A non-banking financial company is a corporate entity registered under the Companies Act that undertakes financial activities without holding a full banking license. These institutions are active in providing loans and advances, acquiring shares, stocks, bonds, debentures, and other government-issued securities, along with conducting leasing, hire-purchase, insurance, and chit fund operations. They are essential players in the financial system, catering to credit needs in sectors where traditional banking channels may not be fully accessible.
The statutory foundation for defining such companies comes from Section 45-I(f) of the Reserve Bank of India Act, which outlines three core categories. First, any financial institution structured as a company is considered part of this category. Second, a non-banking institution registered as a company whose primary business involves receiving deposits under any arrangement or lending in any form also falls within the definition. Third, the Reserve Bank of India, with prior approval from the central government and through notification in the Official Gazette, may specify other classes of non-banking institutions to be treated as such.
The scope includes loan companies, investment companies, asset finance companies, mutual benefit financial companies, and factors registered under the Factoring Regulation Act. An important caveat for depositors is that deposits with such entities do not enjoy coverage under deposit insurance schemes, which means the repayment risk rests entirely with the depositor.
Nature of NBFC Activities and the Role of Fixed Deposits
While some entities secure registration as non-banking financial companies, not all actively carry out the core financial activities for which they are licensed. In certain cases, registered companies may merely place their funds into bank fixed deposits without engaging in lending or investment operations in the open market. The Reserve Bank of India views such deposits as near-money instruments rather than financial assets contributing to non-banking financial activity.
When a registered company fails to commence the intended business within six months of obtaining the certificate of registration, the regulator has the authority to withdraw the certificate automatically. This approach ensures that registration is not used as a nominal status without any active role in financial intermediation. The regulatory position on this was clarified in 2012 through an official circular.
It is also necessary to distinguish between non-banking financial companies, Nidhi companies, and mutual funds. While the first two may engage in deposit-taking or lending activities, mutual funds operate under an entirely different investment pooling structure. This distinction helps prevent confusion among investors and depositors.
RBI as the Primary Regulator with Overriding Authority
The central bank’s authority over non-banking financial companies is established in Chapter IIIB of the Reserve Bank of India Act, specifically from Sections 45H to 45QB. Section 45Q makes it clear that the provisions governing such companies take precedence over any other inconsistent laws, providing the regulator with overriding powers in this domain.
Entities such as hire-purchase companies, leasing companies, housing finance companies, loan companies, and investment companies are bound to follow the regulatory directions issued by the Reserve Bank of India. While chit fund companies and Nidhi companies may technically fall within the broad classification of non-banking financial companies, their day-to-day regulation is typically managed by other designated authorities.
Companies whose principal business involves industrial production or agricultural operations are excluded from the non-banking financial classification. This distinction ensures that manufacturing or agriculture-oriented businesses are not subject to financial sector regulations unless they conduct financial activities as their core function.
Registration is a mandatory prerequisite, and the regulator publishes an updated list of registered entities. It is important to note that deposits with these companies are unsecured and carry no guarantee from the Reserve Bank of India. Additionally, they are exempt from the provisions of state money lending laws, a position upheld by the Supreme Court in a notable case involving a finance company and the State of Kerala.
Transition of Housing Finance Companies to RBI Supervision
Previously, housing finance companies were regulated by the National Housing Bank. However, following amendments introduced by the Finance Act of 2019, these companies now fall under the jurisdiction of the Reserve Bank of India. To ensure financial stability, the regulator has introduced minimum net owned funds requirements. Existing housing finance companies were required to achieve a net owned funds threshold of fifteen crore rupees by April 2022 and twenty crore rupees by January 2023. New companies must secure a minimum of twenty crore rupees before commencing operations in the housing finance sector.
RBI Master Directions and Their Scope
Since January 2016, the Reserve Bank of India has issued a comprehensive framework known as Master Directions for the regulation of non-banking financial companies. These directions cover areas such as registration procedures, prudential norms for asset classification, provisioning and income recognition, capital adequacy requirements, rules for accepting public deposits, investment restrictions, asset-liability management guidelines, and reporting obligations.
The regulator has also issued sector-specific directions, including guidelines for peer-to-peer lending platforms, mortgage guarantee companies, core investment companies, account aggregators, and monitoring of frauds within non-banking financial companies. These directions are updated periodically to adapt to market conditions and emerging risks.
