NBFCs—Formation, Regulation & Remedies

Raghvendra Singh Raghuvanshi *

****

INTRODUCTION

The article endeavor to address the intricacies involved in the business of Non-Banking
Financial Companies (hereinafter to be referred as “NBFC”). It shall cover the law
governing the NBFCs, with detailed provisions of law and directions issued by different
regulators, right from its formation and functions to the regulation of its operation in the
market. It shall also deal in detail with the actions available against the NBFCs in
noncompliance
with the norms prescribed by different regulators and includes judicial
approach towards NBFCs with comparison between NBFCs and Foreign Institutional
Investors (FII) followed by the conclusion.

WHAT IS NBFC?

NBFCs are those type of companies which are not banking companies but engaged in the
business activities related to loan, finance, investment, leasing, hire-purchase and other
fund based activities. These companies are required to comply with the provisions of RBI
Act and the rules and directions thereof, in addition to the provisions of Companies Act,
1956.

STATUTORY DEFINITION UNDER THE RBI ACT

NBFC is defined under sec. 45-I(f)1 as under:

Sec. 45-I(f): ) “non-banking financial company” means

(i) a 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;
*

Final Year Student, National Law Institute University, (NLIU) Bhopal.

(raghav_nliu@rediffmail.com)
1 Inserted by Reserve Bank of India (Amendment Act), 1997, w.e.f. 9.1.1997.

Page 1 of 1
(iii) such other non-banking institution 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.
The Act defines ‘Financial Institution’ (FI) u/s 45-I(c) as:

“financial institution” means any non-banking institution which carries on as its

business or part of its business any of the following activities, namely :

(i)
The financing, whether by way of making loans or advances or otherwise, of
any activity other than its own;
(ii)
The acquisition of shares, stock, bonds, debentures or securities issued by a
government or local authority or other marketable securities of a like nature;
(iii)
Letting or delivering of any goods to a hirer under a hire-purchase
agreement;
(iv)
the carrying on of any class of insurance business;
(v)
Managing, conducting or supervising, as foreman, agent or in any other
capacity, of chits or kuries as defined in any law which is for the time being in
force in any State, or any business, which is similar thereto;
(vi)
Collecting, for any purpose or under any scheme or arrangement by whatever
name called monies in lump sum or otherwise, by way of subscriptions or by
sale of units, or other instruments or in any other manner and awarding
prizes or gifts, whether in cash or kind, or disbursing monies in any other
way, to persons from whom monies are collected or to any other person,
The definition of FI uses the definition of a Non Banking Institution (NBI) and NBI has
been defined under the Act as follows:

Sec.45-I(e) : “non-banking institution” means a company, corporation or co-operative

society.”

Page 2 of 2
Under section 45-I(a) of the RBI Act,1934 ‘business of non banking financial
institution2‘, is defined in terms of the business of a financial institution and NBFC.

Sec: 45-I(a) : “business of a non-banking financial institution” means carrying on the

business of a financial institution referred to in clause (c) and includes business of a non-
banking financial company referred to in clause (f).

An analysis of forgoing provisions reveals that except for specifically notified categories,
a company that is a FI, or a NBI receiving deposits, alone would qualify as an NBFC. A
further reading of the definitions of FI and NBI reveals that for a company to be an
NBFC it should either carry on any of the businesses as enumerated in (i) to (vi) of Sec.
45-I(c) or it should otherwise receive public deposits in any manner.

FUNCTIONS OF NBFCS

More specifically, an NBFC is a company registered under the Companies Act, 1956, and
obtained a certificate of registration U/s. 45-IA (5) of the Reserve Bank of India Act,
1934 (hereinafter to be referred as “RBI Act”) and is engaged in the business very much
similar to banks and also deals in the business of loans and advances, acquisition of
shares/stock/bonds/debentures/securities issued by Government or local authority or other
securities of like marketable nature, leasing, hire-purchase, insurance business, chit
business but does not include any institution whose principal business is that of
agriculture activity, industrial activity, sale/purchase/construction of immovable property.
A non-banking institution which is a company and which has its principal business of
receiving deposits under any scheme or arrangement or any other manner, or lending in
any manner is also a non-banking financial company (Residuary non-banking company).

2 ibid.

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DIFFERENCE BETWEEN NBFC AND BANK

NBFCs are doing functions akin to that of banks, however there are few differences.

NBFC BANK
1. A NBFC cannot accept
demand deposits.
1. A bank can accept demand
deposits.
2. . It is not a part of the
payment and settlement system
and as such cannot issue
cheques/Demand Drafts to its
customers.
2. A bank can issue cheques/
Demand Drafts to its
customers.
3. Deposit insurance facility of
Deposit Insurance and Credit
Guarantee Corporation
(DICGC) is not available for
NBFC depositors.
3. Deposit insurance facility
of DICGC is available for
Bank’s depositors and their
money is pari passu secured.

FORMATION OF NBFC

An NBFC can be either a private limited company or a public limited company. Section
12(1) of the Companies Act, 1956 provides for the mode of forming incorporated
company. 3 The persons who intend to incorporate an NBFC are required to fill in the
concerned box in the appropriate Form for incorporating their company as an NBFC
thereby complying with the other requirements of the Companies Act, 1956 like drafting
of Memorandum of Association, Articles of Association etc.

