As a practitioner in the financial services sector, we have often encountered questions around the capital adequacy and activity thresholds that govern Non-Banking Financial Companies (NBFCs) in India. Two of the most critical metrics-Net Owned Funds (NOF) and Principal Business Criteria (PBC)-form the bedrock of regulatory compliance for NBFCs. The article covers the evolution, current framework, and key amendments over the years and how they impact NBFCs' operations.
1. Defining Net Owned Funds (NOF)
Net Owned Funds represent the core capital base that an NBFC must maintain to safeguard its creditors and ensure financial stability. Put simply, NOF is calculated as follows:
Net Owned Funds = Paid-up Equity Capital + Free Reserves - Accumulated Losses - Deferred Revenue Expenditure
By setting a minimum NOF threshold, the Reserve Bank of India (RBI) ensures that firms have sufficient skin in the game before they extend credit or offer financial services.
2. Tracing the Evolution of NOF Requirements
- 1998: RBI's NBFC Directions initially set a minimum NOF of Rs 2 crore for all NBFCs to curb undercapitalization.
- 2015-2016: Press release clarified that new NBFCs needed Rs 10 crore NOF for registration, even as existing entities continued under the Rs 2 crore threshold.
- October 2021: Introduction of Scale-Based Regulation (SBR); RBI announced a glide path raising NOF for lending-focused NBFCs to Rs 10 crore by 2027.
- October 2023: Master Direction formalized timelines: Rs 5 crore by March 2025 and Rs 10 crore by March 2027 for mid-tier NBFCs.
The RBI has made it clear that non-compliance with these timelines could result in cancellation of Certificate of registration (CoR).
3. Principal Business Criteria (PBC)
Purpose?
Often, companies incorporated with the Registrar of Companies (ROC) engage in activities-such as lending, advancing loans, investing in securities, leasing, factoring, or microfinance-that fall squarely within the ambit of NBFC operations, even though they have neither registered with the RBI as an NBFC nor listed NBFC activities in their Memorandum of Association. Over time, these non‑financial businesses may find that their core commercial or manufacturing operations shrink to a negligible scale, as the volume and value of their inadvertent NBFC‑type transactions eclipse their original objectives. In many cases, this shift isn't deliberate: it may occur without the company's awareness of RBI regulations governing NBFCs, or simply represent a temporary phase of expansion. Legally, however, any company whose financial activities cross certain thresholds is deemed to be an NBFC under RBI rules-and by continuing to operate without registration, it breaches those regulations. To help such entities recognize when they have effectively become NBFCs, the RBI applies the "Principal Business Criteria" test, which gauges whether lending and other financial services constitute a substantial portion of a company's overall business.
Principal Business Criteria define the core activities an NBFC must undertake to be classified under various regulatory buckets. The PBC measure ensures that entities classified as NBFCs derive a significant share of their income or assets from traditional lending activities.
PBC can be tested in two ways:
For companies with a total asset size of Rs. 1000 crore or more, the PBC is defined as:
- Financial assets comprising 50% or more of total assets (net of intangible assets).
- Financial income comprising 50% or more of gross income.
For companies with an asset size below Rs. 1000 crore, the PBC is defined as:
- Financial assets comprising 75% or more of total assets (net of intangible assets).
- Financial income comprising 75% or more of gross income
Meeting either of these tests is sufficient for PBC compliance.
4. Implications for NBFCs
- Capital Planning: A higher NOF mandate compels NBFCs to plan equity raises or reserve accretions well in advance to avoid regulatory non-compliance.
- Business Focus: Stringent PBC thresholds steer NBFCs to concentrate on lending and investment activities, discouraging conglomerate-style diversification under the NBFC label.
- Supervisory Oversight: Crossing the Systemically Important NBFC threshold triggers enhanced reporting, risk management norms, and RBI inspections.
5. Preparing for Future Amendments
Given the RBI's ongoing consultations, NBFCs should:
- Monitor Regulatory Circulars: Stay abreast of RBI notifications on NOF hikes or PBC tweaks.
- Scenario-Plan Capital Needs: Model capital adequacy under proposed NOF scenarios.
- Adjust Asset Deployment: Align loan portfolios and investment instruments to meet evolving PBC standards.
Conclusion
Net Owned Funds and Principal Business Criteria are fundamental safeguards that bolster the NBFC sector's stability and focus. By tracing their evolution-from the Rs 2 crore NOF floor and 50% PBC threshold to the proposed Rs 10 crore -we see a clear regulatory intent: to weed out undercapitalized players and ensure that NBFCs remain committed to their core financial activities. As these metrics continue to evolve, proactive planning and robust governance will be indispensable for NBFCs aiming to thrive in India's dynamic financial landscape.
Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.
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