India’s banking and financial sector is highly regulated under the Reserve Bank of India (RBI), the central bank established under the Reserve Bank of India Act, 1934 (RBI Act).

The RBI’s jurisdiction extends to banks, non-banking financial institutions (NBFCs), and other entities offering financial services in and from India. Its role includes:

• Formulating and implementing the monetary policy;
• Regulating and supervising India’s financial systems including payment and settlement systems; and
• Regulating and managing foreign exchange transactions.

One of the RBI’s key roles is prescribing the instructions, directions and overall framework within which banks and financial institutions are required to operate, coupled with various supervisory and audit powers to monitor such compliance.

That being said, companies that do financial business but are regulated by other regulators, such as insurance companies and stock brokers, are specifically exempted from the RBI’s regulatory requirements to avoid duality of regulation.

RBI framework

While the central government enacts legislation for the banking and financial systems, the RBI is empowered to regulate and monitor the operation of these systems.

Due to the wide gamut of services and activities falling within the domain of financial systems, numerous enactments govern them. These include the RBI Act, Banking Regulation Act, 1949, Payment and Settlement Systems Act, 2007, and Foreign Exchange Management Act, 1999.

This article focuses on laws governing NBFCs, namely entities predominantly engaged in financial activities but not operating as banks or as part of the payment and settlement system.

Regulating NBFCs

The parent enactment dealing with NBFCs is the RBI Act, which requires every NBFC to obtain a registration certificate from the RBI to carry out its operations.

From time to time, the RBI issues various circulars and directions to regulate the functioning of NBFCs, the most recent being Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 (Master Directions NBFCs).

When considering applications for NBFC registration, one of the key aspects that RBI looks at is whether the general character of the NBFC management meets its “fit and proper” criteria, and whether it would not act in a manner prejudicial to public interest.

Towards this end, the RBI originally issued the Non-Banking Financial Companies (Approval of Acquisition or Transfer of Control) Directions, 2015 (2015 directions), which mandated prior RBI approval in case of a change in control or management of NBFCs.

The Master Directions NBFCs have now consolidated the requirements under the 2015 directions, which are now repealed.

Takeover approval process

Following is a step-by-step guide to obtaining approval, including requirements and timelines, in terms of the Master Directions NBFCs:

If an NBFC triggers any of the following thresholds, prior approval of the RBI is required:

1. Any takeover or acquisition of control that may or may not result in a change of management;
2. Any change in shareholding, including progressive increases over time, which would result in the acquisition/transfer of a shareholding of 26%, subject to certain exceptions; and
3. Any change in management that would result in a more than 30% change of the directors, subject to certain exceptions.

To obtain prior approval of the RBI, the concerned NBFC must submit an application along with the following documents:

1. Relevant information about proposed directors/shareholders in accordance with the above-mentioned scale-based regulations;
2. Sources of funds of proposed shareholders acquiring the NBFC’s shares;
3. Declaration by proposed directors/shareholders stating they are not associated with any unincorporated body accepting public deposits;
4. Declaration by proposed directors/shareholders stating they are not associated with any company for which an application for a certificate of registration has been rejected by the RBI;
5. Declaration by proposed directors/shareholders that there is no criminal case (including for any offence under section 138 of the Negotiable Instruments Act), against them; and
6. Report by the bankers on proposed directors/shareholders.

The application is to be submitted to the Regional Office of the Department of Supervision of the RBI in the local jurisdiction of the NBFC’s registered office. On receipt of the application, the RBI may ask for further information and documents.

If the RBI gives its approval, a public notice is to be issued by the NBFC, along with the proposed transferee, at least 30 days prior to the transaction.

The notice published in at least one leading national and one vernacular newspaper must demonstrate:

1. Intention to sell or transfer ownership/ control;
2. Particulars of the transferee; and
3. Reasons for such a sale or transfer of ownership/control.

On expiry of the 30-day period, the parties may consummate the proposed transaction.

It is important to note that the Master Directions NBFCs do not provide any timeline within which RBI approval must be granted. However, in practice, it usually takes about five to six months.

Challenges and tips for success

With growing investment in NBFCs, it becomes very important for incoming acquirers to apprise themselves of the prior RBI approval requirement. Some common challenges faced in the approval process are:

• Credentials of new management. One of the key RBI requirements when considering applications for change in management is whether the concerned persons meet the “fit and proper” criteria. The RBI requires information pertaining to pending litigations, educational qualifications and experience in the financial sector.
  It is important that the new management comprises individuals with a clean track record and significant experience in the relevant field of financial sector. They should also have the requisite educational qualifications and be able to demonstrate their expertise in exercising a management role in the NBFC.
• Mapping timelines for listed NBFCs. The takeover of a publicly listed NBFC requires its own set of regulatory compliances, including making an open offer to the public under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. When calculating timelines for the various regulatory actions to be done for the acquisition of a listed NBFC, it is important to take into account the timelines required to receive RBI approval, as an inordinate delay may lead to the duplicity of compliances.

A comprehensive checklist and tracker setting out this schedule is important to give stakeholders a clear view of the processes required, to ascertain whether commercial arrangements need to be reconsidered as a result.

The transaction documentation for such arrangements also needs to be drafted taking into consideration the time required for the various approvals and processes, and calculating the long-stop date for consummation accordingly, with the flexibility of an extension.

• Confidentiality of information. RBI approval requires incoming shareholders/management to disclose various details including: the source of funds for the acquisition; ownership of substantial interest in other entities; principal bankers including overseas bankers; beneficial ownership; and other important details. Apart from this, the RBI is well within its rights to ask for extensive details concerning the incoming shareholder/management.

Some of this information may be sensitive and confidential to the concerned party, so it is important to have clear sight of the extent of details to be disclosed prior to entering into definitive documentation.

To avoid any last-minute surprises, it is important to keep the new shareholder/management appraised of the kind of documentation and details required by the RBI, and to have the requisite documentation and information prepared in advance to avoid unnecessary delays.

It is also beneficial to have strong confidentiality clauses built into the transaction documentation, to mitigate leakage of sensitive information.

• Strong follow-up and communication channel. An interesting case came to light recently where, due to a practical issue of non-intimation of a revised address for communication, the RBI’s follow-up queries reached the wrong address and went unanswered, resulting in the rejection of approval. It therefore becomes increasingly important to have strong follow-up and proper channels of communication to ensure the approval is not rejected or delayed on account of logistical issues.

Therefore, the NBFC’s authorised person for this purpose should have the requisite knowledge and experience to ensure that frequent follow-up and proper communication channels are in place to avoid delays and rejections.

Conclusion

When considering any transaction for acquisition of control, shareholding or management of an NBFC, concerned stakeholders should be made aware of the RBI approval requirements – including anticipated timelines, necessary documentation, practical challenges and suggested mitigants – to work towards a streamlined and successful approval outcome.