3 Section 12(1): “Any seven or more persons, or where the company to be formed will be
a private
company, any two or more persons, associated for any lawful purpose may, by
subscribing their names to a
memorandum of association and otherwise complying with the requirements of this Act
in respect of
registration, form an incorporated company, with or without limited liability.”

Page 4 of 4
A. CERTIFICATE OF INCORPORATION FOR PRIVATE LIMITED COMPANY
On the satisfaction of the Registrar of Companies (hereinafter to be referred as ‘ROC’)
that the requirements specified in sections 33(1) and 33(2), Companies Act, 1956 have
been complied with by the company, he shall retain and register the Memorandum of
Association (MOA) and Articles of Association (AOA) and other documents. Section
34(1) casts an obligation on the ROC to issue a certificate of Incorporation, normally
within 10 days of the receipt of documents.4

B. CERTIFICATE OF COMMENCEMENT OF BUSINESS FOR PUBLIC LIMITED

COMPANY

Private limited company and companies not having share capital may commence its
business activities from the date of its incorporation. Public limited companies having
share capital are required to obtain, in addition to the certificate of incorporation of public
limited company, a separate certificate of commencement of business according to
Section 149(2A) of the Companies Act, 1956.

C. CERTIFICATE OF REGISTRATION OF NBFC FROM RBI

A company incorporated as an NBFC under the Companies Act, 1956 is mandatorily
required to be registered with RBI under section 45-IA of the RBI Act to commence or
carry on any business of non-banking financial institution as defined in clause (a) of
Section 45 I of the RBI Act.

Section 45-IA, RBI Act reads as:

“Notwithstanding anything contained in this Chapter or in any other law for the time
being in force, no non-banking financial company shall commence or carry on the
business of a non-banking financial institution without

(a) obtaining a certificate of registration issued under this Chapter

4 Section 34(1): “On the registration of the memorandum of a company, the Registrar
shall certify under
his hand that the company is incorporated and, in the case of a limited company that the
company is
limited.”

Page 5 of 5
(2) Every non-banking financial company shall make an application for registration
to the bank in such form as the bank may specify”
D. NET OWNED FUND REQUIREMENTS FOR NBFC
A company incorporated under the Companies Act, 1956 and desirous of commencing
business of Non-Banking Financial Institution as defined under Section 45 I(a) of the
RBI Act, 1934 should have a minimum net owned fund of Rs 25 lakh (raised to Rs 200
lakh)5 under Section 45-IA (b), RBI Act, 1934.

What is Net Owned Fund (NOF)?

Explanation to Section 45-IA(7), RBI Act defines NOF as:

NOF
=
Paid up equity capital + Free Reserves
Minus (-)

1.
[Accumulated balance of loss + deferred revenue expenditure + other intangible
assets
2.
INVESTMENT in its subsidiaries + companies in the same group + all other
NBFCs
3.
BOOK value of debentures, bonds, outstanding loans and advances made to its
subsidiaries and companies in the same group to the extent such book value
exceeds 10% of the aggregate paid up capital and free reserves].
WHO ARE THE REGULATORS?

OBJECTIVE OF RBI IN REGULATORY FRAMEWORK OF NBFC’S

RBI is entrusted with the responsibility of regulating and supervising NBFCs by virtue of
powers vested in Chapter IIIB and by sections 45J, 45K and 45 MA of the RBI Act. The
regulatory and supervisory objective is to;

5 RBI notification No. DNBS 132/CGM (VSNM)-99 dated 20-04-1999 issued by

Department of Non
Banking Supervision, RBI (w.e.f April 21, 1999).

Page 6 of 6
•
Ensure healthy growth of financial companies;
•
Ensure that these companies function as a part of the financial system within
the policy framework, in such a manner that their existence and functioning
do not lead to systematic aberration; and that
•
The quality of surveillance and supervision exercised by the Bank over the
NBFCs is sustained by keeping pace with developments that take place in this
sector of the financial system.
A. RESERVE BANK OF INDIA—RELEVANT PROVISIONS
The activities of the NBFCs accepting deposits from public are regulated by the
provisions chapter IIIB of the RBI Act, 1934. It was generally felt that these provisions
were neither adequate to regulate the business activities of these companies nor did they
provide adequate protection to the depositors. Therefore, the RBI Act, 1934 was amended
as Reserve Bank of India (Amendment) Act, 1997.6 The changes made, in main, relates
to as follows:

1.
Compulsory registration of NBFCs with RBI with minimum net owned funds
(Section 45IA)
2.
Maintenance of liquid assets (Section 45IB)
3.
Creation of reserve funds and transfer of certain percentage of profits every year
to the fund (Section 45IC)
4.
Empowering RBI to issue directions (Section 45JA)
5.
Issue of directions by RBI to NBFCs and the auditors relating to annual accounts,
disclosure of liabilities or any other matter and to order special audit (Section
45MA)
6.
Prohibit acceptance of deposits by NBFCs and alienation of assets (Section
45MB)
7.
RBI is empowered to file a petition for winding up of an NBFC (Section 45MC)
8.
Power to conduct inspection (Section 45N)
9.
Power of RBI to impose fine (Section 58G)
6 W.e.f. 09/01/1997

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10. Nomination facility for deposits held by the NBFCs has been introduced on the
lines of bank deposits under section 45ZA of Banking Regulation Act, 1943. The
primary purpose of this provision is to regulate the acceptance of public deposits
by NBFCs of all categories, with a view to safeguard the interest of the
depositors. (Section 45QB).
A.1 NON-BANKING FINANCIAL COMPANIES ACCEPTANCE OF PUBLIC
DEPOSITS
(RESERVE BANK) DIRECTIONS, 19987

In the above-said RBI directions, certain restrictions have been put on acceptance of
public
deposits by the NBFCs.

