NEDUMPILLI FINANCE COMPANY LIMITED VS STATE OF KERALA

NEDUMPILLI FINANCE COMPANY LIMITED VS STATE OF KERALA CASE

Landmark Cases of India / सुप्रीम कोर्ट के ऐतिहासिक फैसले

    REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION/

CRIMINAL ORIGINAL JURISDICTION 

CIVIL APPEAL NO. 5233 0F 2012

NEDUMPILLI FINANCE COMPANY LIMITED … APPELLANT(S)

VERSUS

STATE OF KERALA & ORS.                              …  RESPONDENT(S)

WITH

CIVIL APPEAL NO. 5230 OF 2012

CIVIL APPEAL NO. 5190 OF 2012

CIVIL APPEAL NO. 5191 OF 2012

CIVIL APPEAL NO. 5184 OF 2012

CIVIL APPEAL NO. 5241 OF 2012

CIVIL APPEAL NO. 5185 OF 2012

CIVIL APPEAL NO. 5111 OF 2012

CIVIL APPEAL NO. 5188 OF 2012

CIVIL APPEAL NO. 5187 OF 2012

1

CIVIL APPEAL NO. 5183 OF 2012

CIVIL APPEAL NO. 5113 OF 2012

CIVIL APPEAL NO.3857 OF 2022

(@Special Leave Petition (Civil) No.8331 of 2015)

TRANSFER PETITION (CRL.) NO. 359 OF 2015

CIVIL APPEAL NO. 5186 OF 2012

CIVIL APPEAL NO. 5192 OF 2012

CIVIL APPEAL NO. 5189 OF 2012

CIVIL APPEAL NO. 5112 OF 2012

CIVIL APPEAL NO. 5232 OF 2012

CIVIL APPEAL NO. 5231 OF 2012

CIVIL APPEAL NO. 5234 OF 2012

CIVIL APPEAL NO. 5237 OF 2012

CIVIL APPEAL NO. 5238 OF 2012

CIVIL APPEAL NO. 5315 OF 2012

CIVIL APPEAL NOS. 18786­18787 OF 2017

CIVIL APPEAL NO. 1324 OF 2015

CIVIL APPEAL NO. 7836 OF 2012

2

J U D G M E N T

V. RAMASUBRAMANIAN, J.

1. The question as to whether Non­Banking Financial Companies

(for short “NBFCs”) regulated by the Reserve Bank of India, in terms

of the provisions of Chapter III­B of the Reserve Bank of India Act,

1934 (hereinafter referred to as “RBI Act”) could also be regulated by

State   enactments   such   as   Kerala   Money   Lenders   Act,   1958

(hereinafter referred to as “Kerala Act”) and Gujarat Money Lenders

Act, 2011 (hereinafter referred to as “Gujarat Act”), has arisen for

our consideration in these appeals, with the Kerala and Gujarat

High Courts taking opposite views.

2. We have heard the learned counsel for the respective parties,

the learned senior counsel appearing for the State of Kerala, the

learned standing counsel appearing for the State of Gujarat and the

learned counsel appearing for RBI.

3

FACTUAL MATRIX

3. A brief sojourn into the factual matrix may provide the setting,

in the context of which, the above question of law has arisen. It

goes as follows:­

KERALA

3.1 The legislature of the State of Kerala passed the Kerala Act,

1958, with the professed object of providing for the regulation and

control of the business of money lending in the State of Kerala. The

statement of objects and reasons spelt out, that by passing the said

enactment, “it was intended to regulate the interest to be charged by

money lenders and to provide protection to borrowers”. At the time

when this Act was enacted, the concept of non­banking financial

companies was not very familiar in India. Therefore, the Reserve

Bank of India and the Parliament had not stepped in to regulate

financial companies which were not banks or banking companies.

3.2 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.   Therefore,   after   unsuccessfully   approaching   the

4

Government of Kerala for exemption, NBFCs filed a batch of writ

petitions on the file of the High Court of Kerala.

3.3 A learned Judge of the High Court of Kerala dismissed the

batch of writ petitions and the said order was confirmed by the

Division Bench of the High Court. Therefore, NBFCs operating in

the State of Kerala have come up with the above batch of appeals.

3.4 All the appeals, by the NBFCs operating in the State of Kerala,

arise   out   of   writ   petitions   seeking   a   declaration   that   NBFCs

registered under the RBI Act will not come within the purview of the

Kerala Act. Apart from several appeals, there is also a petition in

Transfer Petition (Crl.) No.359 of 2015, filed by the Chief Executive

Officer of one NBFC by name Bajaj Finance Limited, seeking a

transfer of the quash petition pending on the file of the High Court

of Kerala under Section 482 of the Code of Criminal Procedure

praying for quashing an FIR registered under the Kerala Act.

GUJARAT

3.5 The Bombay Money Lenders Act, 1946, which was applicable

in the State of Gujarat, was sought to be invoked by the Registrar in

the   office   of   the   Prevention   of   Money   Lenders,   against   NBFCs

5

operating in the State of Gujarat, in the year 2009. Challenging the

action so initiated, NBFCs filed a batch of special civil applications

before the High Court of Gujarat. When it was pending, the decision

of the Kerala High Court came. But disagreeing with the view taken

by the Kerala High Court, a learned Judge of the Gujarat High

Court quashed the notices issued to the NBFCs under the Bombay

Money Lenders Act, by a judgment dated 13.01.2010. 

3.6 Thereafter, the legislature of the State of Gujarat passed the

Gujarat Act, 2011 (Gujarat Act 14 of 2011) which received the

assent of the Governor on 6.04.2011 and was published in the

Gujarat Government Gazette on 8.04.2011.

3.7 Therefore, a fresh batch of special civil applications were filed,

seeking a declaration that the provisions of the Gujarat Act 14 of

2011 are not applicable to NBFCs registered under the RBI Act. The

Division   Bench   of   the   High   Court   allowed   the   special   civil

applications holding that Gujarat Act 14 of 2011 is ultra vires the

Constitution for legislative incompetence, to the extent that it seeks

to   have   control   over   NBFCs   registered   under   the   RBI   Act.   A

consequential direction was also issued by the Gujarat High Court

6

restraining the State Government from applying the provisions of

the   Gujarat   Act   against   NBFCs   registered   under   the   RBI   Act.

Therefore, the State of Gujarat has come up with Civil Appeals. 

Scheme of Kerala Act, Gujarat Act and RBI Act

4. In the background of the facts narrated above, the legal issue

arising   for   consideration   has   to   be   resolved   by   looking   at   the

scheme of the two State enactments, the scheme of RBI Act and the

relevant Entries in the appropriate List of the Seventh Schedule, to

which these enactments can be traced.

4.1 List­I of the Seventh Schedule to the Constitution contains

three entries which may be taken note of.  They are:­

(i) Entry No.38: Reserve Bank of India

(ii) Entry   No.43: incorporation, regulation and winding

up   of   trading   corporations   including   banking,

insurance and financial corporations but not including

cooperative societies.

(iii) Entry No.45: Banking

4.2 List II (State List) of the Seventh Schedule contains an entry

in Entry No.30, which reads: “money lending and money lenders;

relief of agricultural indebtedness”.

7

4.3 Therefore,   any   State   enactment   regulating   the   business   of

money lending and intended to afford protection to borrowers, may

fall   under   Entry   No.30   of   List­II.   But   at   the   same   time   any

parliamentary enactment dealing with incorporation, regulation and

winding up of financial corporations, would fall under Entry No.43

in List­I.

4.4 Therefore, at the outset, it is clear that the competence of the

legislatures of the States of Kerala and Gujarat to enact a law for

the   regulation   of   the   business   of   money   lending   cannot   be

questioned, as their power is traceable to Entry 30 of List­II of the

Seventh   Schedule.   But   at   the   same   time,   we   will   have   to   see

whether after the enactment of a law by the Parliament for the

incorporation   and   regulation   of   financial   corporations,   such

financial corporations would continue to be regulated also by the

State enactments, on the ground that they may also fall within the

definition   of   the   expression   “money   lenders”   under   the   State

enactments.

