A 13-Year-Old Case Brings Clarity For India's Non-Bank Lenders
Non-bank finance companies in India will not fall under the jurisdiction of moneylending legislation passed by state governments. The clarity that the Reserve Bank of India Act of 1934 trumps any state law came in a case that dates back nearly 13 years.
In an order passed on Tuesday, the Supreme Court of India ordered that NBFCs shall be governed by the Reserve Bank of India Act, 1934, and that provisions of the moneylenders act of Kerala and Gujarat would not apply to them.
"...the power of intervention available for the RBI over NBFCs, is from the cradle to the grave," a bench of Justices Hemant Gupta and V Ramasubramanian said in its order.
A 13-Year-Old Battle
The issue, under litigation since 2009, started with the Kerala government asking NBFCs to register themselves under the Kerala Act, 1958. The law seeks to regulate and control the business of moneylending in the state. It would also control the level of interest that any moneylender, including an NBFC, could charge a customer seeking loans from them.
"It appears that after the mushroom growth of NBFCs, the government of Kerala started insisting upon NBFCs to take a license under the Kerala Act, failing which penal consequences were threatened," the Supreme Court said in its order.
After having failed to get any relief from the state, non-bank lenders filed various applications at the Kerala High Court. However, the high court ruled in favour of the state in November 2009.
"We have already found that the provisions of the RBI Act are essentially to protect the depositors and there is hardly any provision therein to protect the interest of the borrowers, for which purpose Kerala Money Lenders Act is enacted by the State," the Kerala High Court said in its judgment.
Around the same time, the registrar at the office of Prevention of Money Lenders in Gujarat sought to move against NBFCs operating in the state, if they were not registered under the Bombay Money Lenders Act, which was effective in Gujarat at the time.
Here, too, the non-bank lenders moved the Gujarat High Court.
In its order delivered in January 2010, the Gujarat High Court ruled in favour of the lenders and said the state government could not proceed against them.
Another attempt by the state to bring NBFCs under the Gujarat Money Lenders Act in 2011 was similarly struck down by the high court in April 2011.
"On consideration of the entire materials on record, we, therefore, hold that the GML (Gujarat Money Lending) Act is ultra vires the Constitution of India for legislative incompetence of the state legislature only to the extent it seeks to have control over the NBFCs registered under the RBI Act," the April 2011 order said.
Appeals filed by NBFCs in Kerala and the Gujarat state government were placed before the Supreme Court for further hearing.
Separately, a petition by the chief executive officer at Bajaj Finance Ltd. also found its way to the Supreme Court. This petition, filed in 2015, sought to quash a first information report filed against him under the Kerala Act.
All matters were consolidated for the consideration of the Supreme Court in 2012 and hearings have been underway since.
In its order, the apex court held that the state government legislation cannot be applied to NBFCs.
"...we are of the considered opinion that the Kerala Act and the Gujarat Act will have no application to NBFCs registered under the RBI Act and regulated by RBI," Justices Hemant Gupta and V Ramasubramanian said in their order.
Additionally, they also quashed the FIR in the Bajaj Finance matter.
NBFCs registered with the banking regulator are only governed by Chapter IIIB of the RBI Act, the apex court noted in its order.
Chapter IIIB of the RBI Act lays down the legal framework for a company to register as an NBFC with the banking regulator, maintaining minimum net-owned funds, maintaining a reserve fund, filing regulatory returns, among other things. It also the sets framework for the RBI to either initiate any punitive actions against the NBFC or cancel its certificate of registration.
The order also pointed out that Section 45Q of the RBI Act states that Chapter III B shall override all other acts in law.
Relief For NBFCs
The order lays to rest years of confusion where NBFCs were subjected to additional scrutiny and regulation by state governments. According to a senior official at a large NBFC, despite the matter being subjudice, state governments have, from time to time, attempted to take action against non-bank lenders under their respective moneylending norms.
"For many years there was avoidable and unnecessary confusion around the extent of state government regulations," said Raman Agarwal, director at Finance Industry Development Council. "This judgment has put to rest all of that. The state has no power to regulate moneylending business of NBFCs. It is a victory for the NBFC sector as a whole."
The issue of dual regulation is not alien to India's financial services landscape. Previously, the regulation of certain segments of cooperative banks was similarly split between state governments and the RBI, leading to regulatory lapses, such as that in Punjab & Maharashtra Cooperative Bank. However, the central government's revised legislation in September 2020 gave the RBI more powers, which has directly led to stricter supervision and a rise in penalties against such banks.