1. Minimum Credit Rating requirements

On and from January 31, 1998,

•
No non-banking financial company having Net Owned Fund (hereinafter
referred to as ‘NOF’) of twenty five lacs of rupees and above shall accept
public deposit unless it has obtained minimum investment grade or other
specified credit rating for fixed deposits from any one of the approved credit
rating agencies at least once a year
Provided that this clause shall not apply to an Equipment Leasing or Hire
Purchase Finance Company.

•
In the event of upgrading or downgrading of credit rating of any non-
banking financial company to any level from the level previously held by
the non-banking financial company, it shall within fifteen working days of
its being so rated inform, in writing, of such upgrading/downgrading to the
Reserve Bank of India.
7 Also Including relevant amended directions inserted in NBFC (APD) Directions, 1998,
as Amended by a
RBI Amendment Notification w.e.f. March 4, 2003.

Page 8 of 8
2. Prohibition from accepting demand deposit:
On and from January 31, 1998, no NBFC shall accept or renew any public deposit
whether accepted before or after January 31, 1998, which is repayable on demand.

3. Period of Public Deposit

On and from January 31, 1998, no NBFC shall accept or renew any public deposit
whether accepted before or after January 31, 1998 unless such deposit is
repayable after a period of twelve months but not later than sixty months from the
date of acceptance or renewal thereof.

4. Ceiling On Quantum Of Deposits

No equipment leasing company or hire purchase finance company or Loan Company
or Investment Company shall, accept or renew public deposit except as provided
hereunder:
Equipment Leasing Company (EL) or Hire Purchase Finance Company
(HPFC)
An ELC/HPFC having:

•
NOF of twenty five lacs of rupees or more;
•
Minimum investment grade credit rating;
•
May accept or renew public deposit, not exceeding four times of its NOF
or public deposit up to ten crore of rupees, whichever is lower.
Loan Company (LC) or An Investment Company (IC)

An LC/IC having:

•
NOF of twenty five lacs of rupees or more;
•
Minimum investment grade credit rating; and
•
May accept or renew public deposit not exceeding one and one half times
of its NOF
Page 9 of 9
5.
Ceiling on the rate of interest
•
On and from March 4, 2003, no NBFC shall invite or accept or renew
public deposit at a rate of interest exceeding 11% per annum.
•
On and from September 18, 2003, no NBFC shall invite or accept or
renew repatriable deposits from Non-Resident Indians under Non-
Resident (External) Account Scheme at a rate exceeding the rate specified
by the Reserve Bank of India for such deposits with scheduled commercial
8

banks.

6. Payment of brokerage
On and from January 31, 1998 no NBFC shall pay to any broker on public deposit
collected by or through him brokerage, commission, incentive or any other benefit
by whatever name called, in excess of 2% of the deposit so collected.

7.
Branches and appointment of agents to collect deposits
On and from January 13, 2000, no NBFC shall open its branch or appoint agents
to collect deposits except as provided hereunder:

An NBFC having the certificate of registration issued by RBI U/s. 45IA, RBI Act,
may open its branch or appoint agents if its:

•
NOF is up to Rs. 50 crore within the State where its registered office is
situated; and
•
NOF is more than Rs. 50 crore and anywhere in India its credit rating is
AA or above
•
For the purpose of opening a branch, an NBFC shall notify to the RBI of
its intention to open the proposed branch;
8 In terms of Notification No.FEMA.5/2000-RB dated May 03, 2000.

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8.
Employees Security Deposit
An NBFC receiving any amount in the ordinary course of its business as security
deposit from any of its employees for due performance of his duties shall keep
such amount in an account with a scheduled commercial bank or in a post office
in the joint names of the employee and the company on the conditions that

•
It shall not withdraw the amount without the consent in writing of the
employee; and
•
The amount shall be repayable to the employee along with interest payable
on such deposit account unless such amount or any part thereof is liable to
be appropriated by the company for the failure on the part of the employee
for due performance of his duties.
9.
Safe custody of approved securities
Every non-banking financial company shall open a Constituent’s Subsidiary General
Ledger (CSGL) account with a scheduled commercial bank, or the Stock Holding
Corporation of India Ltd. (SHCIL) or a dematerialized account with a depository through
a depository participant registered with the SEBI and keep the unencumbered approved
securities required to be maintained by it in such CSGL account or dematerialised

account.