8

4.5 For finding an answer to the above question, it may be useful

to take a bird’s eye view of the scheme of the Kerala and Gujarat

State enactments.

Broad scheme of Kerala Act

4.6 In a way, the Kerala  Act  is a legacy of the Madras Pawn

Brokers Act, 1943, whose provisions continued to be in force in the

Malabar District, even after the States Reorganisation Act, 1956,

until it was repealed by Kerala Money Lenders (Amendment) Act 33

of 1963.

4.7 As seen from the statement of objects and reasons, the only

object of the Kerala Money Lenders Act was to afford protection to

borrowers   from   unscrupulous   money   lenders   who   advanced

usurious   loans.   Though   it   was   proclaimed   in   the   statement   of

objects,   in   general   terms,   that   it   was   intended   to   regulate   the

business of money lending, the Act was primarily intended only to

cover one aspect of the business of financing.

4.8 Section 2(7) of the Kerala Act, defines a “money lender” as

follows:­

9

“2. Definitions.  xxx xxx xxx 

(7)  “money­lender”  means   a   person   whose   main   or

subsidiary   occupation   is   the   business   of   advancing   and

realising loans or acceptance of deposits in the course of such

business and includes any person appointed by him to be in

charge of a branch office or branch offices or a liaison office or

any other office by whatever name called, of his principal

place of business and a pawn broker, but does not include­

(a) a bank or a co­operative society; or

(b) the   Life   Insurance   Corporation   of   India   established

under section 3 of the Life Insurance Corporation Act,

1956 (Central Act 31 of 1956); or

(bb)  the   Industrial   Credit   and   Investment   Corporation   of

India Limited incorporated under the India Companies

Act, 1913 (7 of 1913);

(c) the  Industrial  Finance  Corporation established  under

section   3   of   the   Industrial   Finance   Corporation   Act,

1948  (Central Act 15 of 1948); or

(d)  x x x x

(e)  the   State   Financial   Corporation   established   under  

section 3 of the State Financial Corporation Act, 1951 

(Central Act 63 of 1951); or

(f) any   institution   established   by   or   under   an   Act   of

Parliament or the Legislature of a State, which grants

any loan or advance in pursuance of the provisions of

that Act or,

(g)  any   other   institution   in   the   public   sector,   whether

incorporated  or not  exempted by the  Government by

notification.

Explanation I.  Where a person, who carries on in the State ―

of

Kerala  the  Business  of advancing  and  realising  loans  is 

resident outside the State, the agent of such person resident

in the State shall be deemed to be the money­lender in respect

of that business for the purposes of this Act.

10

Explanation II.  For the purposes of this Clause, clause (7A), ―

Proviso to sub­section (1) of section 3, clause (a) of sub­section

(3) of section10, [section 16B] and section 17, the word

“person” shall include “a firm or a joint family;””

4.9  As   seen   from   the   definition,   7   different   types   of   business

entities are excluded from the definition of the expression “money

lending”. A financial corporation which is not a bank and which is

otherwise   known   as   NBFC,   is   not   listed   as   one   of   the   entities

excluded from the definition of the expression “money lender”.

4.10   A bank is excluded from the definition of the expression

“money lender”, by virtue of clause (a). But the word “bank” is

defined in Section 2(1A) as follows:­

“Sec. 2 (1A) “bank” means­

(i) a banking company to which the Banking Regulation

Act, 1949 (Central Act 10 of 1949), applies;

(ii) the   State   Bank   of   India   constituted   under   the   State

Bank of India Act, 1955 (Central Act 23 of 1955);

(iii)  a subsidiary bank as defined in clause (k) of section of

the State Bank of India (Subsidiary Banks) Act. 1939

(Central Act 38 of 1959);

(iv)  the Industrial Development Bank of India established

under the Industrial Development Bank of India Act,

1964 (Central Act 18 of 1964);

(v)  a corresponding new bank constituted under section 3

of the Banking Companies (Acquisition and Transfer of

Undertakings) Act, 1970 (Central Act 5 of 1970); 

11

(vi)  a Regional Rural Bank established under the Regional

Rural Banks Act, 1976 (Central Act 21 of 1976);

(vii)  a corresponding new bank constituted under section 3

of   the   Banking   Companies   (Acquisition   and   Transfer

of Undertakings) Act, 1980 (Central Act 40 of 1980); 

(viii)  the Export Import Bank of India established under the

Export Import Bank of India Act, 1981, (Central Act 28

of 1981);

(ix)   the National Bank for Agriculture and Rural Development

established   under   the   National   Bank   for  

Agriculture and Rural Development Act, 1981 (Central

Act 61 of 1981);

(x)    the Industrial Reconstruction Bank of India established

under the Industrial Reconstruction Bank of India Act,

1984 (Central Act 62 of 1984);

4.11  The   Banking   Regulation   Act,   1949   defines   a   “banking

company” under Section 5(c) as follows:­

“5. Interpretation – 

xxx xxx xxx

(c) "banking company" means any company which transacts

the business of banking in India;

Explanation.   ­   Any   company   which   is   engaged   in   the

manufacture   of   goods   or   carries   on   any   trade   and   which

accepts   deposits   of   money   from   the   public   merely   for   the

purpose of financing its business as such manufacturer or

trader   shall   not   be   deemed   to   transact   the   business   of

banking within the meaning of this clause;”

4.12  The word “banking” itself is defined in Section 5(b)  of the

Banking Regulation Act, 1949 as follows:­

12

“5. Interpretation – 

xxx xxx xxx

(b) "banking" means the accepting, for the purpose of

lending or investment, of deposits of money from the

public,   repayable   on   demand   or   otherwise,   and

withdrawal by cheque, draft, order or otherwise;”

4.13  By virtue of the definition of the word “banking” contained in

Section 5(b) of the Banking Regulation Act, 1949, an institution or

business entity which does not accept deposits of money from the

public,   either   for   the   purpose   of   lending   or   for   the   purpose   of

investment,   will   not   be   a   banking   company.   While   a   banking

company   may   be   involved   in   both   the   business   of   accepting

deposits   and   lending   money,   a   financial   institution   which   is

engaged only in the business of lending, may not be covered by the

definition of the expression “banking company” under the Banking

Regulation Act, 1949. 

4.14   Since NBFCs which do not accept deposits from the public do

not come within the purview of the Banking Regulations Act, the

Reserve Bank of India Act, 1934 had to step in. To make things

more clear that there is no duplication of control, Section 45­H of

the RBI Act states that the provisions of Chapter III­B shall not

13

apply to a Banking Company as defined in Section 5 of the Banking

Regulation Act. 

4.15    But   the   definition   of   “money   lender”   in   the   Kerala   Act

excludes   only   a   “bank”   to   which   the   Banking   Regulation   Act

applies.  It does not exclude a non banking institution from the

definition. Therefore, the Kerala State authorities started claiming

and technically rightly so, that NBFCs are not excluded from the

definition of “money lender”. Though the NBFCs claimed that under

clause (f) of sub­section (7) of Section 2, “any institution established

by or under an Act of Parliament or the Legislature of a State”  are

excluded from the definition of the expression “money­lender” and

that NBFCs are established under a Parliamentary enactment, this

argument was found by the State to be based on a convoluted logic.

We also think that the State was right in thinking so, since NBFCs

are not established by  or  under  an Act of  Parliament  or  the

legislature of a State. Incorporation/registration of a business

entity   under   an   Act   of   Parliament   or   the   Legislature   of   a

State,   is   completely   different   from   being   established   by   or

under an Act. For instance, all companies are incorporated under

14

the  Companies Act. But  a corporation  like the  LIC  of India, is

established under the LIC of India Act. Therefore, the appellants

were not right in claiming that they fall under the exclusion clause

in clause (f) of sub­section (7) of Section 2. Keeping this aspect in

mind, let us now see the scheme of the Kerala Act. 

