RBI Compliance for NBFC

Introduction

People borrow money. Normally, such borrowings are done from banks with which the person has a bank account. But at times, the banks may not be able to give the loans due to requirements list to be met by the person taking the loan. When the bank cannot sanction the loan, the person may approach other entities for loans. One of the entities is a Non-Banking Financial Company. 

An NBFC can be of many kinds. Some give loans, some may not. The Non-Banking sector in India is very large. Also, this sector has seen many scams and financial irregularities. There have also been companies that have lived within the legal boundaries and earned profits at the time having offered quality service to its clients. Thus, the government, in the interest of the public, has created a comprehensive legal framework of various acts, rules and regulations  and guidelines for governing the companies in this sector. 

Reserve Bank of India issues the guidelines, norms etc for overseeing the activities of these NBFCs. Thus for being an NBFC, it has to first be incorporated as a Company. An LLP or any other entity cannot be an NBFC. Then, the Company can register as an NBFC under the Reserve Bank of India Act, 1934.

Legal Framework under Reserve Bank of India

Let us now see the various acts, guidelines, rules regulations that are applicable on an NBFC.

1. Reserve Bank of India Act, 1934 (RBI Act): 

The RBI Act provides the legal foundation for the functioning of the RBI. It empowers the RBI to oversee and regulate the activities of NBFCs. This act gives RBI the authority to issue directions and guidelines, prescribe minimum capital requirements and impose penalties.

2. The Banking Regulation Act, 1949: 

Though this Act is primarily for commercial banks, it also gives RBI the authority to regulate and supervise NBFCs w.r.t. certain aspects . NBFCs are subject to specific provisions of this act, particularly when they deal with the acceptance of deposits.

3. Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998: 

These directions lay down the terms and conditions for NBFCs accepting public deposits. It covers aspects such as interest rates, maturity periods, and reserve requirements for public deposits.

4. Prudential Norms for Non-Banking Financial Companies (NBFCs): 

The RBI issues detailed guidelines on prudential norms covering income recognition, asset classification, and provisioning. These norms ensure that NBFCs maintain the quality of their assets and provisions against possible losses.

5. Know Your Customer (KYC) and Anti-Money Laundering (AML) Guidelines: 

Money laundering is the threat to any government. It helps create a secondary economy, the people involved are not responsible for any of their acts and this money is used to create anarchy.  Thus, any government has to enact a law to prevent money laundering to protect its economy and that tax collection is robust. Thus the Central Government through RBI has issued guidelines for Know Your Customer which in turn helps track any illegal transactions etc. and thereby stop money laundering. Banks and NBFCs have to do their KYC every year and at times even bi-annually. RBI framework makes it mandatory for NBFCs to establish and maintain effective KYC and AML procedures. 

6. Corporate Governance Guidelines: 

Just as a listed company has to follow corporate governance norms, similar norms for NBFCs have been prescribed by RBI for NBFCs, wherein it has issued norms for relating to board composition, audit committee formation and its duties responsibilities etc., risk management, disclosure norms etc.

7. Asset-Liability Management (ALM) Guidelines: 

The asset liability ratio has to be within the limits as specified by RBI under the ALM guidelines. An NBFCs has to properly and judiciously manage its assets and liabilities in a way that minimizes liquidity and interest rate risks. These guidelines require NBFCs to maintain a certain level of liquidity and report their ALM positions regularly to the RBI.

8. Fair Practices Code: 

The RBI has mandated that NBFCs follow a Fair Practices Code (FPC) in their dealings with customers. This code emphasizes transparency, responsible lending, and ethical behavior towards customers.

9. Regulation of Sensitive Activities: 

The RBI regulates specific sensitive activities conducted by NBFCs, such as lending against gold and real estate, to mitigate risks associated with these activities.

10. Registration and Licensing: 

NBFCs must obtain registration or licensing from the RBI to operate legally. The RBI classifies NBFCs into various categories based on their activities and mandates specific requirements for each category.

11. Disclosure and Reporting Requirements: 

NBFCs are required to submit periodic reports and disclosures to the RBI to keep the regulator informed about their financial health, operations, and compliance with regulations.

12. Non-Banking Financial Companies – Systemically Important (Reserve Bank) Directions, 2015: 

This framework lays down the criteria for identifying Systemically Important NBFCs (NBFCs-ND-SI) and the additional regulations and capital requirements applicable to them.

