Control of the RBI over non-banking companies, financial and non-financial
Banking Law · Unit II · Topic 6 of 21 · 6 min read
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1. Why non-banking companies need control
Finance companies, hire-purchase and leasing firms, chit funds and investment companies collect money from the public and lend it, but are not banks: they do not take deposits withdrawable by cheque, so the Banking Regulation Act does not reach them. When they fail, depositors lose everything; there is no deposit insurance. They also affect the credit system the RBI is trying to steer. Chapter IIIB therefore gives the RBI power to register, regulate and, if necessary, wind them up. Chapter IIIB does not apply to banks, RRBs, co-operative banks or primary credit societies, which have their own law (s.45H).
2. The definitions (s.45-I)
- Non-banking institution (s.45-I(e)): a company, corporation or co-operative society.
- Financial institution (s.45-I(c)): a non-banking institution which carries on as its business or part of its business any of these: financing any activity other than its own by loans or advances; acquiring shares, bonds or securities; hire-purchase; insurance; chits or kuries; or collecting money by subscriptions or units and awarding prizes or gifts. It excludes an institution whose principal business is agricultural operations, industrial activity, purchase or sale of goods or providing services, or purchase, construction or sale of immovable property.
- Non-banking financial company (s.45-I(f)): a financial institution which is a company; a non-banking company whose principal business is receiving deposits or lending in any manner; and any other class the RBI notifies with Government approval.
- Deposit (s.45-I(bb)) is defined widely, as any receipt of money by way of deposit or loan or in any other form, but excludes share capital, partners' capital, money from banks and specified financial institutions, security and dealership deposits, earnest money, advances against orders, and chit subscriptions.
The principal business test is not defined in the Act. The RBI applies it by its “50-50” criterion: a company is treated as an NBFC if its financial assets are more than half its total assets and income from financial assets is more than half its gross income.
The syllabus speaks of financial companies and non-financial companies. The first are NBFCs, controlled under Chapter IIIB. The second are manufacturing and trading companies whose principal business is not finance; when they accept deposits they are governed by ss.73–76 of the Companies Act, 2013 and the Companies (Acceptance of Deposits) Rules, 2014, not by the RBI. Unregulated deposit schemes of any kind are banned by the Banning of Unregulated Deposit Schemes Act, 2019.
3. Registration and prudential controls
- Registration and net owned fund (s.45-IA). No NBFC shall commence or carry on the business of a non-banking financial institution without a certificate of registration from the RBI and a net owned fund of ₹25 lakh or such higher amount, up to ₹100 crore, as the RBI notifies; different amounts may be fixed for different categories. The RBI may cancel the certificate.
- Liquid assets (s.45-IB). An NBFC must invest in unencumbered approved securities at least 5 per cent, or such higher percentage up to 25 per cent as the RBI specifies, of its outstanding deposits.
- Reserve fund (s.45-IC). At least 20 per cent of net profit every year, before any dividend, to a reserve fund, from which withdrawals are permitted only for purposes the RBI specifies.
- Directions (s.45JA). In the public interest, to regulate the financial system, or to protect depositors, the RBI may determine policy and give directions to NBFCs on income recognition, accounting standards, provisioning for bad debts, capital adequacy, deployment of funds and concentration of credit. The current scale-based regulation, sorting NBFCs into base, middle, upper and top layers by size and risk, rests on this power.
- Prospectus and advertisements (s.45J) soliciting deposits may be regulated or prohibited.
4. Information and directions to non-banking institutions generally
Two older powers reach beyond NBFCs:
- s.45K: the RBI may require every non-banking institution to furnish statements about deposits received, and give directions as to receipt of deposits, including the rate of interest and the period of deposit.
- s.45L: to regulate the credit system, the RBI may call for information from financial institutions and give them directions about the conduct of their business.
Every non-banking institution must comply (s.45M), and auditors must report contraventions to the RBI (s.45MA).
5. Sanctions
- Prohibition (s.45MB). If an NBFC breaks the Chapter or a direction, the RBI may prohibit it from accepting deposits and from selling or alienating its assets.
- Supersession (s.45-IE) of the board of an NBFC (other than a Government company) and appointment of an administrator; removal of directors (s.45-ID); resolution schemes of amalgamation or reconstruction (s.45MBA), inserted in 2019 after the failure of a large infrastructure finance group.
- Winding up (s.45MC). The RBI may petition for winding up if the NBFC is unable to pay its debts, has lost its registration, has been prohibited from receiving deposits for at least three months, or its continuance is detrimental to the public or depositors.
- Unincorporated bodies (s.45S). An individual, firm or unincorporated association may not accept deposits if its business includes financing activity or its principal business is receiving deposits or lending. Offences carry imprisonment and fine (s.58B).
- Investigation (s.45T): magistrates may issue search warrants on complaints of unauthorised deposit-taking.
6. The cases
In Peerless General Finance and Investment Co. Ltd. v. Reserve Bank of India, 1992 INSC 32, the Court upheld the RBI's directions to residuary non-banking companies, which required them to invest the whole of their deposit liability in safe instruments such as bank deposits and government securities. The directions were issued under ss.45J, 45K and 45L to protect small depositors, and the Court refused to examine their wisdom: the RBI is the expert body, and its monetary and credit judgments are not reviewed on merits unless they are arbitrary.
The breadth of the RBI's regulatory power was considered in Internet and Mobile Association of India v. Reserve Bank of India, 2020 INSC 264, (2020) 10 SCC 274. The RBI's 2018 circular forbade the entities it regulates to deal with persons dealing in virtual currencies. The Court held that the RBI had the power to regulate or prohibit such an activity, since it could affect the payment and credit systems, but struck the circular down as disproportionate under Article 19(1)(g): the RBI had not shown any actual harm to its regulated entities and had not considered less intrusive measures.
How this is examined
“Discuss the powers of Reserve Bank of India over non-banking companies” (August 2024) is the essay. Give the reasons for control, the three definitions, the registration and prudential controls with section numbers, directions under ss.45JA, 45K and 45L, the sanctions, and Peerless. Add the distinction between financial companies (RBI) and non-financial companies (Companies Act, 2013), because the syllabus names both. IAMAI makes a good closing paragraph on the limits of RBI power.
Now try the real questions: Banking Law past question papers.