4.16    The scheme of the Kerala Act is:­

(i) To make it obligatory for a money lender to obtain a

licence under the Act;

(ii) To prohibit any person from carrying on or continuing

the business of money lending without licence;

(iii) To prevent money lenders from charging interest at a rate

higher than the rate prescribed under the Act;

(iv) To   prevent   money   lenders   from   giving   any   gifts,

commissions or presents other than the interest provided

in Section 4(2) to any depositor;

(v) To enable the debtor to deposit the money due in respect

of a loan, into any Court having jurisdiction to entertain

a suit for recovery of the loan and to seek the recording of

full or part satisfaction of the loan;

(vi) To make it mandatory for money lenders  to keep books

of accounts and to give receipts;

15

(vii) To make it compulsory for a pawn broker to issue a pawn

ticket,   the   possession   of   which   will   give   rise   to   a

presumption that the holder of the pawn ticket has a

right to redeem the pledge;

(viii) To prescribe the procedure for redemption of pledge, sale

of pledge and compensation for depreciation of pledge;

(ix) To appoint inspectors with certain powers of inspection

and search;

(x) To empower the licensing authority to demand additional

security   from   the   money   lender,   if   there   is   excess   of

liabilities over the assets of the money lenders at any

time; and 

(xi) Providing for cancellation of licence, forfeiture of security

and imposing penalty for violation of the provisions of the

Act.

5. Gujarat Act

5.1   The Gujarat Act defines a “money lender”, in Section 2(10) to

mean “an   individual,   a   HUF,   a   company,   a   pawn­broker   or

unincorporated company (i) who/which carries on the business

of   money   lending   in   the   State   or   (ii)   who/which   has   his

principal or subsidiary place of such business in the State”. 

16

5.2     The expression “business of money lending” is defined in

Section 2(3) to mean “the business of advancing loans, whether

in cash or kind and whether or not in connection with or in

addition  to  any  other  business  and  includes  the  business  of

payment of loan by an agreement under any law for the time

being in force”.

5.3   By virtue of the aforesaid definitions, the application of the

Gujarat Act to any business entity/individual revolves around the

definition of the word “loan”. It is defined in Section 2(9) as follows:

“loan” means an advance whether of money or in kind, at an

interest, with or without security, and includes advance, discount,

money paid for or on account of or on behalf of or at the request of

any   person,   or   the   forbearance   to   require   payment   of   money

owing on any account whatsoever, and every agreement under

any law for the time being in force (whatever its terms or form

may be) which is in substance or effect a loan of money, but does

not include – 

(a) a deposit of money or other property in a Government post

office, a bank, a company or a co­operative society; 

(b) a loan to, or by, or a deposit with any society or association

registered under the Societies Registration Act, 1860, or any other

enactment relating to a public, religious or charitable object; 

(c) a loan advanced by the State Government or by any local

authority authorized by the State Government; 

17

(d)  a  loan  advanced  to  a Government  employee  from  a fund,

established   for   the   welfare   or   assistance   of   Government

employees and which is sanctioned by the State Government; 

(e) a deposit of money with or a loan advanced by a cooperative

society;

(f)  an  advance  made  to   a  subscriber  to,  or  a  depositor  in,  a

provident fund from the amount standing to his credit in the fund

in accordance with the rules of the fund; 

(g)   a   loan   to   or   by   an   insurance   company   as   defined   in   the

Insurance Act, 1938; 

(h) a loan advanced by a Government company as defined in the

Companies Act, 1956; 

(i) an advance made bona fide by any trader carrying on any

business, other than money­lending, if such advance is made in

the regular course of such business; 

(j) a loan advanced by the National Bank for Agriculture and

Rural   Development   established   under   the   National   Bank   for

Agriculture and Rural Development Act, 1981; 

(k)   a   loan   advanced   by   the   Export­Import   Bank   of   India

established under the Export­Import Bank of India Act, 1981; 

(l) a loan advanced by the Small Industries Development Bank of

India, established under the Small Industries Development Bank

of India Act, 1989; 

(m) a loan advanced by the National Housing Bank, constituted

under the National Housing Bank Act, 1987 ; 

(n) a loan advanced by State Financial Corporations established

under the State Financial Corporations Act, 1951 ; and 

(o) a loan advanced by any institution ­ (1) established by or

under an Act of Parliament or the legislature of a State, which

grants any loan or advance in pursuance of the provisions of that

Act, or (2) notified in this behalf by the State Government, in

consultation with the Reserve Bank;     

18

5.4 By virtue of the aforesaid definitions, the authorities under the

Gujarat Act sought to apply the provisions of the Act to NBFCs also.

Therefore, it is essential that we look at the scheme of the Act.

5.5 The broad scheme of the Gujarat Act is :

(i) To provide for the registration of money lenders;

(ii) To prohibit any person from carrying on the business of

money lending without a valid certificate of registration in

respect of the area concerned;

(iii)  To empower the Registrar General, Registrar and other

officers   appointed   under   the   Act   to   require   the

production of records and documents and to carry out

searches and seizures;

(iv) To mandate every money lender to keep and maintain

proper books of Accounts and other registers;

(v) To make it obligatory for money lenders to file yearly

statement of accounts of each of the debtors;

(vi) To prohibit the disposal of any article taken by a money

lender from a debtor as a bond, pledge or security for the

loan advanced, for a period of two years from the date

stipulated for financial repayment of the loan;

19

(vii) To regulate the powers of the Civil Court while deciding

the suits to which the Act applies, so that the Court is

satisfied that the provisions of the Act are complied with;

(viii) To curtail the power of the Court to award interest in a

sum greater than the principal of the loan due on the

date of the decree;

(ix) To empower the Court to allow payment of the decretal

amount by instalments;

(x) To empower the Court even to reopen past transactions;

(xi) To enable the borrower to deposit the amounts due in

respect of a loan into Court;

(xii) To empower the State Government to fix the maximum

rate of interest, for any local area or class of business;

(xiii) To prohibit money lenders from receiving from the debtor,

any amount by way of costs, charges or expenses;

(xiv) To make it obligatory  for the money lender to provide

advance information, whenever the loan is assigned to a

third party;

(xv) To prohibit money lenders from accepting any promissory

note, acknowledgment, bond or other writing which does

not state the actual amount of loan or which states the

amount   wrongly   or   which   contains   erasures   or   overwriting; and

(xvi) To   provide   for   penalties   for   contravention   of   the

provisions of the Act.

20

5.6 It may be of interest to note that Section 39 of the Gujarat Act

contains a very strange provision which reads as follows:­

“Notwithstanding anything contained in this Act or any other

law for the time being in force, no money lender shall recover

the principal of the loan advanced by him  or  the interest

thereon either in part or in whole except in cash.”

5.7 Though   we   are   not   concerned   with   the   validity   of   such   a

provision we could not resist the temptation to take note of the said

provision which is in the teeth of Section 269­SS of the Income Tax

Act, 1961.

6. Role  of  RBI,  the  scheme  of  Chapter  III­B  of  the  RBI  Act

and the Regulatory measures taken by RBI from time to time  

6.1    As   observed   by   this   Court   in  Internet   and   Mobile

Association of India  vs.  Reserve Bank  of India1

,  “the role of a

Central   Bank   such   as   the   Reserve   Bank,   in   an   economy,   is   to

manage  (i)  the   currency;  (ii)  the   money   supply   and  (iii)  interest

rates”. One of the objects the Reserve Bank of India Act, 1934 as

spelt out in its preamble is “to  operate   the  currency and   credit

system of the country to its advantage”.