The legal weight of these directions is significant, as courts have recognized them as having the force of law. This position has been reaffirmed in multiple judicial decisions, underlining the statutory authority of the regulator’s instructions.
Non-Banking Non-Financial Companies and Their Distinction
Not all companies registered under the Companies Act that operate outside the banking framework are classified as non-banking financial companies. Entities engaged in manufacturing, mining, or trading activities are categorized as non-banking non-financial companies. These businesses fall outside the scope of Reserve Bank regulation in the context of financial activities and are not required to submit deposit-related returns to the regulator.
Categories of Non-Banking Financial Companies
The regulatory classification divides non-banking financial companies into two primary categories: deposit-taking and non-deposit-taking.
Deposit-taking companies, known as NBFC-D, are authorized to accept public deposits under conditions laid down in specific regulatory directions. Non-deposit-taking companies, known as NBFC-ND, operate without accepting public deposits and are further divided into various subtypes based on their business model.
Subcategories include microfinance institutions, factoring companies, and infrastructure debt funds. Each category is subject to its own operational guidelines, reflecting the nature of its activities and associated risks.
Deposit-Taking NBFCs
Deposit-taking companies must comply with a dedicated set of rules contained in the regulator’s master directions. These include prudential norms, disclosure requirements, caps on interest rates, and reserve requirements. The framework ensures that public deposits are managed responsibly, given that they do not enjoy insurance protection.
Infrastructure Finance Companies
An infrastructure finance company is a non-deposit-taking institution with a minimum net owned funds threshold exceeding three hundred crore rupees. It must maintain at least seventy-five percent of its total assets in infrastructure loans and hold a credit rating of at least grade A. This structure supports large-scale infrastructure financing while maintaining stringent creditworthiness criteria.
Factoring Companies
A factoring company must have at least seventy-five percent of its assets in factoring receivables and earn at least fifty percent of its income from such activities. Registration under the Factoring Regulation Act is mandatory for entities in this category. They provide liquidity to businesses by purchasing their receivables at a discount, enabling faster cash flow cycles.
Miscellaneous Non-Banking Companies
This classification covers institutions that collect and lend money to their members, operating in a manner similar to chit funds. While chit funds themselves are outside the Reserve Bank’s direct control, these miscellaneous non-banking companies fall within its regulatory scope to the extent they meet the legal definition.
Systemic Importance and Size-Based Regulation
Non-banking financial companies are also classified based on their asset size to determine whether they are systemically important. A non-deposit-taking company with assets of five hundred crore rupees or more is considered systemically important, reflecting its potential impact on the broader financial system.
Smaller companies below this threshold are categorized as non-systemically important and follow a lighter regulatory framework, although they remain subject to basic prudential norms. The regulator maintains separate master directions for these two groups to ensure proportional regulation.
Residuary Non-Banking Companies
Residuary non-banking companies engage in deposit-taking under schemes that do not fall within the scope of investment companies, asset financing companies, or loan companies. While there is no upper limit on the amount of deposits they can mobilize, they must comply with strict prudential norms regarding investment and liquidity management to safeguard depositor interests.
Core Investment Companies
A core investment company holds equity and debt primarily in its group companies, with at least ninety percent of its net assets in such investments and at least sixty percent in equity shares of group entities. These companies do not trade their investments except for disinvestment purposes. When the total assets of such a company exceed one hundred crore rupees, it is deemed systemically important and must register with the Reserve Bank of India.
Mortgage Guarantee Companies
Mortgage guarantee companies provide guarantees on home loans through tripartite agreements between the borrower, the lender, and the guarantor. They are subject to specific regulatory guidelines but are exempt from certain provisions of the Reserve Bank of India Act relating to registration and reserve requirements.
RBI’s Regulatory Powers and Compliance Framework for NBFCs
The Reserve Bank of India plays a pivotal role in regulating and supervising Non-Banking Financial Companies to ensure financial stability, protect depositors’ interests, and maintain trust in the financial system. The regulatory structure provides a uniform framework, ensuring that NBFCs operate transparently, efficiently, and in alignment with national economic policies.
