MODULE_3_13_

BANKING &
INVESTMENT LAWS

CERTIFICATE COURSE

DEVELOPED BY
Corp Comm Legal

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MODULE - 3

NON-BANKING FINANCIAL COMPANIES

3.1. INTRODUCTION TO NON-BANKING types of banking services, but do not hold a banking
FINANCIAL COMPANIES license.

3.1.1. What is a Non-Banking Financial Company? 3.1.2. What makes them different from a bank?

A Non-Banking Financial Company (NBFC) is a NBFCs are allowed to lend, make investments and do
company registered under the Companies Act, 2013. everything which an institution that is allowed to
They usually engage in ‘loans and advances’ business, provide finance is allowed, which is what makes them
acquisition of shares/ stocks. Bonds/ debentures/ analogous to banks; However, since they are not a
securities issued by the Government or local licensed banking institution, some rudimentary
authority or other marketable securities of a like functions that are subjective only to Banking
nature, leasing, hire-purchase, insurance business, institutions are not allowed to them. Such as: -
chit funding etc. These companies are however not
inclusive of those institutions whose principal ▪ Disallowed to accept demand deposits
objectives are agriculture activity, industrial activity, ▪ They are not allowed to issue cheques since
purchase or sale of any goods (other than securities)
or providing any services and they cannot form a part of the payment and
sale/purchase/construction of immovable property. settlement system.
Any NBFC whose principal business includes, ▪ They are not allowed to Deposit insurance
receiving deposits under any scheme or arrangement facility of Deposit Insurance and neither is
in one lump sum or in instalments by way of Credit Guarantee Corporation available to
contributions or in any other manner, would also be depositors of NBFCs, which is available in the
constituted as a non-banking financial company case of banks.
(Residuary non-banking company). In simple terms, a
NBFC is a financial institution that provides certain The deprivation of these primary banking functions is
what renders them as a non-banking financial
institution.

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3.2. CATEGORIES OF NBFCS REGISTERED WITH THE RBI assets that support “productive/economic
activity, such as automobiles, tractors, lathe
Any company that is registered under the Companies machines, generator sets, earth moving and
Act, 2013 and wishes to branch out into a Non- material handling equipment’s, moving on
banking financial institution as per 45 I(a) of the RBI own power and general-purpose industrial
Act, 1934 must be in compliance with the following: - machines”. Such principal businesses for the
purpose of AFCs are defined as the
▪ It must be registered with the Companies Act, “aggregate of financing real/physical assets
2013 and that support economic activity, income
arising therefrom is not less than 60% of its
▪ Must have a minimum net owned fund of two total assets and total income respectively”
hundred lakh. (Rs. 200 lakh). ▪ Investment Company (IC): ICs are companies
acting as financial institutions, whose
As per the RBI rules, there are three distinct principal business includes acquisition of
categories of NBFCs securities.
▪ Loan Company (LC): LC are those companies,
A. Categorisation in terms of the type of liability, who principal business includes providing
which can be classified as ‘deposit accepting finance, by issuing loans, advances, for any
NBFCs’ and ‘Non-deposit accepting NBFCs’. activity other than its own but does not
include any Asset Financing company. These
B. ‘Non-deposit accepting NBFCs can be further financial institutions are known as ‘simple
sub-categorised by “their size into loan NBFCs’.
systemically important and other non-deposit ▪ Infrastructure Finance Company (IFC): These
holding companies (NBFC-NDSI and NBFC- non-banking companies are those that “i)
ND)” deploy at least 75 per cent of their total assets
in infrastructure loans,
C. The last categorisation is based on the ‘type of ii) have a minimum Net Owned Funds of Rs
activity’ undertaken 300 crore,

Categorisation of NBFCs based on the ‘type of
activity’ can again be of the following kinds: -

▪ Asset Finance Company (AFC): AFCs are
financial institutions whose principal
business includes the financing of physical

