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Supreme Court ruling on NBFCs

  • Published
    17th May, 2022
Context

The recent ruling by the Supreme Court that underscores the primacy of the Reserve Bank of India (RBI) as the regulator and supervisor of the non-banking financial companies (NBFCs), has removed a key regulatory overhang, rating agency CRISIL.

About

Issue:

  • Before the Apex Court, the issue raised by NBFCs (challenging Kerala HC judgment) and State of Gujarat (challenging Gujarat HC Judgment) was whether NBFCs regulated by the Reserve Bank of India, in terms of the provisions of Chapter III­B of the Reserve Bank of India Act, 1934 could also be regulated by State enactments such as Kerala Money Lenders Act, 1958 and Gujarat Money Lenders Act, 2011?

SC’s Ruling:

  • The Supreme Court has held that the state enactments such as Kerala Money Lenders Act, 1958 and Gujarat Money Lenders Act, 2011 will have no application to Non­-Banking Financial Companies (NBFC) regulated by the Reserve Bank of India (RBI).
  • The apex court has, in the matter of Nedumpilli Finance Company vs State of Kerala and several other civil appeals, held in its final judgment that Chapter III-B (dealing with NBFCs in RBI Act) is a complete code in itself as regards regulation of NBFCs.
    • In addition to this, the RBI Act has provisions which override other state laws.
    • This would imply that NBFC regulation is only under the RBI Act, and only the Central bank has the powers to regulate the NBFCs registered with it.
  • The Supreme Court has held that Section 45-Q of RBI Act confers overriding effect upon Chapter III-B over other laws. 
  • The SC said that while the state enactments regulating the business of money-lending has a one-eyed focus only to protect borrowers, the RBI Act takes a holistic approach to the business of banking, money-lending and operation of the currency & credit system of India.
    • The judges said no NBFC can start or carry on business without obtaining a certificate of registration under the RBI Act
    • their continuation in business would depend upon compliance with the RBI Act and circulars/directions issued by the RBI
    • The RBI has the power to supersede the Board of Directors of a NBFC and has power even to wind up a NBFC.
    • Thus the supervision and regulation of NBFCs, by the RBI, is from the time of birth till the time of death.

Non-Banking Financial Companies (NBFCs):

  • These are establishments that provide financial services and banking facilities without meeting the legal definition of a Bank.
  • Hence they are frequently referred to as “shadow banks”. The term ‘shadow bank’ was coined by Paul McCulley in 2007, with specific reference to American non-bank financial institutions that used short-term deposits to finance long-term loans.
  • They are covered under the Banking regulations laid down by the Reserve Bank of India and provide banking services like loans, credit facilities, TFCs, retirement planning, investing and stocking in money market.
  • However, they are restricted from taking any form of deposits from the general public.
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