RBI’s Overriding Authority Under the RBI Act
Chapter IIIB of the Reserve Bank of India Act contains comprehensive provisions governing NBFCs. Sections 45H to 45QB deal with various aspects of regulation, including licensing, deposit acceptance, and reporting requirements. The powers conferred upon the Reserve Bank are overriding in nature, as Section 45Q specifies that these provisions shall prevail over any inconsistent law in force. This ensures that the RBI’s directions and decisions cannot be undermined by other legislations.
The overriding nature of these provisions allows the RBI to regulate NBFCs more effectively, ensuring that even in cases of overlapping jurisdiction, its directives take precedence. This legal clarity enables the regulator to respond quickly to emerging challenges in the sector.
Registration Requirements and Approval Process
All NBFCs must obtain a Certificate of Registration from the Reserve Bank before commencing operations. The application process involves detailed scrutiny of the company’s financial standing, governance structure, capital adequacy, and business plan. The RBI verifies that the applicant meets the prescribed minimum Net Owned Fund requirements and that the proposed business activities fall within the scope of permissible NBFC functions.
The approval process ensures that only fit and proper entities enter the NBFC sector, reducing the risk of financial instability. Once registered, NBFCs must comply with the ongoing regulatory requirements specified in the Master Directions.
Deposits with NBFCs and Investor Protection
A key regulatory consideration is that deposits placed with NBFCs are not protected by deposit insurance. This contrasts with bank deposits, which are covered under the deposit insurance scheme.
Consequently, depositors must rely on the prudential supervision of the RBI and the financial soundness of the NBFC itself. The absence of a deposit guarantee means that NBFCs must maintain higher transparency in financial reporting and adhere strictly to prudential norms to retain depositor confidence.
Exclusive Regulatory Framework for NBFCs
NBFCs are not subject to the State Money Lenders Act. This position was reinforced by the Supreme Court in Nedumpilli Finance Co Ltd. v. State of Kerala (2022), where it was clarified that the central regulation of NBFCs by the RBI excludes state-level money lending laws from applying to such entities. This ensures uniformity in the regulation of NBFCs across the country.
Housing Finance Companies under RBI Control
Housing Finance Companies were previously regulated by the National Housing Bank. The Finance Act No. 2 of 2019 transferred the regulation of HFCs to the Reserve Bank. This change brought HFCs into the fold of RBI’s comprehensive supervisory framework, aligning their governance standards with other NBFCs.
For existing companies, the minimum Net Owned Funds requirement was set at 15 crore rupees by 1 April 2022, increasing to 20 crore rupees by 1 January 2023. New companies entering the sector must have at least 20 crore rupees before commencing housing finance as a principal business. This phased approach ensures that only financially strong entities operate in the housing finance segment.
RBI Master Directions as a Regulatory Tool
Since January 2016, the Reserve Bank has consolidated its regulatory instructions into Master Directions. These documents provide a single reference point for NBFCs, covering areas such as registration procedures, prudential norms, capital adequacy requirements, public deposit regulations, investment restrictions, asset-liability management, and reporting obligations.
Examples of specific Master Directions include those for peer-to-peer lending platforms issued in 2017, directions for mortgage guarantee companies in 2016, guidelines for core investment companies in 2016, norms for account aggregators in 2016, and procedures for monitoring frauds in NBFCs in 2016. These directions are periodically updated to address market developments and emerging risks.
Legal Status of RBI Directions
Judicial pronouncements have affirmed that RBI directions have the force of law. In Central Bank of India v. Ravindra (2001) and Sudhir Shantilal Mehta v. CBI (2009), it was held that these directions are binding and must be complied with by the entities to which they apply. This recognition reinforces the importance of strict adherence to RBI’s regulatory framework.
Non-Banking Non-Financial Companies (NBNFCs)
Certain companies engaged primarily in manufacturing, mining, or trading may have incidental financial transactions. However, these are classified as Non-Banking Non-Financial Companies and are regulated under the Companies Act rather than the RBI framework. Since they are not engaged in financial business as their principal activity, they are not required to submit deposit-related returns to the RBI.
Categories and Special Types of NBFCs
NBFCs are classified into various categories based on their activities and whether they accept public deposits. These categories help the RBI apply tailored regulations to different business models.