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iii) have a minimum credit rating of ‘A ‘or a. A loan ought to be disbursed by an
equivalent NBFC-MFI to a borrower, whose
iv) and a CRAR of 15%”. rural household annual income does
As the title suggests, their primary function is not exceed Rs 1,00.000 (1 lakh) or an
to finance Infrastructure-related businesses. urban and semi-urban household
▪ Systematically Important Core Investment income that does not exceed Rs
Companies (CIC-ND-SI): These NBFCs are 1,60,000. (One lakh sixty thousand)
those that carry on the business of acquisition
of shares and securities. b. Any loan amount that does not
▪ Infrastructure Debt Fund: Non- Banking exceed Rs 50,000 (fifty thousand) in
Financial Company (IDF-NBFC): These the first cycle and Rs 1,00,000 in any
companies are registered as NBFCs to of the subsequent cycles.
facilitate long term debt flow into projects
dealing with infrastructure development. c. The total indebtedness of the
These companies raise their resources by borrower does not at any point
issuing currencies such as Rupee or Dollars by exceed Rs 1,00,000.
denominating the bonds for a minimum of 5-
year maturity. Only companies that are IFCs d. Tenure of the loan must not be given
can sponsor any IDF-NBFCs, the reason being for a period less than 24 month for
to support the primary objective of any loan amount that exceeds Rs
Infrastructure financing. 15,000 with the condition of pre-
▪ Non-Banking Financial Company-- Micro payment without imposing penalty
Finance Institution (NBFC-MFI): These are
non-deposit taking financial institutions e. Such loans to be extended without a
which have not less than 85% of their assets demand for collaterals.
in the nature of qualifying assets again with
the requirement of satisfying the following f. Aggregate amounts of loans, given
criteria: for income generation must not be
less than 50 % of the total loans
given by the Micro Finance
institution.

g. Such loans must be repayable on
weekly, fortnightly or monthly

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instalments at the choice of the 3.2.1. Actions to be taken against person/financial
borrower. companies making false claims of being regulated by
▪ Non-Banking Financial Company- Factors the Reserve Bank
(NBFC-Factors): These are non-deposit
taking financial institutions that engage in the Since these are financial entities that are not under
principal business of factoring. “The financial the purview of licensed banking, they will not be
assets in the factoring business should regulated by the Reserve Bank. Which means, any
constitute at least 50 percent of its total financial entity or unincorporated body that makes a
assets and its income derived from factoring false claim of being so to mislead the public in order
business should not be less than 50 percent of to collect deposits and will therefore be liable for
its gross income”. penal action under the Indian Penal Code which is
▪ Mortgage Guarantee Companies (MGC)- why it is recommended that one make a note of the
These are financial institutions for which at list of the registered NBFCs available before
least 90% of the business turnovers are a proceeding to make any deposits with any NBFC.
mortgage guaranteeing business or at least
whose gross income from the mortgage 3.3. THE HISTORY OF NBFCs IN INDIA
guarantee business is about 90% and the net
owned fund is not less than 100 crores. The Reserve Bank of India Act, 1934 was amended on
▪ NBFC- Non-Operative Financial Holding 1 December 1964 by the Reserve Bank Amendment
Company (NOFHC)- These financial Act, 1963. This amendment brought in ‘Chapter III-B
institutions are those wherein the promoters which introduces the ‘regulatory provisions’
or the promoter groups will be permitted to pertaining to Deposits accepting NBFCs.
set up a new bank. They are wholly-owned
Non-Operative Financial Holding company. The different types of committees to review the
“These institutions hold the bank as well as all existing framework of the NBFCs are as follows:
other financial services companies regulated
by the RBI or other financial sector regulators 3.3.1. James Raj Committee
to the extent permissible under the applicable
regulatory prescriptions.” In 1972, the Banking commission was asked by the
Government of India to study the Functioning of Chit
Funds and Examining activities of Non-Banking

