Diluting RBI's NBFC Capital Requirements Could Have Impact On India's Financial System: Bombay High Court

The Bombay High Court recently observed that permitting dilution of the Reserve Bank of India's directions on the minimum Net Owned Fund (NOF) requirement in favour of a Non-Banking Financial Company with weak financial standing and low NOF could have repercussions on the country's financial system.

It upheld the Reserve Bank of India's decision cancelling the company's Certificate of Registration after it failed to achieve the prescribed NOF by the stipulated deadline.

A division bench of Justice Bharati Dangre and Justice Manjusha Deshpande observed:

"If the directions issued by the RBI are permitted to be diluted in favour of the company with weak financial standing and low NOF, it would have repercussions on the whole financial system in the country. If in its wisdom, the RBI has deemed it appropriate not to allow the Petitioner, with the history of low NOF to continue its business, we definitely cannot substitute the said wisdom."

The court was hearing a petition filed by Mane Finance Pvt. Ltd. challenging the RBI's decision cancelling its Certificate of Registration (CoR) to carry on business as a Non-Banking Financial Company.

The Appellate Authority, Department of Financial Services, Ministry of Finance, had upheld the RBI's decision.

Mane Finance obtained its CoR in 1999, when the minimum NOF requirement was ₹25 lakh. The RBI's notification dated March 27, 2015 required existing NBFCs with an NOF below ₹2 crore to increase it to ₹1 crore by April 1, 2016 and ₹2 crore by April 1, 2017 to continue carrying on business.

On May 7, 2018, the RBI issued a show-cause notice after finding that the company had failed to achieve the prescribed ₹2 crore NOF by April 1, 2017. In response, the company relied on an unaudited balance sheet showing an NOF of ₹12.63 crore as on March 31, 2018. It requested that its CoR not be cancelled.

Before the High Court, the company argued that although it had not met the NOF requirement by the prescribed date, it had become compliant by the time the show-cause notice was issued.

The RBI submitted that the company's NOF was negative ₹26 lakh as on March 31, 2016 and negative ₹2.84 crore as on March 31, 2017. It argued that the company had failed to meet even the earlier minimum NOF requirement of ₹25 lakh, apart from the revised thresholds prescribed under the 2015 notification.

The court observed that attaining the prescribed NOF was a mandatory precondition for commencing or carrying on business as an NBFC. It also observed that there was little scope for judicial interference with the RBI's assessment of the company's financial credentials.

"..the RBI took cognizance of the negative NOF of the company and if it was of the view that the financial credentials of the company did not inspire confidence,so as to permit it to continue the business as Non-banking financial institution, we find very little scope for us to intervene, as we may not be in a position to substitute our decision in financial matters, when the RBI did not deem the Petitioner company creditworthy for continuing its business.", the court ruled.

The court noted that the company did not achieve the mandatory ₹2 crore NOF by April 1, 2017 despite the relaxation granted under the 2015 notification.

It also observed that the company had a negative NOF for two consecutive years, remained below even the earlier minimum requirement of ₹25 lakh, and relied only on an unaudited balance sheet instead of audited financial statements before the RBI.

Accordingly, the court upheld the RBI's order cancelling the company's Certificate of Registration, affirmed the appellate order, and dismissed the writ petition.