1 (2020) 10 SCC 274

21

6.2   Therefore, in contrast to the state enactments regulating the

business   of   money   lending,   whose   one­eyed   focus   is   only   the

protection of borrowers, the RBI Act takes a holistic approach to the

business of banking, money lending and operation of the currency

and credit system of the country. But when RBI Act was enacted,

the business of banking and finance was not as complicated as it

later turned out to be.

6.3 In  the early 1960s, the  Government found it  necessary to

regulate   institutions   which   were   not   banks,   but   which   were

carrying on other businesses allied to banking. Therefore, a bill to

amend the RBI Act, The Banking Companies Act, 1949, and the

State Bank of India (Subsidiary Banks) Act, 1959 was introduced in

November, 1963. The Statement of Objects and Reasons spelt out

that the existing enactments relating to banks did not provide for

any control over such banks or institutions and that therefore it

was felt necessary that the RBI should be enabled to regulate the

conditions   on   which   deposits   may   be   accepted   by   non­banking

companies   or   institutions,   for   the   purposes   of   ensuring   more

effective supervision and management of the monetary and credit

22

system by the Reserve Bank.  One of the important objects spelt out

in the Statement of Objects and Reasons reads as follows:­

“The Reserve Bank should also be empowered to give to any

financial   institution   or   institutions   directions   in   respect   of

matters, in which the Reserve Bank, as the central banking

institution of the country, may be interested from the point of

view of the control of credit policy”

Clause (5) of the Notes on Clauses accompanying the Bill read as

follows:­

“Clause 5.­A new Chapter is proposed to be introduced in the

Reserve Bank of India Act for enabling that bank to obtain

returns and information from (a) certain financial institutions,

namely, firms, companies or other bodies corporate which are

financing trade,  industry,  commerce  or agriculture, or  are

carrying on as a part of their business the acquisition of

shares, stocks, bonds, debentures or other securities, or are

engaged mainly in the financing of hire­purchase transactions

and   (b)   non­banking   institutions   accepting   deposits   from

members of the general public.   The objects in view are to

provide for­

(i) the supervision and control of the financial 

institutions mentioned above in the interests of better or 

more effective control of credit, and

(ii) the regulation of the business of acceptance 

of deposits by these and other non­banking institutions, 

in the public interest.

The Reserve Bank will be empowered to provide, by general

or   special   order,   for   the   forms   in   which   returns   and

information   are   to   be   furnished   to   it,   and   also   to   give

directions to any class of institutions or to any institution in

particular for the purposes specified.  The Reserve Bank will

also be enabled to carry out inspections, where necessary,

for carrying out the purposes of the new Chapter.”

23

6.4 Accordingly, the Banking Laws (Miscellaneous Provisions Act),

1963, was enacted, amending the provisions of the aforesaid three

Parliamentary enactments. It was by this amendment which came

into force on 01.02.1964 that Chapter III­B was inserted in RBI Act.

The Chapter heading for this Chapter read as, “Provisions Relating

to   Non­Banking   Institutions   Receiving   Deposits   and   Financial

Institutions”. However, this  Chapter III­B was made inapplicable

under Section 45­H to a banking company as defined in Section 5

of   the   Banking   Companies   Act,   1949.   Section   45­I   defined   a

‘financial   institution’   under   clause   (c)   to   mean   any   non­banking

institution   which   carries   on   the   business   of   financing   or   the

business of acquisition of shares, stocks etc., or the business of

hire­purchase transactions.

6.5 Chapter   III­B   as   it   was   introduced   by   the   Banking   Laws

(Miscellaneous Provisions Act), 1963, contained no spell­binding or

path­breaking provisions. Broadly, Chapter III­B as it was originally

introduced in 1963, (i) empowered RBI to regulate or prohibit the

issue of prospectus or advertisement soliciting deposits of money;

(ii)  empowered the RBI to collect information from non­banking

24

institutions about deposits and to give directions;  (iii)  empowered

the RBI to call for information from financial institutions and to give

directions, for the purpose of regulating the credit system of the

country;  (iv)  obliged   the   non­banking   institutions   to   furnish

statements   to   the   RBI;  (v)  provided   for   inspection   by   RBI;  (vi)

prescribed penalties for any violation and conferred overriding effect

to Chapter III­B over other laws. 

6.6 After the introduction of Chapter III­B under Act 55 of 1963,

three amendments which are not relevant for our purpose, were

made to the provisions contained in Chapter III­B, under Act 51 of

1974, Act 21 of 1976 and Act 1 of 1984.

6.7 Post the insertion of Chapter III­B under Act 55 of 1963, the

working   of   non­banking   financial   intermediaries   came   to   be

reviewed by two study groups, one under the chairmanship of Dr.

Bhabhatosh Datta in 1971 and another under the chairmanship of

Shri James Raj in 1975. Certain recommendations were made by

these two study groups. Thereafter, the issue was considered by

three other committees namely,  (i)  the Committee to Review the

Working of the Monetary System (Chakravarty Committee­1985);

25

(ii)  the Working Group on the Money Market (Vaghul Committee1987);   and  (iii)  the   Committee   on   the   Financial   System

(Narasimham Committee­1991).

6.8 Those reports and various socio­economic and political factors

led to the liberalisation of the economy in 1991. The liberalisation of

the   economy   saw   the   growth   of   non­banking   financial   services

sector   in   India   accompanied   by   a   corresponding   growth   in   the

number of NBFCs offering a diversified range of financial services

and products. Therefore, a need was felt for rationalisation of the

regulatory framework for these companies keeping in view the trend

towards liberalisation of economy in general and the financial sector

in particular. In order to make an in­depth study of the role of

NBFCs and to suggest regulatory and control measures to ensure

healthy growth and operations of these companies, RBI constituted

a Working Group under the Chairmanship of Dr. A.C. Shah, in

May, 1992. The terms of reference of the Working Group in simple

terms2

 were:­

2 Report of the Working Group on Financial Companies C.R. 483 submitted in September, 

1992

26

(i) To review the role of various categories of non­banking

financial intermediaries;

(ii) To   review   the   provisions   of   the   RBI   Act,   1934;   NonBanking Financial Companies (Reserve Bank) Directions

1977,   Miscellaneous   Non­Banking   Companies   (Reserve

Bank)   Directions,   1977;   Residuary   Non­Banking

companies (Reserve Bank) Directions, 1987; The National

Housing   Bank   Act,   1987   and   The   Housing   Finance

Companies (NHB) Directions, 1989;

(iii) To enquire into the methods of operation of non­banking

financial intermediaries and to recommend measures for

ensuring   their   orderly   growth   and   in   particular,   the

eligibility criteria for their entry, growth and exit, their

viability,   capital   adequacy,   liquidity   ratio,   debt   equity

ratio, credit concentration ratio, disclosure requirements

and other prudential norms;

(iv) To consider the adequacy of the supervision and control

of RBI over such institutions and suggest measures for

further strengthening them;

(v) To   examine   the   adequacy   of   protection   to   depositors’

money; and

(vi) To make recommendations on any other related matter.

27

6.9 The Working Group chaired by Dr. A.C. Shah, took note of the

fact that the total number of NBFCs which stood at 7063 in 1981

increased to 24,009 by 1990 and that there were different categories

of   NBFCs   operating   in   the   country   such   as   loan   companies,

investment companies, hire­purchase finance companies, equipment

leasing   companies,   mutual   benefit   finance   companies,

miscellaneous   finance   companies,   miscellaneous   non­banking

companies, residuary non­banking companies and housing finance

companies.   This   Working   Group   actually   recommended   in

paragraph   6.72   of   its   Report   that   though   NBFCs   were   being

regulated by the directions issued under Chapter III­B of the RBI Act

and Chapter­V of the NHB Act, it would be better to enact a separate

legislation. The Working Group went to the extent of recommending

that such a legislation should be put under Schedule IX of the

Constitution.