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Financial Intermediaries to which the commission In December 1982, Dr Manmohan Singh, the then
then recommended the implementation of the Governor of RBI then appointed a committee under
Uniform Chit Fund Legislation to regulate such the chairmanship of ‘Prof Sukhamoy Chakravarty’.
activities throughout the country. After which, the This committee’s primary objective was to review the
Model Bill was prepared by the RBI to regulate chit functioning of the monetary system of India.
fund conduct and made a subsequent
recommendation to a study group under the Recommendations:
chairmanship of James S. Raj.
This committee recommended that the assessment
Another study group, in June 1974 then of links which existed amongst the Banking, Non-
recommended the ban on Prize Chit and other Banking Financial Institutions and the un-organised
schemes. This directed the Parliament to enact a sectors is necessary to scrutinize the several
legislation that ensures a uniform application in both instruments of Monetary, and Credit policy in terms
the provisions and their implementation on chit funds of their impact on the Indian Credit system and the
in the whole country. In reference to this, the Economy as a whole.
parliament then enacted two legislations. (i) Prize
Chits and Money Circulation Schemes (Banning) Act, 3.4. PROVISIONS RELATING TO NON-BANKING
1978 and (ii) The Chit Funds Act, 1982. Both these INSTITUTIONS RECEIVING DEPOSITS AND
acts primarily focused on maintaining a uniformity in FINANCIAL INSTITUTIONS.
the conduct of chits and schemes.
Chapter III, Section(s) 45H to 45QB deal with the
3.3.2. Chakravarty Committee provisions pertaining to non-banking institutions
receiving deposits and financial institutions. Chapter
‘Monetary Management’ was one of the crucial issues III B of the Reserve Bank of India Act, 1934
that the RBI faced during the Planning Era, and introduced these regulations to regulate the
therefore put in several efforts to establish a ‘sound framework for NBFCs and bring about a system of
monetary system’. However, no such model was uniform changes. This regulatory framework has
completely fool-proof, due to which there were been in place since 1963 and directions have been
several loopholes that hindered its success. All issued in their furtherance. The regulation of these
attempts at strengthening the social objectives of the deposits’ acceptance activities of the NBFCS began
monetary policies of the country were going in vain. during 1960 with the primary objective of

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safeguarding depositor’s interests and ensuring that achieved that effect. “The directions were therefore
they function on healthy lines. Furthermore, in 1963, restricted to the liability-side of the balance sheet,
a new Chapter III B was inserted to effectuate the and that too solely to deposit acceptance activities.”.
supervision, control and regulation of deposit These directions failed to extend to the asset-side of
acceptances in these institutions. the balance sheet of the NBFCs, and consequently
upon examination of the several experts/working
The very famous Bhabatosh Datta Study Group groups of the functioning of the NBFCS, a unanimous
(1971) was set up to “examine the role and operations understanding of the inadequacy of the legislative
of NBFCs”. They recommended that the NBFCs framework was shown. This made it very clear that a
should be divided into two categories; The ‘approved’ requirement for the enhancement of the existent
and the ‘non-approved’ categories, and the primary framework was required.
regulation should focus mainly on the ‘approved’
category. The ‘approved’ NBFCs category dealt with This is when the Chakravarthy Committee, in its
those that satisfied the additional requirements such report of 1985 suggested and recommended that a
as adequate amount of capital, reserves, liquid assets. system of licensing the NBFCs be introduced to
The subsequent framework that came into place was protect the interests of the depositors. Thereafter,
suggested by the James Raj Study Group (1974), following on the same footsteps, the Narasimham
where the regulation aimed at keeping the magnitude Committee (1991) outlined a framework, that
of deposits accepted by NBFCs within reasonable rationalized the functioning of the NBFCs. The
limits, to ensure that they were in conformity with the Narasimham committee was of the view that
objectives of the country’s monetary and credit “keeping in mind the growing importance of NBFCs in
policy. the financial intermediation process and their
resource to borrowing, regulatory framework to
However, the provisions of the Chapter III B of the govern these institutions should be specified. Such a
RBI Act, 1934 placed a limited amount of power on framework would have to include, in addition to the
the Reserve Bank. Though the legislative intent was existing requirements of gearing and liquidity ratios,
clear and aimed at the moderation of NBFCs and certain norms that pertain to capital adequacy, debt-
subsequently providing indirect protection to equity ratio, credit concentration ratio, adherence to
depositors by linking the quantum of deposit sound accounting practices, uniform disclosure
acceptance to Net Owned Fund, it never really requirements and asset valuation. Furthermore, the