A.2 PUBLIC DEPOSITS BY PRIVATE LIMITED NBFCs

The provisions of section 3(1) of the Companies Act, 1956 have been amended in terms
of which the definition of ‘private company’ has been modified. The additional
requirement imposed by the amendment for a private limited company is that any
invitation or acceptance of deposits from persons other than its members (shareholders),
directors or their relatives is prohibited.10

It is advised that the NBFCs, which were hitherto private limited companies and were
intending to take or holding public deposits are now public deposit companies under the

9 In pursuance of Section 45-IB of the RBI Act, 1934 and the Notification No. DFC.121/
ED(G)-98, dated
January 31, 1998.
10 Inserted by Companies (Amendment) Act, 2000 (w.e.f. 13/12/2000)

Page 11 of 11
companies Act, 1956. It is presumed that they have done the needful as required of them
under the companies Act. They may approach RBI for change in the certificate of
registration to reflect the new name as a public limited company.11

12

A.3 GUIDELINES FOR ENTRY INTO INSURANCE SECTOR

1.
Any NBFC registered with RBI having net owned fund of Rs. 2 crore would be
permitted to undertake insurance business as agent of insurance companies on fee
basis, without any risk participation.
2.
All NBFCs registered with RBI, which satisfy the eligibility criteria given below,
will be permitted to set up a Joint Venture (JV) company for undertaking
insurance business with risk participation, subject to safeguards. The maximum
equity contribution such an NBFC can hold in the JV company will normally be
50% of the paid up capital of the insurance companion a selective basis, RBI may
permit a higher equity contribution by a promoter NBFC initially. The eligibility
criteria for JV participant will be as under:
•
The owned fund of the NBFC should not be less than Rs. 500 crore,
•
The CRAR of the NBFC engaged in loan and investment activities holding
public deposits should not be less than 15% and for other NBFCs at 12%,
irrespective of their holding public deposits or not,
•
The NBFC should have net profit for the last three continuous years,
•
The track record of the performance of the subsidiaries, if any, of the
concerned NBFC should be satisfactory.
3.
No NBFCs would be allowed to conduct such business departmentally.
4.
All NBFCs registered with RBI entering into insurance business on risk
participation basis will be required to obtain prior approval of the RBI.
11 RBI Clarification Circular No. DNBS(PD). CC. No. 18/02.01/2001-02, Dated 01-01-
2002.
12 Vide Circular DNBS (PD)CC No.13/02.01/99-2000 dated June 30, 2000.

Page 12 of 12
5.
It has now been decided that NBFCs registered with Reserve Bank of India may
take up insurance agency business on fee basis and without risk participation,
without the approval of Reserve Bank of India13 subject to the following
conditions:
•
The NBFCs should obtain requisite permission from IRDA and comply with
the IRDA regulations for acting as `composite corporate agent’ with
insurance companies.
•
The NBFCs should not adopt any restrictive practice of forcing its customers
to go in only for a particular insurance company in respect of assets financed
by the NBFC. The customers should be allowed to exercise their own choice.
•
The premium should be paid by the insured directly to the insurance company
without routing through the NBFC.
•
The risks, if any, involved in insurance agency should not get transferred to
the business of the NBFC.
A.4 MONTHLY RETURN FILING GUIDELINES FOR NBFCS
The NBFCs accepting/holding public deposits of Rs.50 crore and above shall be required
to file monthly returns to RBI.

NBFCs not accepting/holding public deposits and having assets size of Rs. 100 crore and
above will be required to submit monthly returns. The return shall be submitted within
seven days of the month following the month to which it pertains. The return certified by
statutory auditors may, however, be submitted within seven days of finalisation of final

14

accounts.

13 Vide RBI Circular No. DNBS (PD) C.C. No. 35 / 10.24 / 2003-04, dated February 10,
2004.
14 RBI/2005-06/157/ DNBS (RID) C.C. No. 57/02.05.15/2005-06, dated September 6,
2005.

Page 13 of 13
A.5 BANK FINANCE TO NBFCs
The RBI guidelines to provide finance to the NBFCs15 are as under:

•
Bank credit to Loan And Investment Companies should not exceed twice the NOF
of such companies.
•
Bank credit to Equipment Leasing And Hire Purchase Companies will continue at
the present level of four times the NOF of such companies, provided the company
is predominantly engaged in equipment leasing/hire purchase business i.e. at
least75% of the companies assets are in the Equipment leasing/hire purchase and
75%of its gross income is derived from these two types of activities as per the last
audited balance sheet of the company.
•
The banks should undertake an immediate review of the credit limits sanctioned
to all NBFCs and reassess the limits to ensure that they are within the ceiling
limits now prescribed. In cases, where the outstanding are in excess of the
reassessed limits so arrived at, the excess borrowings should be reduced within a
period not exceeding 30 days form the date of this circular.
A.5.1 NO BRIDGE LOANS OR INTERIM FINANCE BE GRANTED TO NBFCs
The RBI has issued guidelines16 stating that banks should not grant bridge loans or
interim finance against capital/debenture issues and/or in the form of loans of a bridging
nature pending raising of long term funds from the market by way of capital, deposits etc.
to all categories of NBFCs.

Any such loan or interim finance already granted and outstanding in the books of the
banks should be recalled within a period of days, if the agreement entered into by the
banks with their borrowers provides for exercising such a right to recall. In case the
agreement does not provide for an early recall of such bridge loan/interim finance, banks
should ensure that the bridge loan/interim finance stand repaid on the due date.

15 RBI Circular IECD NO. 14/08.12.01/94-95 dated 28-09-1994.

16 ibid.