6.10 All the above led to the promulgation of the Reserve Bank of

India (Amendment) Ordinance, 1997 on 09.01.1997. Subsequently,

a   bill   was   introduced   which   became   the   Reserve   Bank   of   India

(Amendment) Act, 1997. This Act completely revamped Chapter III­B

28

by amending the definition provision in Section 45­I and inserting

certain new provisions such as Section 45­IA, 45­IB, 45­IC, 45­JA,

45­MB, 45­MC etc. After the amendment made to Chapter III­B by

Act 23 of 1997, this Chapter has become a complete Code in so far

as NBFCs are concerned. This can be seen from various provisions

of Chapter III­B, which is summarized in the form of a table for easy

reference as follows:­

PROVISION REQUIREMENT

Section 45­ IA (i)       Certificate of Registration mandatory for a

NBFC to commence or carry on the business of a

non­banking financial institution.

(ii)    Such NBFC should have a net­owned fund of

Rs.25 lakhs or such other amount not exceeding

Rs. 100 crores, as the RBI may prescribe.

(iii)         The   application   for   registration  shall  be

considered by RBI subject to certain parameters

prescribed in sub­section (4)

Section 45­IB (i)         NBFCs   have   to  invest   in  un­encumbered

approved securities, such amount which shall not

be less than 5% or such higher percentage not

exceeding 25% prescribed by RBI.

(ii)    Every NBFC should furnish a return to RBI,

so as to ensure compliance with the provisions of

this Section.

(iii)    Penal interest is liable to be levied if there 

was a shortfall in the investment.

Section 45­IC (i)   Every NBFC should create a reserve fund and

transfer to the said fund a sum not less than 20%

of its net profit every year. No part of the reserve

29

fund shall be appropriated by the NBFC except for

a purpose stipulated by RBI.

Section 45­ID (i)    RBI is entitled to remove the Director of an

NBFC   from   office,   if   it   is   satisfied   that   it   is

necessary to do so in public interest or to prevent

the affairs of a NBFC being conducted in a manner

detrimental   to   the   interest   of   the   depositors   or

creditors or financial stability or for securing the

proper management of such company.

Section 45­IE (i)   RBI will have the power of supersession of the

Board of Directors of a NBFC in public interest etc.

Section 45­J (i)   RBI will have the power to regulate or prohibit

the issue of prospectus or advertisement soliciting

deposits of money.

Section­45JA (i)   In public interest or for the regulation of the

financial system of the country to its advantage or

to   prevent   the   affairs   of   any   NBFC   being

conducted in a manner prejudicial to the interest

of the depositors or prejudicial to the interest of

the NBFC, RBI may  determine the policy and give

directions. 

Section 45­K (i)  RBI may demand every non­banking institution

to   furnish   such   statements   of   information   or

particulars   relating   to   or   connected   with   the

deposits received by the NBFCs.

Section 45­L (i) RBI will have the power to require financial

institutions   to   furnish   such   statements,

information or particulars relating to the business

of  such financial  institutions and to  give such

directions.

Section 45­M (i)   It shall be the duty of every NBFC to furnish

the statements, information or particulars called

for and to comply with any direction issued by

RBI.

Section 45­MA  RBI will have the power to issue directions to the

Auditors   of   NBFCs   relating   to   balance­sheet,

profit and loss account, disclosure of liabilities in

30

the books of accounts or any other matter.

Section 45­ MAA  RBI can take action against the Auditors who fail

to comply with any of the directions.

Section 45­MBA   RBI   may   frame   schemes   providing   for   the

amalgamation of NBFCs or the reconstruction of a

NBFC etc., if RBI is satisfied upon inspection of

the books of accounts that it is in public interest

or in the interest of financial stability to do so.

Section 45­MC RBI will be entitled to move an application for the

winding   up   of   an   NBFC,   under   certain

circumstances.

Section 45­N  Power of inspection.

Section 45­NAA  RBI may at any time direct a NBFC to annex to

its   financial   statements,   such   statements   and

information relating to the business or affairs of

any group company of NBFC.

Section 45­NC RBI may exempt a NBFC from the application of

any or all of the provisions of Chapter III­B

6.11   The above scheme of Chapter III­B of the RBI Act shows that

the power of intervention available for the RBI over NBFCs, is from

the cradle to the grave. In other words, no NBFC can carry on

business without being registered under the Act and a NBFC which

takes birth with the registration under the Act is liable to be wound

up at the instance of the RBI. The entire life of a NBFC from the

womb to the tomb is also regulated and monitored by RBI.  

31

6.12  At this juncture it may be ideal to extract some of the relevant

provisions of Chapter III­B.

6.13   A Non­banking financial company is defined in clause (f) of

Section 45­I as follows:­

“45­I.

(f) “non­banking financial company” means –

(i) a financial institution which is a company;

(ii) a non­banking institution which is a company

and which has as its principal business the

receiving   of   deposits,   under   any   scheme   or

arrangement   or   in   any   other   manner,   or

lending in any manner;

(iii) such other non­banking institution or class of

such institutions, as the Bank may, with the

previous approval of the Central Government

and   by   notification   in   the   Official   Gazette,

specify.”

6.14   Section 45­JA which gives power to the RBI to determine the

policy and issue directions, reads as follows:­

“45JA.   Power   of   Bank   to   determine   policy   and   issue

directions. ­­ (1) If the Bank is satisfied that, in the public

interest or to regulate the financial system of the country to

its advantage or to prevent the affairs of any non­banking

financial company being conducted in a manner detrimental

to the interest of the depositors or in a manner prejudicial to

the   interest   of   the   non­banking   financial   company,   it   is

necessary or expedient so to do, it may determine the policy

and give directions to all or any of the non­banking financial

companies   relating   to   income   recognition,   accounting

standards, making of proper provision for bad and doubtful

debts, capital adequacy based on risk weights for assets and

credit conversion factors for off balance­sheet items and also

relating to deployment of funds by a non­banking financial

company or a class of non­banking financial companies or

32

non­banking financial companies generally, as the case may

be,   and   such   non­banking   financial   companies   shall   be

bound to follow the policy so determined and the direction so

issued.

(2)  Without prejudice to the generality of the powers

vested under sub­section (1), the Bank may give directions to

non­banking financial companies generally or to a class of

non   banking   financial   companies   or   to   any   non­banking

financial company in particular as to­­

(a) the purpose for which advances or other fund

based or non­fund based accommodation may

not be made; and

(b) the   maximum   amount   of   advances   or   other

financial   accommodation   or   investment   in

shares and other securities which, having regard

to the paid­up capital, reserves and deposits of

the non­banking financial company and other

relevant considerations, may be made by that

non­banking financial company to any person or

a company or to a group of companies.”

6.15   Section 45­K which empowers the RBI to collect information

reads as follows:­

“45K. Power   of   Bank   to   collect   information   from  nonbanking   institutions   as   to   deposits   and   to   give

directions. – 

(1) The Bank may at any time direct that every non­banking

institution shall furnish to the Bank, in such form, at such

intervals and within such time, such statements information

or particulars relating to or connected with deposits received

by the non­banking institution, as may be specified by the

Bank by general or special order.

(2)  Without prejudice to the generality of the power

vested in the Bank under sub­section (1), the statements,

information or particulars to be furnished under sub­section

(1), may relate to all or any of the following matters, namely,

the amount of the deposits, the purposes and periods for

33

which,   and   the   rates   of   interest   and   other   terms   and

conditions on which, they are received.

(3)  The Bank may, if it considers necessary in the

public   interest   so   to   do,   give   directions   to   non­banking

institutions   either   generally   or   to   any   non­banking

institution   or   group   of   non­banking   institutions   in

particular, in respect of any matters relating to or connected

with the receipt of deposits, including the rates of interest

payable on such deposits, and the periods for which deposits

may be received.

(4)   If any non­banking institution fails to comply

with any direction given by the Bank under sub­section (3),

the Bank may prohibit the acceptance of deposits by that

non­banking institution.