Deposit-Taking NBFCs (NBFC-D)
NBFCs that accept public deposits must comply with strict guidelines under the relevant Master Directions. These include limits on interest rates payable, restrictions on the quantum of deposits, and stringent asset classification norms. The prudential oversight is designed to safeguard depositor interests and prevent liquidity crises.
Non-Deposit-Taking NBFCs (NBFC-ND)
These companies do not accept public deposits but are still subject to prudential regulations. A sub-category of NBFC-NDs is identified as systemically important based on their asset size.
Infrastructure Finance Companies (IFC)
An IFC is a non-deposit-taking NBFC with a minimum Net Owned Fund of 300 crore rupees. It must deploy at least 75 percent of its total assets in infrastructure loans and maintain a minimum credit rating of “A” or equivalent. This category is critical for financing large-scale infrastructure projects that drive economic growth.
NBFC-Factor
These entities specialize in factoring business, where they purchase receivables from businesses and provide immediate liquidity. To qualify as an NBFC-Factor, the company must have at least 75 percent of its assets and 50 percent of its income from factoring activities. It must also be registered under the Factoring Regulation Act, 2011.
Miscellaneous Non-Banking Companies (MNBCs)
MNBCs are financial institutions that collect and lend money to their members. They operate similarly to chit funds, although chit funds themselves are regulated separately by state laws and are not under RBI’s control. MNBCs cater primarily to community-based financing needs.
Systemically Important and Non-Systemically Important NBFCs
The Reserve Bank classifies NBFCs with an asset size of 500 crore rupees or more as systemically important. These NBFC-ND-SIs have a significant influence on financial stability, and their operations are closely monitored.
Smaller NBFCs, with asset sizes below this threshold, are categorized as non-systemically important and have relatively lighter regulatory requirements. Separate Master Directions apply to each category, reflecting the difference in their potential impact on the broader financial system.
Residuary Non-Banking Companies (RNBCs)
RNBCs operate on deposit acceptance schemes not covered under investment, asset financing, or loan company categories. While there is no cap on the deposits they can accept, they are subject to strict prudential norms, especially concerning asset deployment and liquidity management. These norms ensure that the funds raised are invested in safe and liquid assets to protect depositors.
Core Investment Companies (CICs)
CICs primarily hold equity and debt in group companies. At least 90 percent of their net assets must consist of investments in group companies, with a minimum of 60 percent in equity shares. They do not engage in trading activities, except for the purpose of disinvestment. CICs with asset sizes exceeding 100 crore rupees are classified as systemically important and must be registered with the RBI.
Mortgage Guarantee Companies
These NBFCs provide guarantees for mortgage loans under a tripartite arrangement between the borrower, the lender, and the guarantor. They are governed by the Mortgage Guarantee Companies Directions, 2016, and are exempt from certain provisions of the RBI Act, such as those relating to registration, reserve requirements, and maintenance of liquid assets. The exemption recognises the specialised nature of their operations.
Emerging Regulatory Trends for NBFCs
Over the years, the RBI has continuously enhanced the regulatory framework for NBFCs to address evolving market conditions. There has been a focus on aligning NBFC regulations with those applicable to banks, especially for large and systemically important NBFCs. The aim is to reduce regulatory arbitrage and ensure that entities performing similar functions are subject to comparable oversight.
Digital transformation in the NBFC sector has also prompted the RBI to issue new guidelines covering cyber security, digital lending practices, and data protection. These initiatives are aimed at safeguarding consumers while promoting innovation.
Regulatory Framework for Specialized NBFC Categories
NBFCs encompass a wide variety of specialized entities, each with specific regulatory obligations. While the core framework is provided by the Reserve Bank of India under the RBI Act, 1934, specialized directions, circulars, and amendments adapt the rules to suit unique operational models. This section examines some important categories in detail.
Peer-to-Peer Lending Platforms (NBFC-P2P)
Peer-to-peer lending platforms are innovative NBFC models facilitating direct lending between lenders and borrowers through an online platform. RBI recognized their systemic importance and issued the Non-Banking Financial Company – Peer to Peer Lending Platform Directions in 2017.
These platforms must be incorporated as companies, hold a valid certificate of registration, and operate exclusively as intermediaries without engaging in direct lending. They have to maintain transparency in borrower and lender profiling, disclose default rates, and adhere to exposure limits.