Page 14 of 14
A.6
AMALGAMATION/MERGER OF NBFCs WITH BANKS
With regard to amalgamation/merger of a NBFC with a bank, it has been decided that in
order to ensure that the post-merger bank continues to be in compliance with the legal
provisions contained in the Banking Regulation Act, 1949 and other relevant statutes and
also the regulatory prescriptions of RBI, banks should obtain prior approval of Reserve
Bank of India before initiating steps for amalgamation/merger of a NBFC with the
bank.17

A.7
PARTIAL EXEMPTION FROM RBI ACT TO CERTAIN KINDS OF NBFCS
A.7.1 Vide the RBI Notification,18 the provisions of section 45IA, 45IC, 45MB and
45MC of RBI Act and provisions of Non Banking Financial Companies Acceptance of
Public Deposits (Reserve Bank) directions, 1998,19 the Non Banking Financial
Companies Prudential Norms (Reserve Bank) Directions, 199820 shall not apply to any
NBFC:
1.
Not holding/accepting public deposits
2.
Doing the business of insurance, holding a valid certificate of registration issued
under Section 3 of The Insurance Act, 1938;
3.
Being a stock exchange, recognized under Section 4 of the Securities Contracts
(Regulation) Act, 1956;
4.
Doing the business of a stock broker or sub-broker holding a valid certificate of
registration obtained under Section 12 of the Securities And Exchange Board Of
India Act, 1992.
A.7.2
The provisions of Sections 45IA, 45IB and 45IC of the RBI Act shall not apply to
any NBFC:
1.
Notified under section 620A of the companies Act, 1956 known as Nidhi
Companies; and
2.
Doing the business of chits, as defined in section 2(b) of the Chit Funds Act,
1982.
17 Vide RBI Circular No. DBOD.BP.BC. 89/21.02.043/2003-04, dated 09/06/2004.
18 No. 164/CGM (CSM)-2003, dated 08/01/2003.
19 As contained in Notification No. DFC. 118/DG (SPT)-98.
20 As contained in Notification No. DFC. 119/DG (SPT)-98.

Page 15 of 15
A.7.3. Government companies falling in the category of NBFCs have also been partially
exempted from the applicability of the provisions of RBI Act relating to maintenance of
liquid assets and creation of Reserve Fund u/s. 45-IC and the direction relating to
acceptance of public deposits (APD Directions of 1998). The registration requirements of
these companies will, however, continue to exist.
B. FOREIGN EXCHANGE MANAGEMENT ACT (FEMA)
FEM (Deposits) Regulations, 2000 framed under Foreign Exchange Management Act,
1999 (FEMA) relate to deposits between a person resident in India and a person resident
outside India. It says that a company incorporated in India including an NBFC registered
with RBI has been granted general permission to accept deposits from NRIs on
repatriation basis.

C. PREVENTION OF MONEY LAUNDERING ACT, 2002

Section 12(1) of the Prevention of Money Laundering Act, 2002 (hereinafter to be
referred as ‘PMLA’) lays down following obligations on banking companies, financial
institutions and intermediaries.
Section 12(1): Every banking company, financial institution and intermediary shall –
(a)
Maintain a record of all transactions, the nature and value of which may be
prescribed, whether such transactions comprise of a single transaction or a
series of transactions integrally connected to each other, and where such
series of transactions take place within a month;
(b)
Furnish information of transactions referred to in clause (a) to the Director21
within such time as may be prescribed;
(c)
Verify and maintain the records of the identity of all its clients, in such a
manner as may be prescribed.
21 Director of Financial Intelligence Unit – India.

Page 16 of 16
Section 12(2): The records referred to in sub-section (1) shall be maintained for a period
of ten years from the date of cessation of the transactions between the clients and the
banking company or financial institution or intermediary, as the case may be."

22

C.1 OBLIGATIONS OF NBFCS UNDER PMLA, 2002—RBI DIRECTIONS

Maintenance Of Records Of Transactions
NBFCs should introduce a system of maintaining proper record of transactions prescribed
under Rule 323, as mentioned below:

1.
All cash transactions of the value of more than Rs.10 lacs or its equivalent in
foreign currency;
2.
All series of cash transactions integrally connected to each other which have been
valued below Rs.10 lacs or its equivalent in foreign currency where such series of
transactions have taken place within a month and the aggregate value of such
transactions exceeds Rs.10 lacs;
3.
All cash transactions where forged or counterfeit currency notes or bank notes
have been used as genuine and where any forgery of a valuable security has taken
place;
4.
All suspicious transactions whether or not made in cash and in manner as
mentioned in the Rules framed by Government of India under the PMLA, 2002.
Information To Be Preserved

NBFCs are required to maintain the following information in respect of transactions

referred to in Rule 3:

1.
The nature of the transactions;
2.
The amount of the transaction and the currency in which it was denominated;
3.
The date on which the transaction was conducted; and
4.
The parties to the transaction.
22 DNBS (PD). CC 68 /03.10.042/2005-06, dated April 5, 2006.
23 Government of India, Ministry of Finance, Department of Revenue, issued a
notification dated July 1,
2005 in the Gazette of India, notifying the Rules.
Page 17 of 17
D.
COMPANIES ACT, 1956
D.1
INTIMATION OF DEFAULT IN REPAYMENT OF DEPOSITS AND INTERESTS TO
CLB
Section 58-AA (1 & 2) of the Companies Act, 1956 says that-Every company (including
an NBFC24) shall intimate to the regional bench of the CLB25 within 60 days from the
first day of default in repayment of deposits and interest due thereon. The intimation shall
also contain the particulars of the names and address of all small depositors, deposit
amount in each case, reasons for non-payment or late payment and shall send Annual
Reports and cash flow etc.26 This intimation is to be given on monthly basis.27 It may be
noted that a default is deemed to be made in case deposit/interest is not paid even to a
single small depositor on the date of maturity.

