Regulating the Non-Banking Sector

In one line

A company that lends but is not a bank is regulated by the Reserve Bank under a different chapter of a different Act, and the gateway is registration under section 45IA.

In the wording a student can write in an exam: Chapter IIIB of the Reserve Bank of India Act, 1934 regulates non-banking financial companies; by section 45IA no non-banking financial company may commence or carry on business without a certificate of registration from the Reserve Bank and the net owned fund the section requires; sections 45J to 45NC empower the Bank to regulate their deposits, to issue directions, to inspect them and to act against them and their auditors; Chapter IIIC prohibits the acceptance of deposits by unincorporated bodies; and Chapters IIID and IIIE, sections 45R to 45Z, empower the Bank to regulate transactions in derivatives, money market instruments and securities.

Why the sector is regulated separately

Because it is not doing banking, and chapter 10 explained why that matters. A non-banking financial company lends and invests, but it does not take deposits withdrawable by cheque from the public, so it falls outside section 5(b) of the Banking Regulation Act and outside that Act's whole machinery.

But it does the same economic damage when it fails. It borrows, often from banks and from the public through deposits or debentures, and lends long. A large one that fails takes down its creditors, and if banks are among them the failure travels into the banking system, which is what happened in the failures of large finance companies in recent years.

So a second regime was needed, and Parliament put it in the Reserve Bank's own Act rather than in the Banking Regulation Act, which is why students look for it in the wrong statute. The design differs from bank regulation in one crucial respect: the object is the protection of depositors and of the system, not the protection of a licence to do banking.

The definitions: section 45I

Section 45I is the definition section for Chapter IIIB, and three of its definitions do the work.

"Financial institution" means any non-banking institution which carries on as its business or part of its business any of the activities the clause lists: the financing of activities other than its own by making loans or advances or otherwise; the acquisition of shares, stock, bonds, debentures or securities; hire-purchase business; insurance business; chit business; and the managing, conducting or supervising of chits or kuries; but not an institution which carries on as its principal business agricultural operations, industrial activity, the purchase or sale of goods other than securities, or the providing of services or the purchase, construction or sale of immovable property.