RBI Regulation of NBFCs under Chapter IIIB and Payment Systems

The Reserve Bank regulates more than banks. Chapter IIIB of the Reserve Bank of India Act, 1934 gives it authority over non-banking financial companies, which lend and invest without being banks, and the Payment and Settlement Systems Act, 2007 gives it authority over everyone who operates a payment system, from the real time gross settlement system down to a mobile wallet. Both bodies of law exist because financial activity moved outside the banking licence, and regulation had to follow it.

1. What a Non-Banking Financial Company Is

Figure 1: The test for a non-banking financial company

• The definition (Section 45-I(f)): a non-banking financial company means 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; and such other non-banking institution or class of such institutions as the Bank may specify with the previous approval of the Central Government.
• Financial institution (Section 45-I(c)): a non-banking institution carrying on as its business or part of its business the financing of activities other than its own, the acquisition of shares, stock, bonds, debentures or securities, hire purchase, insurance business, managing or conducting chits, or collecting money by subscriptions or sale of units under a scheme that awards prizes or gifts. An institution whose principal business is agricultural operations, industrial activity, the purchase or sale of goods other than securities, the providing of services, or the purchase, construction or sale of immovable property, is expressly excluded.
• The principal business test: administratively, the Bank applies the test that financial assets must be more than fifty per cent of total assets and income from financial assets more than fifty per cent of gross income. Both limbs must be satisfied.
• What makes it not a bank: an NBFC cannot accept demand deposits, cannot issue cheques drawn on itself, is not part of the payment and settlement system on the same footing as a bank, and its depositors have no deposit insurance cover.

2. Registration and Net Owned Fund

• Two conditions: a certificate of registration and the prescribed net owned fund. Both are mandatory, and the notwithstanding clause makes the requirement override other law.
• Net owned fund (explanation to Section 45-IA): paid-up equity capital and free reserves, less accumulated losses, deferred revenue expenditure and other intangible assets, and less investments in shares of subsidiaries, group companies and other non-banking financial companies and the book value of debentures and loans to them, to the extent they exceed ten per cent of the owned fund.
• The amount in force: the proviso lets the Bank fix different amounts for different categories. The present clause (b), with its ceiling of ₹100 crore, was substituted by the Finance (No. 2) Act, 2019. Under the scale based framework, investment and credit companies moved from ₹2 crore to ₹5 crore by 31 March 2025, and microfinance institutions and factors to ₹7 crore, all three reaching ₹10 crore by 31 March 2027. Peer to peer platforms and account aggregators need ₹2 crore, housing finance companies ₹20 crore and infrastructure finance companies ₹300 crore.
• Cancellation (Section 45-IA(6)): the Bank may cancel the certificate where the company ceases to carry on the business in India, fails to comply with a condition of registration or a direction, fails to maintain accounts or submit to inspection, or has been prohibited from accepting deposits by an order in force for at least three months.
• Exemptions: certain categories, such as those regulated by other authorities, are exempted from registration by notification.

Other obligations under Chapter IIIB

• Liquid assets (Section 45-IB): a deposit taking company must invest in unencumbered approved securities a percentage of its deposits that is not less than five and not more than twenty five per cent, as the Bank specifies.
• Reserve fund (Section 45-IC): at least twenty per cent of net profit each year must be transferred to a reserve fund before any dividend is declared, and no appropriation may be made from it except for a purpose the Bank specifies.
• Directions (Section 45JA): the Bank may determine policy and give directions on income recognition, accounting standards, provisioning, capital adequacy and the deployment of funds.
• Removal of directors (Sections 45-ID and 45-IE): the Bank may remove a director and may supersede the board of a company other than a Government company.
• Repayment of deposits (Section 45QA): the Tribunal may direct a defaulting company to repay a deposit, and failure to comply is an offence.
• Override (Section 45Q): the provisions of Chapter IIIB have effect notwithstanding anything inconsistent in any other law.

