilution or disinvestment (iv) It does not carry on any other financial activity – clause 2(1) of Core Investment Companies (Reserve Bank) Directions, 2016 issued on 25-8-2016.

Section 45-IA of RBI Act shall not apply to non systematically important CICs (Core Investment Company).

Section 45-IA(1)(b) of RBI Act shall not apply to Systemically Important Core Investment Company, if it meets with capital requirements and leverage ratio as specified in CIC Directions.

CICs having asset size of Rs. 100 crore an above would be treated as systemically important CIC (CIC-ND-SI) – clause 3(xxiv) of Core Investment Companies (Reserve Bank) Directions, 2016 issued on 25-8-2016.

The Core Investment Companies can make overseas investments as per Core Investment Companies Overseas Investment (Reserve Bank) Directions, 2012.

CIC Companies with asset size exceeding Rs. 100 crores will have to obtain registration from RBI (CoR – Certificate of Registration). They should maintain minimum capital ratio and Leverage ratio. However, they will be exempt from requirements of prudential regulations.

CIC with an asset size of less than Rs. 100 crores are exempt from registration. For this, all CICs belonging to a group will; be aggregated.

7. Mortgage guarantee company

Banks and housing finance companies lend housing loans against mortgages. Banks and housing finance companies will have greater comfort if mortgage can be guaranteed through a three way contract among borrower, lender and guarantor – Speech of Finance Minister while presenting 2007-08 Union Budget.

Provision for mortgage guarantee company is made with this idea.

A mortgage guarantee company will be treated as NBFC.

Provisions of sections 45-IA, 45-IB and 45-IC of RBI Act will not apply to the mortgage guarantee companies.

RBI has issued instructions on registration and operations of Mortgage Guarantee Company vide Mortgage Guarantee Companies (Reserve Bank) Directions, 2016 issued on 10-11-2016.

These directions also contain directions regarding prudential regulation, investment policy and income recognitions, which were earlier given as separate directions.