Other Legal Framework 

The environment as created by RBI is in addition to the legal framework established by the Central government in other areas and we will discuss these other related fields to an NBFC here. 

1. Companies Act, 2013: 

In the abbreviation NBFC, ‘C’ stands for Company. Thus, only a company becomes an NBFC. So, first a company has to be incorporated. At the time of incorporation it may have its object clause that allows it to function as an NBFC or it may alter iys object clause for the same. Many sections of the Companies Act, 2013 may or may not be applicable to an NBFC. Please read our article titled ROC compliance for an NBFC. 

2. Income Tax Act, 1961: 

The provision of Income Tax act and its rules and other provisions related to taxation of income, tax deduction at source (TDS), and other tax-related compliance are all applicable on an NBFC. rather the scrutiny is far more as compared to other general companies..

3. Goods and Services Tax (GST): 

If registration has been taken under the GST act, the the NBFC will also have to comply with the provisions of GST act and file the annual, quarterly or monthly returns as applicable.

4. Securities and Exchange Board of India (SEBI): 

SEBI rules, regulations and acts become applicable to a listed entity. Thus, if the NBFC is listed on any Stock exchange then the entire gamut of SEBI laws will become applicable as and when required by the law. This includes NBFCs involved in activities like mutual funds and portfolio management services.

5. Foreign Exchange Management Act (FEMA): 

NBFCs engaged in foreign exchange transactions must adhere to FEMA regulations. This includes regulations related to foreign investments, foreign exchange transactions, and external commercial borrowings.

6. Credit Information Companies (Regulation) Act, 2005: 

If an NBFC operates as a credit information company, it must comply with this act, which governs the functioning and regulation of credit bureaus in India.

7. Consumer Protection Laws: 

Consumer Protection Act, known more by its acronym  COPRA, will be attracted if there is deficiency in service or product that is offered by the NBFC to its customers, in addition to it being chargeable under the provisions and acts of RBI. 

8. SARFAESI Act, 2002: 

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act empowers banks and certain NBFCs to take possession of and sell assets of borrowers in default.

9. Debt Recovery Tribunal (DRT): 

NBFCs can approach DRTs for the recovery of bad loans and non-performing assets as per the provisions of the DRT Act, 1993.

10. State Money Lending Acts: 

NBFCs are subject to the respective state money lending acts, which regulate the money lending business and may impose restrictions on interest rates and collection practices.

11. Data Protection and Privacy Laws: 

All companies, in today’s digital age, have compiled data of its customers, clients etc. Thus, NBFCs have to comply with rules and regulations related to the collection, storage, and processing of customer data, and includes the Personal Data Protection Bill (PDPB), as and when enacted.

12. Competition Law: 

Monopoly, duopoly or oligopoly are checked and kept at bay by the Competition Act, 2002. Thus, NBFCs must ensure that their business practices comply with the Competition Act, 2002, and are not anti-competitive in nature/ behaviour.

Different types of Non-Banking Financial Companies (NBFCs): 

An NBFC can be of many types, and we discuss it here in brief:

1. Asset Finance Company (AFC):

These NBFCs primarily provide finance for physical assets. They typically fall under the category of Loan Companies. Sections 45-IA and 45-IB of the RBI Act govern AFCs.

2. Investment Company (IC):

ICs are primarily involved in investments and holding securities. They are not allowed to conduct any other financial activity. Section 45-IA of the RBI Act applies to these companies.

3. Loan Company (LC):

Loan Companies primarily focus on providing loans and advances, including personal loans and business loans. They are regulated under Sections 45-IA and 45-IB of the RBI Act.

4. Infrastructure Finance Company (IFC):

IFCs are specifically focused on financing infrastructure projects. They operate under the regulatory framework of the RBI and may also be regulated by the National Housing Bank (NHB).

5. Systemically Important Core Investment Company (CIC-ND-SI):

CIC-ND-SIs are NBFCs that are classified as systemically important. They need to adhere to additional regulations under Section 45-IA of the RBI Act.

6. Infrastructure Debt Fund (IDF):

IDFs exclusively invest in debt securities of infrastructure companies. These are governed by the RBI's regulatory framework for NBFCs.

7. Microfinance Institution (MFI):

MFIs provide microloans to economically disadvantaged individuals. They are subject to regulatory guidelines issued by the RBI, including the Micro Finance Institutions (Development and Regulation) Bill.