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committee also recommended that “the supervision company, State Financial Corporation, IDBI
of these institutions should come within the purview or any other institution specified by RBI;
of the proposed agency to be set up for this purpose ▪ Any amount that was received in the ordinary
under the aegis of the RBI”. The introduction of a course of business through security deposit,
suitable legislation was not only deemed essential for dealership deposit, earnest money, advance
ensuring a sound and healthy functioning of the against orders for goods, properties or
NBFCs, but also to safeguard the interests of the services;
depositors. ▪ Any amount that was received through
subscriptions that were made in respect of a
3.4.1. Deposits ‘Chit’.
▪ §2(1)(xii) of the Non-Banking Financial
It is important to understand the nature, scope and Companies Acceptance of Public Deposits
definition of the term ‘deposit’ with respect to Non- (Reserve Bank) Directions, 1998 defines a
Banking Financial institutions, since any form of 'public deposit’ as a ‘deposit’ that is explained
deposit that doesn’t fall within this definition would under Section 45 I(bb) of the RBI Act, 1934
be exempted from availing any remedy in a case of and further excludes the following:
aggrievance.
- Amount received from the
The definition of ‘deposits’ with respect to those Central/State Government or any other
resting with the Non-Banking Financial institutions is source where repayment is guaranteed
defined under Section 45 I(bb) of the RBI Act, 1934. by Central/State Government
The definition includes and shall be deemed to always
include ‘any receipt of money by way of deposit or - or any amount received from local
loan or in any other form but does not include: authority or foreign government or any
foreign citizen/authority/person;
▪ Any amount that has been raised through
share capitals or made through a contribution ▪ Any amount that is received from a financial
of capital by the partners of a firm; institution;

▪ Any amount that was received from a ▪ Any amount received from other companies
scheduled bank, co-operative bank, a banking as inter-corporate deposit;

▪ Amount received through any subscriptions

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to shares, stock, bonds or debentures pending 3.4.2. Secured debentures excluded from the
allotment or by way of calls in advance if such definition of ‘public deposit’
amount is not repayable to the members
under the articles of association of the These debentures are secured by mortgaging
company; immovable property or other assets of various
▪ Any amount received from shareholders companies. “If this amount does not exceed the
through private companies; market value of the immovable property or other
▪ Any amount received through directors or assets”, then they will not fall within the definition
the relatives of any directors of a NBFC; of a ‘public deposit’ with respect to Non-Banking
▪ Any amount that has been raised through the Financial Companies Acceptance of Public Deposits
issuing of bonds/ debentures secured by way (Reserve Bank) Directions, 1998. These secured
of mortgaging any immovable property or debentures of companies are but debt instruments
other asset of the company subject to that are regulated by Securities and Exchange
conditions; Board of India.
▪ Any amount that is brought in through
promoters from unsecured loans (any); 3.4.3. Acceptance of deposits from NRIs
▪ Amounts received through mutual funds;
▪ Amounts received in the form of hybrid NBFCs cannot accept deposits from NRIs excepts
debts/ subordinated debts; through the debts made to an NRO account of the
▪ Amounts received by issuing a commercial NRI, provided that such an amount does not
paper; represent any inward remittance or transfer from
NRE/FCNR (B) account. They however, are
This definition has explicitly excluded amount subjected to renewal.
raised from certain set of informed lenders who can
make independent decision, from the definition of 3.5. REGISTRATION OF NBFC WITH THE RBI
‘public deposit’.
As per Section 45-IA of the RBI Act, 1934, every
NBFC should be registered with the RBI to

