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Analysis | Why SC ruling on NBFC regulation is a big relief for industry

The issue of dual regulation of NBFCs by the RBI and state governments had created huge uncertainty for the industry. The Andhra Pradesh microfinance crisis is an example.

May 11, 2022 / 03:10 PM IST
Representative image

Representative image

Supreme Court on May 10 ruled that state moneylending Acts by the Kerala and Gujarat governments will not apply to non-banking finance companies (NBFCs) that are the under the regulation of the Reserve Bank of India (RBI). This is a significant ruling that will have implications for similar cases involving other state governments as well.

The court gave its final judgment on the matter of Nedumpilli Finance Company versus state of Kerala and several other civil appeals, where it held that Chapter IIIB (RBI regulation for NBFCs) is a complete code in itself as regards regulation of NBFCs.

Also, there is a clear conflict between RBI Act and Moneylenders Act which cannot be reconciled. Moreover, section 45Q of RBI Act overrides Moneylenders Act, the court said implying that the state has no power to regulate moneylending business of NBFCs.

“…to say that RBI has no say in such a matter of vital interest will strike at the very root of the statutory control vested in RBI,” the court observed.

What does it mean?

Close

The court ruling would mean that only RBI has the power to regulate NBFCs thus avoiding dual regulation. In its order, Supreme Court said that section 45­Q enables Chapter III­B to override other laws.

Therefore, the states of Gujarat and Kerala cannot contend that the laws made by them are in addition to the provisions of Chapter III­B. The court noted that NBFCs controlled by RBI play a very vital role in contributing to   the financial health of the country.

Further, the court noted that the RBI has the power to supersede the board of an NBFC and has power even to wind up an NBFC.

“Thus the supervision and regulation of NBFCs by the RBI is from the time of birth till the time of death,” the court observed.

“If a statutory enactment which provides for such  type of control and supervision is not a complete code in itself, we do not know what else could be a complete code,” the court said.

Industry experts welcomed the order.

“This settles a long pending issue. The order has come as a relief for the industry,” said Raman Agarwal, director and spokesperson for Financial Industry Development Council, an industry lobby.

“The order clearly shows that the state has no power to regulate working NBFCs,” said Agarwal.

Why is the ruling significant?

The ruling is significant as the tussle between the RBI and the state government on certain aspects of NBFC regulation has created quite a stir on some occasions when the state governments intervened in the operations of NBFCs citing state moneylending Act.

The issue of dual regulation — where both state governments and RBI act as regulators for companies engaged in lending — had resulted in regulatory uncertainty in many states including Gujarat and Kerala. This gap gave room for local politicians to meddle with operations of NBFCs.

One example is the Andhra Pradesh microfinance crisis of 2010 when the then state government imposed a draconian law on microfinance institutions (MFIs) including those operating in the form of NBFCs.

The state imposed restrictions on operations of all such institutions including NBFCs, eventually leading to the collapse of the industry and closure of many companies.

With the Supreme Court clarifying the regulatory aspect of NBFCs, similar situations can be avoided in future.

“Justice delayed is justice denied, as they took 10 years to give this verdict, whatever damage that had to happen might have already happened,” said Kishor Kumar Puli, managing director and chief executive of Pradakshina Fintech. Puli used to earlier head Trident Microfinance, which was shut down following the Andhra Pradesh crisis.

“Similar case of Andhra Pradesh MFI Act is still pending at the Hyderabad high court. Hopefully, it should protect NBFCs from such draconian Acts of state government,” Puli said.

 



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Dinesh Unnikrishnan is Deputy Editor at Moneycontrol. Dinesh heads the Banking and Finance Bureau at Moneycontrol. He also writes a weekly column, Banking Central, every Monday.
first published: May 11, 2022 03:10 pm
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