8. Non-Systemically Important Non-Deposit Taking Company (NBFC-ND):

NBFC-NDs are NBFCs that do not take public deposits and are not classified as systemically important. They are regulated under the RBI framework for NBFCs.

9. Peer-to-Peer Lending Platforms (P2P Lending):

These are online platforms where normal people like you and me (called peers) get together and may start giving loans/ borrow loans. For eg. person X has extra funds and wants to earn more interest than that offered by a bank and there is a person B who requires funds and does both have sufficient credibility with the banking syste. Thus, in P2P lending platforms, they both register and are risk weighted. As per the risk appetite, the P2P lending system works. These platforms are regulated by RBI. The regulatory framework for P2P lending platforms is provided in the Master Directions on ‘P2P lending platforms’.

10. Housing Finance Company (HFC):

HFCs specialise in providing loans for purchase of houses. They are regulated by the National Housing Bank (NHB), established under the National Housing Bank Act, 1987.

Process for Registering an NBFC

Before the process for registration of NBFC can start, mental work relating to the type of NBFC that we are creating and its purpose should be clear in the heads of the promoter. Will it act as a holding company, will it be taking deposits and giving loans, etc. The various decision making points for creating and registering a Non-Banking Financial Company (NBFC) with the Reserve Bank of India (RBI) involves the following steps: 

1. Decide the Type of NBFC:

Determine the specific type of NBFC you want to establish, such as an Asset Finance Company (AFC), Investment Company (IC), Loan Company (LC), etc.

2. Company Registration:

Begin by registering a company under the Companies Act, 2013, as a private limited company or a public limited company. The company should have a minimum net owned fund (NOF) of Rs. 2 crore.

3. Ensure Eligibility:

Determine the type of NBFC you wish to establish, ensuring it aligns with the eligibility criteria specified by the RBI for that category.

4. Application to RBI:

Prepare and submit an application to the Regional Office of the RBI. The application should include details such as the proposed business plan, financial projections, management team, and a declaration of compliance with the RBI's eligibility criteria.

5. Eligibility and NOF:

Ensure that your company meets the eligibility criteria for the chosen type of NBFC. Each type of NBFC may have specific minimum Net Owned Funds (NOF) requirements. Refer to Section 45-IA and 45-IB of the RBI Act for NOF requirements.

6. Due Diligence:

The RBI will conduct a thorough due diligence process, which may include background checks on the promoters and scrutiny of the proposed business model.

7. Fit and Proper Criteria:

Promoters and directors of the NBFC must meet the "fit and proper" criteria set by the RBI.

8. Registration Fee:

Pay the necessary registration fee as per RBI guidelines.

9. Registration Certificate:

If the RBI approves the application, a Certificate of Registration as an NBFC will be issued to the company.

10. Compliance:

Ensure ongoing compliance with the regulations and guidelines set by the RBI. This includes maintaining the minimum NOF, adhering to prudential norms, and following KYC and AML procedures.

11. Reporting:

Submit regular reports and returns to the RBI as required by the regulations. These reports may include information on financial performance, asset-liability management, and more.

12. Regulatory Changes:

Stay informed about any changes in NBFC regulations issued by the RBI and ensure compliance with these changes.

Compliances by an NBFC:

1. Annual Statutory Audited Financial Statements: 

NBFCs have to submit their audited financial statements, including balance sheets, profit and loss accounts, cash flow statements etc with RBI. The financials should be submitted within six months of the financial year ending of the company

Generally this coincides with the provisions of the Companies Act, where the financials have to be adopted within 6 months of the end of the financial year and then be filed with the Ministry of Corporate Affairs (MCA) within 30 days from the date of its AGM. 

The RBI differs from the Companies Act, wherein it wants the company to submit its financials within 6 months of the close of the financial year. Thus, NBFCs generally hold their AGMs well in advance from the last date as mandated by the Companies Act, 2013.

2. ALM Returns: 

NBFCs that hold public deposits of ₹ 20 crore or more or asset size of ₹ 100 crore or more will have to submit Asset-Liability Management (ALM) returns to the RBI. These returns provide information on the maturity profiles of assets and liabilities, liquidity positions, and interest rate risk profiles.

3. KYC and AML Reports: 

While KYC and AML compliance is an ongoing process, annual audits and reviews may be necessary to ensure that NBFCs are in compliance with the RBI's guidelines on these matters.

