The working and operations of an NBFC are governed within the framework of the Reserve Bank of India (RBI) Amendment Act, 1997, by RBI. Section 45-IA provides that no NBFC shall start or carry on the activities of Non- Banking Financial Institution (NBFI) without obtaining a Certificate of Registration (CoR) issued by RBI.

The first step is to establish a new Company (Private Limited or Public Limited) under the Companies Act. The minimum Net Owned Fund (NOF) should be Rs. 2 crores. An Application to RBI for CoR has to be made. RBI will conduct due diligence and will issue this certificate before you should commence business.

Chapter III-B of the RBI Act governs the provisions relating to NBFC.

About NBFC as per RBI Act

An NBFC is a company registered under the Companies Act, 1956 or 2013, engaged in operations of:

    • Loans and advances,
    • Asset Financing,
    • Investments in stock/equity/shares/bonds/debentures and other Govt securities, or other marketable securities of similar nature,
    • Hire-purchase,
    • Chit fund,
    • Lease,
    • Insurance business,
    • Currency Exchange,
    • NBFC P2P Lending,
    • Hedge Funds.

But does not include any institution whose principal business concerns:

    • Agricultural activity,
    • Industrial activity,
    • Purchase/sale of any goods and services (except securities), and
    • Sale/purchase/construction of the immovable property.

A non-banking institution which is a company and has the principal business of receiving deposits under a scheme or arrangement in one lump sum or in installments by way of contributions or in some other manner is also an NBFC known as Residuary non-banking company (RNBC).

Financial activity as principal business is when the company’s financial assets constitute more than 50% of the total assets and income from financial assets constitute more than 50% of the gross income. The company fulfilling both these criteria will get NBFC License by RBI.

Hence for companies engaged in agricultural operations, industrial activity, purchase and sale of goods, providing services or purchase, sale, or construction of immovable property as their principal business and are doing some financial business on a smaller scale, they will not be regulated by RBI. This condition is popularly known as a 50-50 test and is applied to determine whether or not a company is into financial business.

Registration – Section 45-IA

A registered company cannot commence or carry on the business of an NBFI until it fulfills the following conditions:

  • obtains a certificate of registration under Chapter III-B of the RBI Act,
  • has NOF of Rs. 2 crores.

Conditions for Granting NBFC License

For registration, the company shall apply in the format as specified by the RBI. Before granting the license, RBI may inspect the books of the NBFC to satisfy the following conditions:

  1. that the NBFC is able to pay its present or future depositors in full as and when their claims accrue.
  2. that its affairs are not likely to be conducted in any manner detrimental to the interest of its existing or future depositors.
  3. the general character of the management and the board of the NBFC shall not be prejudicial to the interest of the public or depositors.
  4. it has adequate capital structure and earning potential.
  5. public interest shall be served by granting NBFC registration to this company.
  6. the grant of CoR shall not be prejudicial to the operation and consolidation of the financial sector consistent with monetary stability, economic growth, and considering such other relevant factors that RBI considers important.

Cancellation of NBFC License

RBI may cancel the License awarded to any NBFC if –

  • The company ceases to carry on NBFI business in India.
  • It has failed to comply with an essential condition based on which the CoR was issued to it,
  • Has failed to fulfill any of the conditions under which registration has been granted, at any time.
  • The company fails to
    1. comply with any direction issued by RBI in this chapter,
    2. maintain accounts according to the requirements of any law.
    3. to offer or submit its books of account and other relevant documents when so demanded by the inspecting authority of RBI, for inspection.
    4. has been forbidden from accepting deposit by an order made by RBI under the provisions of this Chapter and such order has been in force for a period of not less than 3 months.

A company aggrieved by the order of rejection of application for registration or cancellation of certificate of registration may choose to appeal against such a decision. This appeal has to be filed within a period of 30 days from the date on which such order of rejection or cancellation was communicated to it.

Maintaining Asset Ratio – Section 45-IB

Every NBFC shall invest between 5% up to 25% of the deposits outstanding at the close of business on the last working day of the second preceding quarter in unencumbered approved securities in India. This percentage of the investment may be changed by RBI.

RBI would go through the returns filed by the NBFC to check compliance with this provision.

If the amount invested is less than that specified, the NBFC shall be penalized a fine of 3% per annum above the bank rate on the difference for the first quarter, and where non-compliance stretches to the subsequent quarters, the fine will be charged at 5% above the bank rate.

This penalty payment must be done within 14 days from the date on which notice is issued by RBI demanding this payment.

On further failure to pay such dues, RBI may make an appeal to the principal civil court in whose jurisdiction the office of the company is situated and request an order for levying this penalty.

When the court directs the NBFC for payment, it will be in the form of a certificate which shall be enforceable as if it were a decree made by the Court.

RBI may not demand penal interest if it is satisfied that sufficient cause existed for non-compliance.

Reserve Funds of NBFC u/s 45 -IC of RBI Act

Once NBFC Registration has been received, it is required to create a reserve fund where at least 20% of its net profits (before the declaration of dividend), as per the P&L Account, are to be transferred every year.

The NBFC shall not appropriate any amount from this reserve fund unless specified by the RBI.

RBI is to be notified for each such appropriation within 21 days of the withdrawal transaction.

The Central Government may waive this requirement on the recommendation of RBI provided that the amount in the reserve fund together with the amount in the share premium account is not less than the paid-up capital of the NBFC.

Issue of Prospectus Soliciting Deposits u/s 45-J

When RBI is of opinion that it is in the general interest of the public, it may issue a general/specific order to:

  • regulate or prohibit a non-banking institution to get any prospectus or advertisement published to solicit deposits of money from the public.
  • specify the conditions subject to which any such prospectus or advertisement, if not prohibited, may be published.