1

[***]

(6)  Every non­banking institution receiving deposits

shall, if so required by the Bank and within such time as the

Bank may specify, cause to be sent at the cost of the nonbanking institution a copy of its annual balance­sheet and

profit and loss account or other annual accounts to every

person from whom the non­banking institution holds, as on

the   last   day   of   the   year   to   which   the   accounts   relate,

deposits higher than such sum as may be specified by the

Bank.”

6.16   Section 45­L empowers RBI to call for information and to give

directions. It reads as follows:­

“45L. Power   of   Bank   to   call   for   information   from

financial   institutions   and   to   give   directions.­­(1) If the

Bank is satisfied for the purpose of enabling it to regulate

the   credit   system   of   the   country   to   its   advantage   it   is

necessary so to do, it may­­

(a)  require financial institutions either generally or

any  group of financial institutions or financial

institution  in particular, to furnish to the Bank

in such form, at such intervals and within such

time,   such   statements,   information   or

particulars   relating   to   the   business   of   such

financial institutions or institution, as may be

34

specified   by   the   Bank   by   general   or   special

order;

(b)  give to such institutions either generally or to

any   such   institution   in   particular,   directions

relating to the conduct of business by them or

by it as financial institutions or institution.

        (2)  Without prejudice to the generality of the power

vested in the Bank under clause (a) of sub­section (1), the

statements, information or particulars to be furnished by a

financial institution may relate to all or any of the following

matters,   namely,   the   paid­up   capital,   reserves   or   other

liabilities, the investments whether in Government securities

or otherwise, the persons to whom, and the purposes and

periods for which, finance is provided and the terms and

conditions, including the rates of interest, on which it is

provided.

         (3)  In issuing directions to any financial institution

under clause (b) of sub­section (1), the Bank shall have due

regard to the conditions in which, and the objects for which,

the   institution   has   been   established,   its   statutory

responsibilities, if any, and the effect the business of such

financial institution is likely to have on trends in the money

and capital markets.”

6.17    One of the most important provisions contained in Chapter

III­B is Section 45­Q. It reads as follows:­

“45Q.   Chapter   IIIB   to   override   other   Laws.—The

provisions of this Chapter shall have effect notwithstanding

anything inconsistent therewith contained in any other law

for the time being in force or any instrument having effect by

virtue of any such law.”

6.18   It is too long in the day to dispute the fact that the directions

issued by RBI are statutory in character and binding on all NBFCs.

35

It is so, in respect of the directions issued both under the RBI Act

and under the Banking Regulation Act.  

6.19     Once   it   is   found   that   Chapter   III­B   of   the   RBI   Act

provides   a   supervisory   role   for   the   RBI   to   oversee   the

functioning of NBFCs, from the time of their birth (by way of

registration) till the time of their commercial death (by way of

winding up), all activities of NBFCs automatically come under

the   scanner   of   RBI.   As   a   consequence,   the   single   aspect   of

taking care of the interest of the borrowers which is sought to

be   achieved   by   the   State   enactments   gets   subsumed   in   the

provisions of Chapter III­B.

Regulations/Master   Circulars/Directions   issued   by   RBI   from

time to time

6.20    Apart from the provisions of Chapter III­B, the regulations,

directions and Master Circulars issued by RBI from time to time,

also bind the NBFCs. There is a long list of Regulations/directions or

Master Circulars issued by RBI from 1977 onwards, which shows

that even before the 1997 Amendment to the RBI Act, some kind of

36

control   was   exercised   by   RBI   over   NBFCs.   After   the   1997

amendment, every aspect of the business of NBFCs, including loans,

is covered by Master Circulars/ Directions issued by RBI. In other

words,   the   only   field   occupied   by   the   State   enactments   stand

appropriated by the Master Circulars/Directions. For demonstrating

that even the subject of grant of loans is covered by these Master

Circulars/Directions, we present in the Table below, the relevant

circulars/directions.

Title   of     the

Circular/ directions

The   provision

under   which

it was issued

Subject   matter   in   general

and  provision  dealing  with

loans and rate of interest

Non-Banking Financial

(Deposit Accepting or Holding)

Companies Prudential Norms

(Reserve Bank) Directions

2007

Section 45JA General policy including loans

Clause 7: Need for Policy on Demand/

Call Loans

Board to frame policy with respect to

 Cut off date for repayment or call

up

 Rate of interest

 Reasons in writing for effecting

Moratorium and sanctioning

interest free loans

Revisions on the Guidelines of

Securitisation Transactions

incorporated in the Reserve

Bank of India (Securitisation

of Standard Assets)

Directions, 2021

Sections 21 and 35A

of the Banking

Regulation Act,

1949; Chapter IIIB

of the Reserve Bank

of India Act, 1934

Securitisation of Standard Assets

Clause 1.2: Minimum Holding Period

 Loans to be securitised only after

minimum holding period

Clause 1.3: Minimum Retention

Requirement (MRR)

 NBFC to have continued stake in

performance of securitised asset

to ensure proper due diligence of

37

sanctioned loans

Master Circular- Fair Practices

Code, 2014

General Fair Practices Guidelines

including in loan appraisal and

disbursement

Clause 2A(ii): Loan Appraisal and

Terms and Conditions:

 Sanction letter to contain loan

amount and annualised Rate of

Interest in vernacular language.

 NBFCs shall mention the penal

interest so charged on late

repayment in bold in loan

agreement.

Clause 2A(iii): Disbursement of loans

including changes in terms and

conditions

 NBFC to give notice of any

change in terms of a loan

including disbursement schedule,

rate of interest etc in vernacular.

 NBFCs should effect change in

rate of interest prospectively

only.

Clause 2A(viii): Regulation of

excessive interest charged by NBFCs

 Board of each NBFC to adopt an

interest rate model taking into

account cost of funds, margin,

risk premium etc.

Rate of interest and the approach for

gradations of risk and rationale for

charging different rates of interest for

different categories of borrowers shall be

disclosed to the borrower and

communicated explicitly in the

sanction letter.

Non-Banking Financial

Company - Non-Systemically

Important Non-Deposit taking

Company and Deposit taking

Company (Reserve Bank)

Directions, 2016

Sections 45JA, 45L

and 45M of the RBI

Act

Chapter IV: Prudential Regulations

Clause 11: Need for policy on

demand/call loans :

 Board of Directors shall frame

policy for applicable NBFCs

which stipulate:

1. Cut-off date for repayment of

38

And

Non-Banking Financial

Company-Systemically

Important Non-Deposit taking

Company and Deposit taking

Company (Reserve Bank)

Directions, 2016

demand or call loan shall be

demanded with reasons in

writing if the cut-off date extends

beyond a period of 1 year from

date of sanction.

2. Rate of interest which shall be

payable on such loans. Such

interest shall be payable either at

monthly or quarterly rests.

Reasons in writing if moratorium

is granted or no interest is

stipulated.

Chapter V: Fair Practices Code for

applicable NBFC

Clause 28: Applications for loans &

their processing

 Communications to borrower to

be in vernacular

language/language understood by

them.

 Loan application forms to

include necessary information

which affects interest of the

borrower & to indicate

documents required to be

submitted.

 To devise a system of giving

acknowledgement for receipt of

all loan applications with time

frame within which applications

will be disposed of.

Clause 29: Loan Appraisal &

Terms/Conditions

 Communication regarding

amount of loan sanctioned along

with T&C including annualised

rate of interest & method of

application etc. in vernacular

language to the borrower.

Interest rate will have to be

clearly specified.

 Not furnishing a copy of loan

39

agreement is unfair practice.

Clause 36: Regulation of excessive

interest charged by applicable NBFC

 Board of NBFCs shall adopt

interest rate model accounting

for relevant factors: cost of

funds, margin & risk premium &

determine rate of interest to be

charged for loans & advances

etc.

 Explicit reasons to be given for

different rates of interest to

different categories of borrowers.