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commence or carry on any business relating to non- 3.6. SALIENT FEATURES OF NBFCs IN INDIA
banking financial institutions as per Section 45 I(a)
of the RBI Act, 1934. To reduce dual regulation, In India, there are several important features and
certain categories of NBFCs are directed by other regulations that highlight acceptance of deposits by
regulations which are exempted from the NBFCs in India. Some of them are as follows:
mandatory requirement of registering with the RBI.
In other words, these companies are venture capital ▪ NBFCs can accept/renew public deposits for
fund/merchant banking companies/stock broking a “minimum period of 12 months and
companies registered with SEBI, insurance maximum period of 60 months.” Deposits
company holding a valid certificate of registration repayable on demand cannot be accepted by
issued by IRDA, Nidhi companies that are notified them.
under Section 620A of the Companies Act, 2013,
chit companies which fall within the definition of ▪ They cannot prescribe interest rates to go
clause (b) of Section 2 of the Chit Funds Act, 1982 or beyond the ceiling rates offered by the
housing finance companies regulated by National Reserve Bank of India. They have to abide by
Housing Bank. the then current ceiling rate of interest
offered, though they are allowed to be
MNBC’s major occupation relates to Chit Fund compounded at rests but not shorter than
Businesses. The term ‘deposit’ is defined under monthly rests.
Section 45I(bb) of the RBI Act, 1934, however the
definition excludes any subscription to Chit Funds. ▪ They are not allowed to offer gifts/incentives
Chit Fund companies are exempted from all the or any other additional benefit to the
core provisions of Chapter IIIB of the RBI Act, which depositor.
includes registration. Therefore, in terms of
Miscellaneous Non-Banking Companies (RBI) and ▪ Other than certain AFCS, all NBFCs should
their directions, “the companies can accept 25 % make a minimum investment in grade credit
deposits and 15% of NOF from public rating.
shareholders”, for a period of 6 months to 36
months, but they cannot accept deposits which are ▪ It is to be made certain that these deposits
repayable on demand/notice. with the NBFCs are not insured.

▪ It is also to be made certain that the
repayment of the deposits by the NBFCs are
not guaranteed by the RBI nor any other
banking regulatory institution.

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▪ Certain mandatory disclosures have to be ▪ The NBFCs must make a conspicuous display
made about the company in the Application of their Certificate of Registration (CoR)
Forms that are issued by the company which is issued by the Reserve Bank, on their
soliciting deposits. website and in annual publication. There must
be a specific mention of the fact that this
3.7. ADVISORY RBI MANDATES DEPOSITORS NBFC has been specifically authorized by the
OUGHT TO CONSIDER BEFORE DEPOSITING RBI to accept deposits. Depositors must
WITH AN NBFC however analyse the certificate to ensure
that the NBFC is indeed authorized to accept
There are several committees as well as reports that deposits.
place a strict set of precautions that any depositor
must confirm to, before being able to proceed with ▪ The depositors must not pay any interest rate
any of the NBFCs. It is recommended that a depositor that exceeds the maximum interest rate of
must at least keep the following factors in check 12.5%. The RBI constantly alters these
interest rates to modulate it according to the
▪ That the NBFC is in confirmation with the RBI macro-economic factors. Thus, the depositors
regulations, it is registered with the RBI, must first check with the current interest rate
specifically authorized to accept deposits. before depositing.
The list of deposits that any NBFC can take is
set by the RBI, and a re-check must be made ▪ A proper receipt is the right of every
with that list. If any depositor deposits an depositor. A receipt is for every amount that
amount against the permissible limits of that is deposited with the company. “It must be
NBFC, then the ‘defence of not being duly signed by the authorizing officer of the
informed’ will not be given its due importance, company and should not only state the date of
since this duty reverts to the depositor. the deposit, but also the name of the
depositor, the amount in words and figures,
▪ The depositors must check the list of the rate of interest payable, maturity date and
NBFCs that are permitted to accept deposits amount”.
as well as the list containing the name of
companies prohibited from accepting public ▪ Every depositor must be careful of
deposits; brokers/agents etc, who collect public
deposits on behalf of their respective NBFCs,

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the depositors must demand clear proof of ▪ The RBI cannot be held accountable for any of
the authorisation of such brokers/agents. the “financial soundness of the company or
▪ The depositor must remember that, all public for any false statements or representations
deposits are unsecured and that the made or opinions expressed by the company
Insurance of their deposit is not available to and for repayment of deposits/discharge of
depositors of the same NBFCs themselves. the liabilities by the company”i.

i Id.

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