4. Prudential Norms Reporting: 

NBFCs must submit periodic reports on prudential norms for income recognition, asset classification, and provisioning. These reports provide details on loan portfolios, provisioning requirements, and non-performing assets.

5. CAR Report: 

Larger NBFCs are required to calculate and report their Capital Adequacy Ratio (CAR) as per the prescribed format to ensure they meet the minimum capital adequacy requirements.

6. Regulatory Returns: 

Depending on the type and size of the NBFC, various regulatory returns may need to be submitted to the RBI. These could include reports on customer complaints, public deposits, and other relevant data.

7. FPC Compliance Report: 

NBFCs should ensure that they are in compliance with the Fair Practices Code (FPC), which promotes transparent and ethical lending practices. An annual report or compliance certificate may be required.

8. Data Security and Privacy Reports: 

Ensure data security and privacy compliance, including annual audits and reviews to verify that customer information is being adequately protected in line with data protection laws.

9. RBS Reports: 

Submission of Risk-Based Supervision (RBS) reports as per RBI guidelines, assessing the risk profile and financial health of the NBFC.

10. Corporate Governance Compliance Report: 

Submission of an annual report on corporate governance compliance, which includes aspects such as board composition, audit committees, and other governance-related requirements.

11. Compliance with Master Directions: 

Compliance with the specific directives and circulars issued by the RBI for the operation of NBFCs. This may include various annual reporting and compliance requirements.

Responsibilities of NBFCs registered with RBI w.r.t. submission on compliances and other information.

A. Returns by deposit taking NBFCs

• Quarterly Returns on deposits in First Schedule- NBS-1 

• Quarterly return on Prudential Norms is required to be submitted by NBFC accepting public deposits- NBS-2 

• Quarterly return on Liquid Assets by deposit taking NBFC-NBS-3 

• Annual return of critical parameters by a rejected company holding public deposits- NBS-4 

• Monthly return on exposure to capital market by deposit taking NBFC with total assets of ₹ 100 crore and above- NBS-6 

• Half-yearly ALM return by NBFC holding public deposits of more than ₹ 20 crore or asset size of more than ₹ 100 crore

• Audited Balance sheet and Auditor’s Report by NBFC accepting public deposits.

• Branch Info Return.

B. Returns to be submitted by NBFCs-ND-SI

• Quarterly statement of capital funds, risk weighted assets, risk asset ratio etc., for NBFC-ND-SI- NBS-7

• Monthly Return on Important Financial Parameters of NBFCs-ND-SI.

• ALM returns:

(i) Monthly Statement of short term dynamic liquidity in format ALM : NBS ALM1

(ii) Half yearly Statement of structural liquidity in format ALM : NBS ALM2 

(iii) Half yearly Statement of Interest Rate Sensitivity in format ALM : NBS ALM3 

• Branch Info return

Compliances under 2 other major Acts: Companies act, 2013 and FEMA, 1999

Companies Act, 2013:

1. Board Meetings and Annual General Meeting (AGM):

Section 173 of the Companies Act, 2013, governs the frequency and conduct of board meetings, while Section 96 mandates the holding of an AGM.

2. Filing of Financial Statements:

Section 137 requires NBFCs to file their financial statements and annual returns with the Registrar of Companies (RoC).

3. Appointment of Auditors:

Section 139 outlines the process for appointing auditors and their qualifications.

4. Related Party Transactions:

Section 188 covers the disclosure and approval of related party transactions, which may apply if the NBFC has related parties.

5. Dividend Declaration:

Section 123 regulates the declaration and distribution of dividends.

Foreign Exchange Management Act (FEMA):

1. Foreign Investment Reporting:

Under FEMA, NBFCs must comply with foreign investment reporting requirements. The specific sections may vary depending on the type and nature of foreign investments received. Reference the relevant FEMA circulars and notifications for guidance.

2. External Commercial Borrowings (ECBs):

If the NBFC intends to raise funds through ECBs, FEMA regulations apply. Specific sections would depend on the nature of the borrowing and the applicable FEMA notifications.

3. Foreign Exchange Transactions:

Compliance with FEMA regulations related to foreign exchange transactions, including import and export of goods and services, may apply. Reference FEMA rules and regulations specific to the nature of foreign exchange transactions conducted.

4. Reporting to RBI:

FEMA regulations often require reporting to the Reserve Bank of India (RBI) for various foreign exchange transactions and investments. The specific sections and guidelines will vary based on the type of transaction or investment.