P2P NBFCs must also ensure credit assessment, proper grievance redressal, and adherence to anti-money laundering regulations. They operate under restrictions such as caps on aggregate lending and borrowing per participant and mandatory reporting to credit bureaus.
Infrastructure Debt Fund NBFCs (NBFC-IDF)
Infrastructure Debt Funds aim to channel long-term capital into infrastructure projects. NBFC-IDFs are set up either as trusts or companies and raise resources through bonds to refinance existing infrastructure loans.
To qualify as an NBFC-IDF, the entity must have a minimum credit rating, maintain capital adequacy, and adhere to limits on exposure concentration. The RBI mandates that only infrastructure projects with a stable revenue stream and completed commercial operations are eligible for refinancing. These NBFCs play a critical role in supporting public-private partnerships and large-scale capital-intensive projects.
Mortgage Guarantee Companies
Mortgage Guarantee Companies provide guarantees to lenders in case of default by borrowers on housing loans. They operate through tripartite agreements involving the lender, borrower, and guarantor.
Such companies must register with the RBI, maintain minimum capital, and comply with prudential norms, though they enjoy exemptions from certain provisions of the RBI Act. The Mortgage Guarantee Companies Directions, 2016 govern their functioning, covering capital adequacy, exposure norms, and guarantee coverage limits.
Capital Adequacy and Prudential Norms
Capital adequacy is essential for ensuring financial stability and resilience against unexpected losses. RBI requires NBFCs to maintain a minimum Capital to Risk-Weighted Assets Ratio (CRAR), varying by category.
Prudential norms include guidelines on income recognition, asset classification, provisioning requirements, and restrictions on exposure to sensitive sectors. Systemically important NBFCs are subject to stricter norms compared to smaller entities.
Asset Classification
NBFCs must classify their assets into standard, sub-standard, doubtful, and loss categories. The classification is based on the period of overdue payments and the quality of the asset. The norms ensure that non-performing assets are recognized promptly, and adequate provisioning is made.
Provisioning Requirements
NBFCs must set aside provisions to cover potential losses from non-performing assets. The provisioning percentages vary depending on the asset classification, with higher percentages required for doubtful and loss assets. These requirements safeguard investor interests and maintain confidence in the NBFC sector.
Exposure Norms
To prevent over-concentration of risk, NBFCs are required to follow exposure limits on lending and investment in single borrowers or groups. These limits are particularly important for NBFCs engaged in infrastructure financing, as large exposures could threaten stability.
Liquidity Management
Liquidity risk management is a priority for NBFCs, especially after market disruptions that have affected the sector in recent years. RBI mandates Asset-Liability Management (ALM) frameworks, liquidity coverage ratios for larger NBFCs, and stress testing.
NBFCs must match the maturities of assets and liabilities to avoid liquidity mismatches. Systemically important NBFCs need to disclose their ALM statements periodically and ensure that adequate high-quality liquid assets are maintained.
Corporate Governance Requirements
Good governance is crucial for the credibility and sustainability of NBFCs. RBI emphasizes board oversight, independent directors, and committees for audit, risk management, and remuneration.
The fit-and-proper criteria for directors, disclosure norms for related party transactions, and whistleblower mechanisms form part of governance requirements. Systemically important NBFCs must also adopt a risk-based internal audit system.
Appointment of Key Management Personnel
Senior management appointments, including CEOs and compliance officers, require adherence to RBI’s fitness criteria. NBFCs are expected to ensure integrity, competence, and relevant experience of top executives.
Certain appointments may require prior intimation to RBI, especially in the case of systemically important companies or specialized categories like CICs.
Transparency and Disclosure Norms
NBFCs are required to publish audited financial statements, disclosures on capital adequacy, asset quality, provisioning, exposure to sensitive sectors, and liquidity positions. Transparency builds market confidence and helps regulators monitor compliance effectively.
Consumer Protection Measures
Consumer protection is a major aspect of NBFC regulation, ensuring fair treatment of borrowers and depositors. RBI has issued Fair Practices Codes applicable to all NBFCs, covering loan appraisal, disbursement, recovery, and grievance redressal.
Fair Practices Code
NBFCs must provide clear terms and conditions of loans, including interest rates, processing fees, and repayment schedules. Changes in terms must be communicated in advance, and repossession policies for secured loans must be transparent.
