Important Update Re: Enhanced Net Owned Fund Requirement for NBFC Licensing

The Reserve Bank of India (RBI) sought to regulate the activities of NBFCs, with financial stability and depositor protection in mind, through the Reserve Bank of India (Amendment) Act, 1997.

Section 45-IA was added to the RBI Act which makes it mandatory for NBFCs to obtain a Certificate of Registration (CoR) and to maintain a Net Owned Fund (NOF).

“Keep in mind- The Act prescribes maintenance of NOF of a minimum amount of twenty-five lakh rupees (25 lakh). But on the counterpart it also allows the RBI to prescribe revised minimum amount of NOF through a notification in the Official Gazette. Such minimum amount must, however, not exceed two hundred lakh rupees (2 crores).”

-Divya Gupta (Market Analyst, MUDS Management Pvt. Ltd.)

At the time when amendment act was passed, all existing NBFCs were required to maintain a minimum NOF of 25 lakh rupees. Section 45-IA provided a period of three years (3 years) to NBFCs to meet the requirement of having a 25 lakh NOF, during which they could continue to carry on the NBFC business despite not meeting a mandatory licencing condition.

Furthermore, the section also provided that RBI, after recording the reasons for its decision in writing, may extend above period of 3 years to maintain required NOF. However, the total extended time should not exceed six years (6 years).

“This effectively allows RBI to use its discretion to extend the time given to NBFCs to meet the NOF requirement by a maximum of 3 years. This is in addition to the 3 years already given to NBFCs by the statute.” 

—Isha Malik (Company Secretary, MUDS Management Pvt. Ltd.)

The RBI has the authority to cancel the CoR of an NBFC which fails to comply by the NOF requirement.

The High Court of Madras, on 29 January, 2019, issued an important judgment pertaining to Section 45-IA. This was the case of M/s.Nahar Finance and Leasing Limited and ors. v. The Regional Director, RBI and ors.

The judgment comes against the backdrop of a notification issued by the RBI on 27 March, 2015. The notification required the NBFC’s to maintain a NOF of 2 crore rupees to continue their business. The same notification allowed NBFC’s time till 1 April, 2016 to raise their NOF to 1 crore and eventually to 2 crores by 1 April, 2017.

Nahar Finance and Leasing Limited and 3 other NBFC’s were issued Show Cause Notices (SCN) on 23 April, 2018, proposing to cancel their CoR’s for non-compliance with above notification. The companies filed replies to SCN’s stating that due to changes in economy and Government policies like De-monetisation and implementation of GST, etc., the NBFC sector was recovering from setbacks. The companies sought for extension of time till 31 March, 2019, to comply with the enhanced NOF requirement. Post this, the RBI passed orders to cancel CoR’s of all four NBFC’s. These orders were sought to be quashed through writ petitions filed by NBFCs.

The Court quashed the orders of RBI cancelling the CoR of NBFCs, on two grounds:

• Ground #1: Violation of principles of natural justice- Section 45-IA requires that before cancellation of CoR’s, RBI must first enable the NBFC’ s to fulfil the prescribed requirements. If NBFC’s fail to meet them, they are to be given a reasonable opportunity of being heard before cancellation of CoRs, which was not done.
• Ground #2: Violation of Section 45-IA where the statute itself prescribes time extensions to meet enhanced NOF requirement. The Court ruled that 3-year extension given to meet the 25 lakh NOF requirement is applicable to all notifications enhancing NOF requirements. Additionally, RBI may extend the 3-year period by another 3 years. In case of the 4 NBFCs, extension has been granted till 31 March, 2019.

“One must not forget that in order to meet the NOF requirement and restore the license, other NBFCs have time only till 31 March, 2018 which MUDS Management Private Limited can facilitate. But before this deadline, NBFCs may file requests for extension of time, till maximum of 31 March, 2021, to show NOF for license restoration.” 

-Shweta Gupta, Founder, and CEO, MUDS