RBI Norms of NBFCs

The working and operations of NBFC are regulated by the Reserve Bank of India (RBI) within the framework of the Chapter III-B: Provisions Relating to Non-Banking Institutions Receiving Deposits and Financial Institutions of the Reserve Bank of India Act, 1934 and directions issued by it.

Though the Chapter III-B was inserted in the RBI Act, 1934 by the Banking Laws (Miscellaneous Provisions) Act, 1963. (w.e.f. 1-2-1964), the term Non-Banking Financial Company (NBFC) was not defined until the insertion of clause (f) in section 45-I by the RBI (Amendment) Act, 1997 (w.e.f. 9/1/1997). Clause (f) of section 45-I of the RBI Act, 1934 defines ‘Non-Banking Financial Company’ as–

  • a financial institution which is a company;
  • 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;
  • 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;

In other words, a Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 (or under the Companies Act, 1956) and also registered under Section 45- IA of the Reserve Bank of India Act, 1934 and which provide banking services (without legally being a bank as they do not possess Banking License) or other specified services. NBFCs are engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services

and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner, is also a nonbanking financial company (Residuary non-banking company).

Section 45-IC of RBI Act says-

(1) Every non-banking financial company shall create a reserve fund and transfer therein a sum not less than twenty per cent. of its net profit every year as disclosed in the profit and loss account and before any dividend is declared.

(2) No appropriation of any sum from the reserve fund shall be made by the non-banking financial company except for the purpose as may be specified by the Bank from time to time and every such appropriation shall be reported to the Bank within twenty-one days from the date of such withdrawal:

Provided that the Bank may, in any particular case and for sufficient cause being shown, extend the period of twenty-one days by such further period as it thinks fit or condone any delay in making such report.

(3) Notwithstanding anything contained in sub-section (1), the Central Government may, on the recommendation of the Bank and having regard to the adequacy of the paid-up capital and reserves of a non-banking financial company in relation to its deposit liabilities, declare by order in writing that the provisions of sub-section (1) shall not be applicable to the non-banking financial company for such period as may be specified in the order:

Provided that no such order shall be made unless the amount in the reserve fund under sub-section (1) together with the amount in the share premium account is not less than the paid-up capital of the non-banking financial company.

Section-45-IC of Reserve Bank of India Act,1934 was created for statutory reserve created under this section. The reserve is required to be created under Section 45-IC, is for the profits earned by a NBFCs. The Reserve Bank of India Act, 1934 can permit appropriation in respect of the said reserve. The assesse can also ask for specific directions from the Central Government subject to proviso to sub-section (3) of the said Section.

As per section 45-IC NBFCs must transfer at least 20% of net profit every year to reserve fund. This fund should not be appropriated except for purpose specified by RBI. Any appropriation must be reported to RBI within 21 days. Appropriation to be reported to RBI within 21 days (extendable) of withdrawal. Central Government on the recommendation of RBI, may exempt specific NBFC from this requirement having regard to the adequacy of the paid-up capital and reserves in relation to deposit held, if amount in the reserve fund together with the amount in the share premium account is not less than the paid-up capital of the NBFC.

Reserves are normally treated as a part of equity which is defined as residual, i.e. assets less liabilities, but sometimes reserves are required to be created by a statute in order to give the entity and its creditors an added measure of protection from the effect of losses. To repeat, a reserve is below the line of allocation of profits. The amount mentioned in the reserve does not get reflected in the Profit and Loss account. Additionally, the amount stated in the reserve is not to be kept in a designated bank account, in the form of assets under the heading ―’Assets’.

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