Coercive recovery methods are prohibited, and NBFCs must ensure that collection agents follow ethical practices.
Grievance Redressal Mechanism
All NBFCs must appoint grievance redressal officers and display their contact details. Complaints must be addressed within a specified time frame, and unresolved grievances can be escalated to the RBI’s Ombudsman scheme.
This framework ensures borrowers and depositors have access to impartial resolution mechanisms.
Impact of the Finance Act, 2019 and 2020 Amendments
The Finance Act, 2019 brought housing finance companies under RBI’s regulatory purview, aligning their requirements with other NBFCs. This change ensured consistency in prudential norms, capital requirements, and governance standards across the sector.
Subsequent amendments in 2020 strengthened the RBI’s oversight powers, allowing for tighter control over unregulated financial activities, stricter penalties for non-compliance, and harmonization of norms between banks and NBFCs.
NBFCs and Anti-Money Laundering Compliance
NBFCs must comply with the Prevention of Money Laundering Act (PMLA), which involves conducting customer due diligence (KYC), maintaining transaction records, and reporting suspicious activities to the Financial Intelligence Unit.
They must have robust internal systems to detect unusual transactions, assess risks, and train staff in compliance obligations. Violations can result in severe penalties and reputational damage.
Know Your Customer (KYC) Requirements
KYC is a critical first step in establishing a business relationship. NBFCs must obtain and verify identity and address documents, conduct risk-based profiling of customers, and update KYC records periodically.
The use of Aadhaar-based eKYC and video KYC processes has made compliance more efficient, while ensuring regulatory safeguards against misuse.
Reporting Obligations
NBFCs must submit reports on cash transactions, suspicious transactions, and cross-border wire transfers to the Financial Intelligence Unit. Timely reporting helps in tracking illicit funds and combating terrorism financing.
Technology and Digital Transformation in NBFCs
NBFCs are increasingly leveraging technology for customer acquisition, credit assessment, loan disbursal, and collections. Digital transformation has improved operational efficiency but also introduced new risks.
RBI’s regulatory technology (RegTech) initiatives encourage the use of digital platforms while emphasizing data protection, cybersecurity measures, and responsible lending.
Cybersecurity Norms
NBFCs must implement comprehensive cybersecurity policies, conduct vulnerability assessments, and report major incidents to RBI. With the growth of digital lending, safeguarding customer data and ensuring secure transactions are paramount.
Incident response plans, regular employee training, and adoption of encryption standards form the core of cyber risk management.
Digital Lending Guidelines
RBI has introduced guidelines for digital lending to curb malpractices, ensure fair interest rates, and protect consumer data. NBFCs must ensure that digital lending apps they work with are transparent about loan terms, obtain informed consent, and follow ethical recovery practices.
Challenges in NBFC Regulation
Despite the comprehensive framework, NBFCs face challenges in maintaining liquidity, managing credit risk, adapting to technological changes, and complying with evolving norms. Market disruptions can quickly affect smaller NBFCs with limited access to funding.
Harmonization of regulations between NBFCs and banks continues to be a focus, aimed at preventing regulatory arbitrage while maintaining flexibility for innovation.
The Road Ahead for NBFCs
RBI’s regulatory stance balances growth and stability, promoting financial inclusion while ensuring the sector’s soundness. Future reforms are expected to focus on strengthening governance, expanding credit to underserved sectors, and leveraging digital finance responsibly.
NBFCs will need to invest in compliance, risk management, and technology to remain competitive and aligned with regulatory expectations.
Conclusion
The Liberalised Remittance Scheme has become a pivotal framework for individuals seeking to transfer funds abroad for various legitimate purposes, from education and medical treatment to investments and travel. By providing a structured yet flexible channel, it enables residents to manage international financial needs with transparency and compliance. Over the years, the scheme has evolved to align with global financial practices while addressing concerns of misuse through clear documentation requirements and reporting standards.
Understanding the scope, permissible transactions, and regulatory limits under LRS is essential for avoiding violations and ensuring smooth remittance processes. Both individuals and authorised dealers share responsibility in adhering to the prescribed guidelines, which safeguard the integrity of cross-border transactions. With proper planning, awareness of procedural steps, and adherence to legal requirements, residents can utilize the LRS effectively to achieve personal and financial goals without encountering regulatory hurdles.