Clause 37: Complaints about

excessive interest charged by

Applicable NBFCs

Board of NBFCs shall lay out appropriate

internal principles & procedures in

determining interest rates & processing

and other charges

Non-Banking Financial

Company-Housing Finance

Company Directions 2021

Section 45L, Section

45MA of RBI Act

Regulation of excessive interest on

loans (Clause 80 and 81)

i) Rate of interest on loans to be made

available on company website as an

annualised rate.

ii) Board to adopt interest rate model

taking account of cost of funds, margin,

risk premium etc

iii) Company to place internal

mechanism to monitor fixing rate of

interest. The chapter pertaining to ‘Fair

Practices’ shall be applicable to interest

on loans.

RBI (Regulatory Framework

for Microfinance Loans)

Directions 2022

Section 21, Section

35A and Section 56

of the Banking

Regulation Act,

1949; Chapter IIIB

of the Reserve Bank

of India Act, 1934

Pricing of loans (Clause 6):

i) policy containing well-documented

interest rate model including factors

such as risk premium, margin, a ceiling

applicable to microfinance loans etc

ii) Rate of interest not to be usurious.

This shall be subject to scrutiny by

RBI

iii) change in rate of interest to be

informed to borrower well in advance

Ombudsman Scheme for

NBFC- 2018

Section 45L Rule 8 empowers any person to file a

complaint with the Ombudsman for the

40

grounds mentioned in the rule.

The procedure for filing a complaint is

given in Rule 9.

Rule 11 provides for settlement of the

complaint by agreement between the

parties.

Rule 12 provides for the alternative

where if the complaint is not settled by

agreement, the Ombudsman can pass an

award.

Rule 14(4) also mandates that the NBFC

must implement the award and send a

report of the same to RBI within 15 days

of the award becoming final

Since the Regulations, Master Circulars and Directions issued by

RBI are binding on NBFCs, it is clear from the above that all aspects

of   NBFCs   are   regulated   by   RBI   and   nothing   is   left   untouched.

However,   there   are   certain   categories   of   NBFCs,   which   may   be

exempt, by RBI itself, in exercise of the power conferred by section

45­NC of the Act, from the application of the provisions of RBI Act.

Let us also take note of them now.

NBFCs  Exempt from RBI Act 

6.21   Section 45­NC of the RBI Act confers power upon the RBI to

declare by notification in the Official Gazette, that any or all of the

provisions of Chapter III­B shall not apply to a NBFC or any class of

NBFCs, either generally or for a specified period, subject to such

41

restrictions, limitations and conditions. In exercise of the power so

conferred, RBI has been issuing Master Directions from time to

time. A Master Direction issued on 25.08.2016, updated as on April

01,   2022   lists   various   categories   of   NBFCs   exempt   from   the

application of certain specified provisions of Chapter III­B. This is

for   the   reason   that   some   of   those   exempted   companies   are

regulated by other regulatory bodies. For instance, Housing Finance

Institutions are regulated by the National Housing Bank; Merchant

Banking companies, Venture Capital Fund Companies and the like

are   regulated   by   SEBI;   Nidhi   companies   and   mutual   benefit

companies are regulated by the Ministry of Corporate affairs; Chit

Fund   companies   are   regulated   by   State   Governments;   and

Insurance Companies are regulated by IRDA. We are not concerned

in this case with the exempted companies, as the dispute on hand

is confined only to NBFCs registered under the RBI Act.

Is Chapter III­B a complete code?

7. To find out whether NBFCs registered under Chapter III­B of

the RBI Act and regulated by RBI could still be controlled by the

State   enactments,   because   of   the   definition   of   the   expression

42

“money lender”, we may first have to see whether Chapter III­B of

the RBI Act is a complete code or not. In  Integrated   Finance

Company Limited  vs.  Reserve Bank of India and Others3

, this

Court held in para 47 of the Report that “Chapter III­B of the RBI Act

is a complete code in itself”.

7.1 We   have   seen   that   no   NBFC   can   commence   or   carry   on

business without obtaining the certificate of registration under the

Act. We have also seen that their continuation in business would

depend upon compliance with certain prescriptions found in the

RBI Act as well as the circulars/directions issued by RBI. The RBI

has the power to supersede the Board of Directors of a NBFC and

has power even to wind up a NBFC. Thus the supervision and

regulation of NBFCs, by the RBI, is from the time of birth till the

time of death. If a statutory enactment which provides for such a

type of control and supervision is not a complete code in itself, we

do not know what else could be a complete code.

7.2 It was argued by Mr. Jaideep Gupta, learned senior counsel

appearing for the State of Kerala that the Reserve Bank of India

3  (2015) 13 SCC 772

43

does not control the rate of interest charged by NBFCs on the loans

advanced by them and that, therefore, a State enactment which

seeks to control this aspect, namely, the rate of interest cannot be

said to be repugnant. According to the learned senior counsel, a

statutory enactment which does not deal with such an important

issue as the rate of interest chargeable on the loans, cannot be said

to be a complete code in itself. Reliance was placed by the learned

senior counsel in this regard on a Constitution Bench decision of

the Supreme Court in Deep Chand vs. State of U.P4

.

7.3    But we do not agree. NBFCs which play a very vital role in

contributing   to   the   financial   health   of   the   country   and   whose

operations are controlled by RBI with the avowed object of operating

the currency and credit system of the country to its advantage, have

as their life line, the income received by way of interest on the loans

advanced. Therefore, 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.

4 AIR 1959 SC 648

44

7.4 It may be true that many times RBI may not be controlling the

rate of interest charged by NBFCs on the loans advanced by them.

It does not mean that they have no power to step in. The power to

determine policy and issue directions, available under Section 45­

JA can always be invoked by RBI.

7.5 However,  it  was  contended  by Mr. Jaideep  Gupta,  learned

senior counsel for the State of Kerala that the power of the RBI

under Section 45­JA to determine the policy and give directions, are

circumscribed   by   the   words   “relating   to   income   recognition,

accounting   standards,   making   of   proper   provision   for   bad   and

doubtful debts, capital adequacy based on risk weights for assets

and credit conversion factors for off balance­sheet items and also

relating to deployment of funds”. 

7.6 But we do not think that the words “relating to” appearing in

Section 45­JA(1) can be taken to restrict the power of RBI to give

directions, only in relation to the matters mentioned after the words

“relating to”. The items mentioned after the words “relating to” can

only be taken to be illustrative and not exhaustive. This is for the

45

reason   that   the   power   conferred   by   Section   45­JA   is   both   for

determining the policy and for issuing directions.

7.7 Moreover, Sub­section (1) of Section 45­JA deals only with the

powers   in   general.   This   is   made   clear   by   the   words   “without

prejudice to the generality of the powers vested under sub­Section

(1)”, appearing in sub­Section (2) of Section 45­JA.

7.8 In any case, Section 45L(1)(b) confers power upon the RBI to

give directions to NBFCs “relating to the conduct of business by

them”. Therefore, to say that RBI has no power in respect of such

an important aspect, may not be correct. The fact that RBI generally

leaves it to the market forces to determine the rate of interest,

without any direct intervention, is not something that could be

taken advantage of by the State of Kerala to step in and prescribe

the maximum rate of interest chargeable by NBFCs on the loans

advanced by them.

7.9   In Deep Chand (supra), the Constitution Bench of this Court

reiterated three important tests of inconsistency or repugnancy,

namely,  (i)  whether   there   is   direct   conflict   between   the   two

46

provisions;  (ii)  whether   Parliament   intended   to   lay   down   an

exhaustive Code in respect of the subject matter replacing the Act of

the State legislature; and (iii) whether the law made by Parliament

and   the   law   made   by   State   legislature   occupy   the   same   field.

Therefore, more than supporting the case of the State, Deep Chand

(supra) actually supports the case of the NBFCs, as we have found

that Chapter III­B is a complete code in itself.