D.2
CONSEQUENCES OF DEFAULT IN PAYMENT OF DEPOSITS/INTERSTS
The following consequences follow in case of default by the company/NBFC in
repayment of deposits and interest thereon on due date of maturity:

•
The company/NBFC shall not accept or invite fresh deposits or renew existing
deposits [Section 58-A(2)(c) and 58-AA(4), Companies Act]
•
A director of a public company, which has failed to repay its deposits or interests
on due date and such default persists for a period of 1 year, shall not be eligible to
be appointed as a director of the company and any other public company for a
period of 5 years form the date of default. [Section 274(1)(g), Companies Act]
•
The company/NBFC shall not make any inter-corporate loan or investment or
give guarantee or provide security [Section 372A(4), Companies Act]
•
The company/NBFC shall not, directly or indirectly, purchase its own shares or
other securities. [Section 77B(1)(c), Companies Act]
24 Section 58-AA also applies to NBFCs vide a RBI Circular NO. DNBSC (PD) CC No.
18/02.01/2001

2002, dated 1-1-2002.

25 Having jurisdiction over the registered office of the company.
26 However, it is open to the company to submit a scheme for repayment of deposits to
small depositors

with full justification and projected cash flow statement for consideration of CLB.
27 Under Section 58-AA (1 & 2) of the Companies Act, 1956.
Page 18 of 18
NBFCs AND FOREIGN INSTITUTIONAL INVESTORS (FII)—COMPARISON

NBFC FII
An NBFC is a company incorporated in A FII may be a company, trust, Asset
the Companies Act, 1956 and registered as Management Companies, Pension Funds,
a private or public company in India. Mutual Funds, Investment Trusts as
Nominee Companies,
Incorporated/Institutional Portfolio
Managers or their Power of Attorney
holders, University Funds, Endowment
Foundations, Charitable Trusts and
Charitable Societies. FII is always an entity
registered outside India.
An NBFC is required to obtain a FIIs are required to apply to SEBI in a
certificate of registration from the RBI common application form in duplicate. A
under Section 45-IA, RBI Act, 1934 to copy of the application form is sent by
commence its business as an NBFC. SEBI to RBI along with their ‘No
Objection’ so as to enable RBI to grant
necessary permission under FEMA. RBI
approval under FEMA enables an FII to
buy/sell securities on Stock Exchanges and
open foreign currency and Indian Rupee
accounts with a designated bank branch. No
permission from RBI is needed so long as
the FIIs purchase and sell on recognized
stock exchange. All non-stock exchange
sales/purchases require RBI permission.

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An NBFC, inter alia, proposes to lend
money/accept deposits from the public and
also finance the equipments.
FIIs cannot accept deposits from public
neither can it commence business like an
NBFC by financing the equipments. FII
proposes to make investment in India by
purchasing/selling the securities of Indian
companies. Thus indirectly it lends money
to the Indian companies and not the public.
Parameters for Registration
1. An NBFC is required to have at
least Rs. 200 lacs as minimum Net
Owned Fund (NOF) as required by
Section 45-IA (b), RBI Act.
Parameters for Registration
1. Applicant’s track record,
professional competence, financial
soundness, experience, general
reputation of fairness and integrity.
2. The applicant should have been
in existence for at least one year,
3. Whether the applicant is
registered with and regulated by an
appropriate Foreign Regulatory
Authority in the same capacity in
which the application is filed with
SEBI.
There is no fee to be paid by an NBFC to The fee payable for getting a FII registered
get the certificate of registration from RBI. with SEBI is US $ 5000.
But for getting it registered as a company,
the fees payable depends upon the
authorized capital of the company at the
time of its registration.

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FIIs REGULATION AND MONITORING BY RBI

The Foreign Institutional Investors (hereinafter to be referred to as “FIIs”) are allowed to

invest in the securities trade in primary and secondary markets. The FIIs, Non-Residents
Indians (NRIs) and Overseas Corporate Bodies (OCBs) may invest in portfolio
investments in any of the listed companies (including any listed NBFC) of Indian Stock
Exchanges subject to the condition that the aggregate holding of shares/convertible
debentures of these institutions put together does not exceed 24% of the issued paid up
capital of the company. The ceiling of 24 per cent for FII investment can be raised up to
sectoral cap/statutory ceiling, subject to the approval of the board and the general body of
the company passing a special resolution to that effect.28

The Reserve Bank of India monitors the ceilings on FII investments in Indian companies
on a daily basis. For effective monitoring of foreign investment ceiling limits, the
Reserve Bank has fixed cut-off points that are two percentage points lower than the actual
ceilings. For instance, the cut-off limit for companies with 24 per cent ceiling is 22 per
cent and for companies with 30 per cent ceiling, is 28 per cent and so on.

Once the aggregate net purchases of equity shares of the company by FIIs reach the
cutoff
point, which is 2% below the overall limit, the Reserve Bank cautions all designated
bank branches so as not to purchase any more equity shares of the respective company on
behalf of FIIs without prior approval of the Reserve Bank. The link offices are then
required to intimate the Reserve Bank about the total number and value of equity
shares/convertible debentures of the company they propose to buy on behalf of FIIs. On
receipt of such proposals, the Reserve Bank gives clearances on a first-come-first served
basis till such investments in companies reach the sectoral caps/statutory ceilings as
applicable. On reaching the aggregate ceiling limit, the Reserve Bank advises all
designated bank branches to stop purchases on behalf of their FIIs clients. The Reserve
Bank also informs the general public about the ‘caution’ and the ‘stop purchase’ in these
companies through a press release.