3. Scale Based Regulation

Figure 2: The four layers of the scale based framework

From 1 October 2022 the Reserve Bank has regulated non-banking financial companies through a scale based framework, under which the intensity of regulation rises with size, activity and perceived risk. The approach followed the failure of large institutions whose distress had spread through the financial system, and it replaced the earlier distinction that turned mainly on whether the company accepted deposits.

• Base layer: non-deposit taking companies below the size threshold, together with peer to peer lending platforms, account aggregators and companies with no public funds and no customer interface. Regulation is lightest here.
• Middle layer: all deposit taking companies regardless of size, larger non-deposit taking companies, and standalone primary dealers, housing finance companies, infrastructure finance companies and core investment companies. Prudential norms approach those for banks.
• Upper layer: companies specifically identified by the Bank as warranting enhanced regulation under a scoring methodology that weighs size, interconnectedness, complexity and supervisory inputs. They face bank like capital, governance and disclosure requirements and a mandatory listing requirement.
• Top layer: ordinarily empty. A company moves here only if the Bank considers that a substantial increase in systemic risk from a specific upper layer company requires it, and it then faces higher capital charges and more intensive supervision.
• Convergence: asset classification has been harmonised with banks. Base layer companies moved to the ninety day norm for non-performing assets in stages, reaching it by 31 March 2026, so the ninety day norm now applies across the layers.

4. Regulation of Payment Systems

• The designated authority (Section 3): the Reserve Bank is the authority for the regulation and supervision of payment systems. Under Section 3(2), as amended by the Finance Act, 2017 and brought into force in May 2025, it acts through the Payments Regulatory Board, constituted with effect from 9 May 2025. Chaired by the Governor, it includes the Deputy Governor and the Executive Director in charge of payment systems, the Secretaries of the Department of Financial Services and the Ministry of Electronics and Information Technology, and one outside member. It replaced the Board for Regulation and Supervision of Payment and Settlement Systems, which was a committee of the Central Board.
• Authorisation (Sections 4 and 7): no person other than the Reserve Bank may commence or operate a payment system except under an authorisation issued by the Bank. The Bank issues or refuses authorisation after satisfying itself on the applicant's standing, the system's safety and the public interest, and refusal must be preceded by an opportunity of being heard.
• Standards (Section 10): the Bank may prescribe the format of payment instructions, the size and shape, the timings, the manner of transfer of funds, and other standards to be complied with by the system and its participants.
• Directions (Sections 17 and 18): the Bank may give directions to a particular system provider or participant where it is necessary, and may give directions generally in the public interest, in the interest of monetary policy or to prevent the affairs of a system being conducted detrimentally.
• Settlement finality (Section 23): settlement effected under the procedures of an authorised system is final and irrevocable, and is not affected by the insolvency, dissolution or winding up of a participant. This provision is the legal foundation of confidence in electronic settlement.
• Penalties (Section 26): operating a payment system without authorisation, failing to comply with the terms of authorisation, disclosing prohibited information or failing to comply with a direction is punishable, with provision for compounding.

The systems themselves

• Real time gross settlement: large value transfers settled individually and in real time across the books of the Reserve Bank, available round the clock since December 2020.
• National Electronic Funds Transfer: retail transfers settled in batches, available round the clock since December 2019.
• The National Payments Corporation of India: an umbrella organisation set up as a not for profit company on the Bank's initiative, which operates the Unified Payments Interface, immediate payment service, the National Automated Clearing House, RuPay, the Aadhaar enabled payment system and National Electronic Toll Collection.
• Prepaid payment instruments: wallets and cards issued under the Bank's directions, subject to know your customer requirements and limits, with the option of interoperability.
• Payment aggregators and gateways: brought within the regulatory net by directions requiring authorisation, net worth and the holding of merchant funds in an escrow account with a scheduled bank.
• The digital rupee: the Finance Act, 2022 amended the definition of a bank note to include currency in digital form, and the Bank has run wholesale and retail pilots of a central bank digital currency since late 2022.