Power of RBI to Regulate NBFC u/s 45-JA of RBI Act

RBI can formulate and change the policies of NBFC Regulation in any of the following circumstances:

  • in the public interest.
  • to regulate the financial system of the country to its advantage.
  • to prevent the affairs of any NBFC being conducted in a manner detrimental to the interest of the depositors.
  • in a manner prejudicial to the interest of the NBFC.

Some of the matters governed by RBI are:

  • income recognition,
  • accounting standards,
  • setting aside a proper provision for bad and doubtful debts,
  • capital adequacy based on risk weights for assets and credit conversion factors for items not listed in the balance sheet,
  • deployment of funds by an NBFC

The RBI may give directions to an NBFC or a certain class of NBFCs as to the purpose for which advances or other fund based/non-fund based accommodation may not be made and the maximum amount of advances or other financial accommodation or investment in shares and other securities that may be made by that NBFC to any person or a company or a group of companies.

Deposits by NBFC under RBI Act – Section 45-K

RBI may direct an entity with NBFC License to furnish statements, details, or particulars relating to or connected with deposits received by it, in general, or as a special order.

Such inquiries may relate to the amount of the deposits, the purposes and periods for them, and the rates of interest and other terms and conditions on them, receipt of deposits, including the rates of interest payable on such deposits, and the duration for which these deposits have been received.

If any NBFC fails to comply with these directions, RBI may prohibit it from accepting deposits in the future.

Every NBFC shall also, if required by RBI, send a copy of its annual balance sheet and profit & loss account or other annual accounts to every person from whom the non-banking institution holds, as on the last day of the year to which the accounts relate, deposits higher than such sum as may be specified by RBI. These statements may be required to be sent one time or at regular intervals, as specified by RBI.

Power of RBI for Information Retrieval – Section 45-L

RBI may ask NBFCs to periodically submit information related to the credits to enable it to regulate the credit system of the country to its advantage as it requires and give, generally or particularly, directions relating to its conduct of business. The requested information may be about paid-up capital, reserves or other liabilities, investments whether in Government securities or otherwise, persons to whom, and the purposes and periods for which, finance is provided and the terms and conditions, including the rates of interest, on which it is provided.

While issuing such directions, RBI shall give due regard to the conditions in which and objects for which the NBFC is established, its statutory responsibilities as well as the effect of such directions on trends in the money and capital markets.

Inspection of NBFC – Section 45-N RBI Act

RBI may, at any time, arrange an inspection to be made by one or more of its officers/employees/other persons:

  • of any non-banking institution, including a financial institution, to verify the correctness or completeness of any information, statement, information or particulars furnished to RBI
  • of any non-banking institution being a financial institution, if RBI feels it necessary or expedient to inspect that institution.

The management of the NBFC must co-operate and produce such documents as may be required before the inspecting agency or agent. The inspector/s may also ask for testimonies by a director or member of the management or employee of the company.

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Frequently Asked Questions

Q. What is an NBFC?

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include an institution whose principal business is agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of the immovable property. A non-banking institution which is a company and receives deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner is also an NBFC-RNBC (Residuary Non-banking Company).

Q. What is the eligibility for NBFC registration?

  1. An entity which is:
    1. registered as a company u/s 3 of the Companies Act,
    2. having a minimum NOF of Rs. 2 crores. (The minimum NOF required for specialized NBFCs such as NBFC-MFIs, NBFC-Factors, CICs differs.

Q. Can all NBFCs accept deposits?

All NBFCs are not allowed to accept public deposits. Only those NBFCs who have taken a special authorization from RBI, after getting an investment-grade rating, are entitled to accept/hold public deposits to a limit of 1.5 times of its NOF. Unrated AFCs or those with a sub-investment grade rating cannot accept fresh deposits, but only renew existing deposits on maturity till they obtain such rating.

Q. What is 50-50 criteria?

A company without financial assets of more than 50% of its total assets and does not earn at least 50% of its gross income from these assets is not an NBFC. Its principal business would be considered non-financial activities such as agricultural operations, industrial activity, purchase or sale of goods, or purchase/construction of the immovable property. Acceptance of deposits by an NBFC is governed by the rules and regulations issued by RBI & MCA (Ministry of Corporate Affairs).

Q. What is the rate of interest and period of deposit which NBFCs can accept?

The maximum interest an NBFC can offer is 12.5%. The interest may be paid or compounded at intervals not shorter than a month. The NBFCs are allowed to accept/renew public deposits from 12 months to a maximum period of 60 months. They cannot accept deposits repayable on demand.

Q. What if companies which are lending or making investments as their principal business do not obtain a CoR?

If companies that must be registered with RBI as NBFCs, are found to be conducting a non-banking financial activity, such as, lending, investment, or deposit acceptance as their principal business, without seeking registration, RBI can impose a fine on them or can even prosecute them in a court of law. If members of the public come across any entity which does such financial activity but does not figure in the list of authorized NBFC on the RBI website, they should inform the nearest Regional Office of RBI, so that appropriate action can be taken for contravention of the provisions of RBI Act, 1934.

Q. What are the regulations applicable to non-deposit holding NBFCs with asset size of less than Rs. 500 crore?

The regulation on non-deposit holding NBFCs with asset size of less than Rs. 500 crore are:

  1. They shall not be subjected to any regulation either prudential or conduct of business regulations such as Fair Practices Code (FPC), KYC, etc. if they have not accessed any public funds and do not have a customer interface.
  2. Those which have a customer interface will be subjected only to conduct of business regulations including FPC, KYC, etc. if they are not accessing public funds.
  3. Those accepting public funds will be subjected to limited prudential regulations but not conduct of business regulations if they have no customer interface.
  4. Where both public funds are accepted and customer interface exists, such NBFCs will be subjected both to limited prudential regulations and conduct of business regulations.