28 In terms of RBI Press Release dated Sept.20, 2001 and FEMA Notification No.45
dated Sept. 20, 2001.

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REMEDIES ENFORCEABLE AGAINST THE NBFCS

A. ACTIONS AVAILABLE AGAINST A DEFAULTING NBFC

Very frequently there is news of a scam committed by some financial company. There
are cases where the finance company has stopped paying interest and maturity amount to
its depositors. The helpless investors, with their dreams shattered, run from pillar to post
in search of recourse against these finance companies. Nothing happens, either because
the investor cannot afford a lawyer to fight a court case or he is ignorant of the laws. Here
I wish to mention certain ways to tackle such a problem and how one can lodge a
complaint against the defaulting NBFC.

Firstly, try to collect as many investors as possible for a united action. To collect more
people, give your advertisement free of cost in the help line column of various
newspapers asking the investors of the defaulting company to telephone you. When you
have collected many investors, hold a meeting and collect individual applications from
each investor to make a joint complaint.

1.
What you have to do is jointly approach the defaulting company with a written
application asking for refund of your interest amount and the maturity amount. If
you all are not satisfied with the reply of the owner of the defaulting company,
then jointly lodge a complaint against the defaulting company with the local
Police Department.29
2.
Another recourse is that you file a complaint with the appropriate Consumer
Forum depending upon the amount involved.
3.
One can also file a complaint against the defaulting company with the Reserve
Bank of India.
4.
Where an NBFC fails to repay any deposit, the Company Law Board (CLB),
either on its own or on being approached by a depositor/depositors, may direct
the NBFC to repay the deposit forthwith, or within such time and subject to such
29
One can lodge an FIR U/s. 154, Cr.P.C. against the concerned NBFC for cheating,
criminal breach of
trust, misappropriation of funds etc. These acts are punishable under the Indian Penal
Code, 1860.

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conditions as may be specified.30 The aggrieved depositor has to make his
application to the concerned CLB Bench, in the prescribed Form No. 4 appended
to the Regulation 37 of the Company Law Board Regulations, 1991 u/s. 58A(9)
of the Companies Act, 1956. The application is required to be accompanied by a
fee of Rs. 50.31

5.
In case of non-compliance with the orders of the CLB, the RBI has been
authorized to take penal action against the NBFC under Section 58E of the RBI
Act, 1934. Non-compliance of order passed is also punishable u/s. 58A(10) of the
Companies Act with imprisonment up to 3 years and fine not less than Rs. 500
per day for each day of default.
6.
Investors’ complaints relating to NBFCs (Listed) are also dealt with by the
Securities and Exchange Board Of India (SEBI).
7.
Public Interest Litigation (PIL) can also be filed in a High Court under its writ
jurisdiction.
B. PENALTY FOR NOT COMPLYING WITH RBI ACT
The RBI has been empowered to impose penalty on NBFCs for violation of the
provisions of the RBI Act. RBI Act provides that carrying on business without a
certificate of registration is an offence punishable with imprisonment of not less than one
year, which may extend to five years and with a fine not less than Rs.1 lac, which may
extend up to the extent of Rs. 5 lacs.32 For any other contravention, a fine not exceeding
Rs. 5000 can be imposed by the Reserve Bank.

Section 58B (4AAA), RBI Act provides that any non-compliance with the order of the
CLB is punishable with imprisonment up to three years and a fine of not less than Rs. 50
everyday during which such non-compliance continues.

30 Company Law Board (CLB) is now also vested with additional powers to take action
against the
defaulting NBFC and to order repayment of deposit. u/s. 45QA of RBI Act, 1934.

31
31

In Edpuganti Bapanaiah v. Nagarjuna Finance Ltd., it was held that the orders of CLB
directing
repayment of deposits and also for recovering deposits of the company with other
companies are
enforceable u/s. 634A, Companies Act, 1956. The CLB can fall back on the assistance of
the courts of
competent jurisdiction for execution of its orders.
32 Section 58B (4A), RBI Act.

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JUDICIAL APPROACH vis-à-vis NBFCs

The ROC has been held to be competent to file a complaint even in the matter of NBFCs.
The case before the Madras High Court was that of Vishwapriya Financial Services and
Securities Ltd. v. ROC.33 In this case an NBFC issued an advertisement for public
deposits. There was a failure to furnish to the Registrar the requisite statement with
details. The court said that the question whether the company was exempt from the
requirement or whether the statement had to be filed only with the RBI could be gone
into at the trial. The court also ruled out the contention that the wording of the
advertisement did not amount to an invitation. The ROC was competent to file the
complaint.

In Re Hindustan Financial Management34An NBFC was lagging behind in repayments.