5. Questions Arising

Why regulate non-banking financial companies at all, if they take no demand deposits?

Because the risk they create is not confined to their own depositors. Large non-banking companies fund themselves through commercial paper and bank borrowing, so their distress transmits directly to banks and to mutual funds holding their paper. They also lend to borrowers whom banks will not serve, which makes their continued functioning a matter of credit supply and not only of investor protection. The scale based framework is the Bank's answer to both concerns.

Does the Reserve Bank regulate the technology companies behind digital payments?

Increasingly, yes, although indirectly and by function rather than by entity. An application that offers a payment service must do so through an authorised payment system or as a third party application provider under the rules of that system. Payment aggregators now require authorisation in their own right, and the Bank's directions on digital lending place responsibility on the regulated lender for the conduct of the platform acting on its behalf.

6. Quick Revision

7. Frequently Asked Questions

What is the difference between a bank and an NBFC?

A bank carries on banking within Section 5(b) of the Banking Regulation Act: it accepts demand deposits withdrawable by cheque from the public. An NBFC may lend and invest but cannot accept demand deposits or issue cheques drawn on itself. A bank needs a licence under Section 22; an NBFC needs registration under Section 45-IA of the RBI Act. Bank deposits carry insurance cover; NBFC deposits do not.

What is the net owned fund requirement for an NBFC?

Section 45-IA fixes it at ₹25 lakh or such other amount not exceeding ₹100 crore as the Reserve Bank may specify, and the Bank fixes it by category. Investment and credit companies needed ₹5 crore by 31 March 2025, and microfinance institutions and factors ₹7 crore, all three rising to ₹10 crore by 31 March 2027. Housing finance companies require ₹20 crore and infrastructure finance companies ₹300 crore.

What is scale based regulation of NBFCs?

A framework in force from 1 October 2022 under which non-banking financial companies are placed in a base, middle, upper or top layer according to size, activity and risk, with regulation becoming progressively more intensive. All deposit taking companies are at least in the middle layer; the upper layer is identified by the Bank and faces bank like norms; the top layer is ordinarily empty.

Who regulates UPI and other digital payments in India?

The Reserve Bank, under the Payment and Settlement Systems Act, 2007, acting since May 2025 through the Payments Regulatory Board. The Unified Payments Interface is operated by the National Payments Corporation of India, itself an authorised system provider, and the applications that ride on it do so under the rules of that system.

What does settlement finality mean?

Under Section 23 of the Payment and Settlement Systems Act, a settlement effected under the procedures of an authorised system is final and irrevocable, and is not affected by the insolvency, dissolution or winding up of a participant. Without it, a liquidator could unwind payments already made, and no one could rely on an electronic transfer.

Can an NBFC accept deposits from the public?

Only a deposit taking company, holding a certificate of registration that permits it, may accept term deposits, and even then within limits on amount, tenor and interest rate fixed by the Reserve Bank. No NBFC may accept demand deposits withdrawable by cheque, because that would be banking under Section 5(b) of the Banking Regulation Act. Such deposits carry no insurance cover, and the company must keep liquid assets under Section 45-IB and transfer twenty per cent of profit to a reserve fund under Section 45-IC.

What happens if a company carries on NBFC business without registration?

The business itself is prohibited. Section 45-IA opens with a notwithstanding clause, so no other law authorises what it forbids. The Reserve Bank may direct the company to stop the business and to repay the deposits it has taken, may apply for its winding up, and the contravention is punishable under Chapter V of the RBI Act. Registration once granted may also be cancelled under Section 45-IA(6).

8. Related Topics and Provisions

• Meaning of banking, banker and bank
• Structure of the Indian banking system
• Licensing of banking companies (Section 22)
• Instruments of monetary control
• Electronic banking and customer liability in unauthorised transactions
• Deposit insurance