The suo motu power of the CLB u/s. 45QA of the RBI Act could be exercised in the
public and depositors’ interest. The delay in repayments was unavoidable because of very
poor inflow of cash. The scheme which was proposed by the company was modified and
approved and the company directed to carry out repayments accordingly. Another case in
which this power was exercised by the CLB in similar circumstances is Members Of The
Public Holding Deposits in Kothari Oriented Finance Ltd. v. Kothari Orient Finance

Ltd.35

In In Re Allianz Capital & Management Services Ltd.36 Using the powers under Section
45QA of the RBI Act, a defaulting NBFC was directed to repay the deposits having
regard to the cash flow projection. Certain guidelines were also provided to the company
for keeping in mind in implementing the scheme of repayment
In Pinna NR v. Commissioner of Police,37 the RBI issued directions to the state
government for follow up action against a defaulting NBFC for protecting the interests of
depositors.

33 (2002) 108 Comp Cases 160 (Mad).

34 (1999) 1 Comp LJ 344 (CLB-NB).
35 (1999) 1 Comp LJ 149 (CLB-SB).
36 (2000) CLC 592 (CLB-NB).
37 (2000) 3 SCL 340 (AP).

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The Calcutta High Court in its decision in state of State of W.B. v. Union of India38
allowed the Writ Petition filed in the interest of depositors by way of Public Interest
Litigation (PIL) and observed that a PIL filed by the State against NBFCs alleging that
they were diverting the money of small depositors to subsidiary companies and were
unable to return their deposits, the petition cannot be dismissed on the ground of
alternative remedy under the companies Act. The provisions of the companies Act can
hardly be said to be efficacious remedies for helpless small depositors belonging to the
weaker section of the society to get their money with the interest on the basis of which it
can be said that such remedies are alternative remedies.
In Nagarjuna Finance Ltd., Re,39 an NBFC was given up financing and became an
industrial company. The industrial company was not entitled to hold as much deposit as it
was holding in its capacity as NBFC. On its application to the CLB, the company was
permitted to retain excess deposits and repay them on maturity.

In Dy. Chief Officer, Department of Non-Banking Companies, RBI v. Arihant Finance

and Chit Fund P. Ltd.,40 The managing director was held liable to be convicted whebn
there was enough proof of the fact that he was running the business of the company in
violation of the RBI Guidelines.

In Reserve Bank of India v. D.K. Kapur,41 it was again the case of an NBFC, which
failed in repayment of deposits, which was also in contravention of RBI directions. The
person sought to be prosecuted was described in the complaint as Executive Director
(Finance). The report attached to the complaint stated that he signed salary cheques and
was also a signatory of various bank accounts. He also signed agreements on behalf of
the company. The court held that the complaint was not to be quashed and maintained the
conviction.

38 AIR 1996 Cal 181.

39 (1999) 97 Comp Cases 171.
40 (1991) 2 Comp LJ 128 (Bom).
41 (2001) 105 Com Cases 639 (Delhi).

Page 25 of 25
In Bari Daob Bank Ltd. v. Union of India,42 Delhi High Court ruled that without
obtaining a certificate of registration, An NBFC cannot carry or commence the business
of NBFI. it is not permitted to the petitioner bank to convert itself into a NBFC.

In RBI v. Kuber Mutual Benefits Ltd.,43 the Allahabad High Court A company is not
entitled to carry on business of non banking financial activity unless it has a certificate of
registration issued by RBI.

In Peerless General Finance and Investment Co. Ltd. v. RBI44, the Supreme Court ruled
that:

1.
RBI can issue directions to NBFCs in respect of matters connected receipts of
deposits including rates of interest payable on such deposits. Such power is
available to the RBI from Section 45-K(3), RBI Act. Any matter and any field is
open for RBI under this Section on which RBI can issue the directions.
2.
If RBI issue directions, which provides the procedure for investing deposits
received by NBFCs and also provides the way it is to be disclosed in account
books, the said directions are covered under Section 45-K(3), RBI Act and are
reasonable and are not invalid.
In Peerless General Finance and Investment Co. Ltd. v. RBI,45 the Supreme court
again ruled that powers of RBI are intra vires in following terms:

1.
RBI is competent under Section 45-K(3) to deal with or take appropriate action,
as it may deem fit and proper in public interest with regard to deposit or receipt
relating to deposits if it so desires.
2.
Under the above-mentioned Section, the RBI must be satisfied that it is necessary
to issue directions to regulate the credit system of the country to its advantage.
42 AIR 1998 Del 95.
43 (2002) 3 CLC 1105 (All).
44 AIR 1992 SC 1033
45 (1996) 85 Comp Cas 808.

Page 26 of 26
CONCLUSION
AFTER A DEEP RESEARCH RELATING TO MANY ASPECTS OF NBFCS I CAN
NOW CONCLUDE
THAT the existing governance system with laws and updated guidelines/directions issued

by Reserve Bank of India is doing justice to many viz. The Economy Of The Nation, as
the guidelines currently existing have pace with the dynamic commercial economy and
the RBI comes up with updated and amended guidelines as and when it is required; The
Public, as the RBI guidelines and the different laws governing NBFCs have been vested
with many powers and procedures so as to enable the depositors of these NBFCs to
enforce their rights; the NBFCs, as the RBI guidelines and the laws governing have
generally given bright prospects to the NBFCs. RBI, thus, can be said to be a cautious
and active watchman of the financial market, who keeps a vigil on the market and ensures
a positive growth of the nation. Emergence of NBFCs in the Indian market has also
created alternative of savings to the people but it has always to be borne in mind while
investing in the NBFCs that they cannot be compared at all with the Banks and today also
Banks are the safest place to deposit/invest money into.

Page 27 of 27