Doctrine of Eclipse, conflict and repugnancy

8. As   indicated   by   the   Constitution   Bench   in  Deep   Chand

(supra), a law may be valid when made, but a shadow may be

cast   on   it   by   supervening   constitutional   inconsistency   or

supervening   existing   statutory   inconsistency.   Assuming   that

the Kerala Act was valid in its application to NBFCs when it was

made,   on   the   ground   that   the   business   of   money   lending   is

traceable   to   Entry   30   of   List   II,   it   has   to   give   way   for   the

parliamentary enactment.  The  moment  the  Parliament  stepped

in to codify the law relating to registration and regulation of

NBFCs, by inserting certain provisions in Chapter III­B of the

47

RBI Act, the same would cast  a shadow on the applicability

(even assuming it is applicable) of the provisions of the Kerala

Act  to  NBFCs  registered  under  the RBI Act  and regulated by

RBI.

8.1 In Innoventive Industries Limited vs. ICICI Bank and Anr.

5

,

this Court was concerned with a professed conflict between the

Insolvency and Bankruptcy Code, 2016 and the Maharashtra Relief

Undertakings (Special Provisions) Act, 1958. After taking note of

Section 107 of the Government of India Act, 1935 and Article 254 of

the Constitution, this Court analysed the Constitutions of other

jurisdictions   on   the   question   of   inconsistency   of   laws   and

summarized the propositions of law as follows:

“51. The case law referred to above, therefore, yields the

following propositions :

51.1. Repugnancy under Article 254 arises only if both the

Parliamentary   (or   existing   law)   and   the   State   law   are

referable   to   List   III   in   the   Seventh   Schedule   to   the

Constitution of India.

51.2. In order to determine whether the Parliamentary (or

existing law) is referable to the Concurrent List and whether

the State law is also referable to the Concurrent List, the

doctrine of pith and substance must be applied in order to

find out as to where in pith and substance the competing

statutes  as a whole  fall. It is only if both fall, as a whole,

5 (2018) 1 SCC 407

48

within the Concurrent List, that repugnancy can be applied

to determine as to whether one particular statute or part

thereof has to give way to the other.

51.3.   The   question   is   what   is   the   subject­matter   of   the

statutes in question and not as to which entry in List III the

competing statutes are traceable, as the entries in List III are

only fields of legislation; also, the language of Article 254

speaks of repugnancy not merely of a statute as a whole but

also “any provision” thereof.

51.4. Since there is a presumption in favour of the validity of

statutes generally, the onus of showing that a statute is

repugnant to another has to be on the party attacking its

validity. It must not be forgotten that that every effort should

be made to reconcile the competing statutes and construe

them both so as to avoid repugnancy­­care should be taken

to see whether the two do not really operate in different fields

qua different subject­matters.

51.5. Repugnancy must exist in fact and not depend upon a

mere possibility.

51.6. Repugnancy may be direct in the sense that there is

inconsistency in the actual terms of the competing statutes

and there is, therefore, a direct conflict between two or more

provisions   of   the   competing   statutes.   In   this   sense,   the

inconsistency must be clear and direct and be of such a

nature as to bring the two Acts or parts thereof into direct

collision with each other, reaching a situation where it is

impossible to obey the one without disobeying the other.

This happens when two enactments produce different legal

results when applied to the same facts.

51.7. Though there may be no direct conflict, a State law

may   be   inoperative   because   the   Parliamentary   law   is

intended to be a complete, exhaustive or exclusive code. In

such a case, the State law is inconsistent and repugnant,

even though obedience to both laws is possible, because so

long as the State law is referable to the same subject­matter

as the Parliamentary law to any extent, it must give way.

One   test   of   seeing   whether   the   subject­matter   of   the

Parliamentary law is encroached upon is to find out whether

the Parliamentary statute has adopted a plan or scheme

49

which will be hindered and/or obstructed by giving effect to

the State law. It can then be said that the State law trenches

upon   the   Parliamentary   statute.   Negatively   put,   where

Parliamentary legislation does not purport to be exhaustive

or unqualified, but itself permits or recognises other laws

restricting or qualifying the general provisions made in it,

there can be said to be no repugnancy.

51.8. A conflict may arise when Parliamentary law and State

law seek to exercise their powers over the same subjectmatter. This need not be in the form of a direct conflict,

where one says "do" and the other says "don't". Laws under

this   head   are   repugnant   even   if   the   rule   of   conduct

prescribed by both laws is identical. The test that has been

applied in such cases is based on the principle on which the

rule   of   implied   repeal   rests,   namely,   that   if   the   subjectmatter of the State legislation or part thereof is identical with

that of the Parliamentary legislation, so that they cannot

both stand together, then the State legislation will be said to

be repugnant to the Parliamentary legislation. However, if

the   State   legislation   or   part   thereof   deals   not   with   the

matters which formed the subject­matter of Parliamentary

legislation but with other and distinct matters though of a

cognate and allied nature, there is no repugnancy.

51.9. Repugnant legislation by the State is void only to the

extent of the repugnancy. In other words, only that portion of

the State’s statute which is found to be repugnant is to be

declared void.

51.10. The only exception to the above is when it is found

that   a   State   legislation   is   repugnant   to   Parliamentary

legislation or an existing law if the case falls within Article

254(2),   and   Presidential   assent   is   received   for   State

legislation,   in   which   case   State   legislation   prevails   over

Parliamentary legislation or an existing law within that State.

Here again, the State law must give way to any subsequent

Parliamentary law which adds to, amends, varies or repeals

the law made by the Legislature of the State, by virtue of the

operation of Article 254(2) proviso.”

50

8.2 In  Innoventive   Industries   Limited  (supra),   this   Court

considered   almost   all   earlier   decisions   starting   from  Zaverbhai

Amaidas  vs.  State  of  Bombay6

;  Tika  Ramji  vs.  State  of  U.P.

7

,

Deep Chand vs. State of U.P and so on and so forth. In sum and

substance, this Court held that repugnancy under Article 254

would arise only if both the Parliamentary law and the State

law are referable to List­III.

8.3 Once it is clear that the RBI Act is traceable only to the Entries

in List­I and the State enactments are traceable only to an Entry in

List­II, the question of repugnancy under Article 254 does not arise,

as has been held in Innoventive Industries Limited.  But in cases

of this nature, Article 246(1) would squarely apply. Article 246(1)

reads as follows:­

“246. Subject­matter of laws made by Parliament and by

the Legislatures of States: ­ 

(1)   Notwithstanding   anything   in   clauses   (2)   and   (3),

Parliament has exclusive power to make laws with respect to

any   of   the   matters   enumerated   in   List   I   in   the   Seventh

Schedule   (in   this   Constitution   referred   to   as   the   “Union

List”).”

6 AIR 1954 SC 752

7  AIR 1956 SC 676

51

8.4 In  UCO   Bank   and   Another  vs.  Dipak   Debbarma   and

Others8

, a sale Notification issued under the Securitisation Act was

challenged on the ground that it constituted an infraction of Tripura

Land Revenue and Land Reforms Act, 1960. This Court found that

the Securitisation Act is traceable to Entry­45 of List­I and the

Tripura Act is traceable to Entries 18 and 45 of the State List. After

referring   to   the   Constitution   Bench   decision   in  State   of   West

Bengal and Others vs. Committee for Protection of Democratic

Rights, West Bengal and Others9

 and other decisions, this Court

held that the Securitisation Act, being a Parliamentary legislation is

the dominant legislation. To come to the said conclusion, this Court

referred to the non­obstante clause in Article 246(1). 

8.5 Many times, this Court has invoked the doctrine of eclipse, in

relation to pre­constitutional laws with reference to Article 13(1) of

the Constitution. But in later years, this doctrine came to be used

even in different contexts. For instance in  Kailash   Sonkar   vs.

Smt.  Maya  Devi10, this Court invoked the doctrine of eclipse to

8 (2017)2 SCC 585

9 (2010) 3 SCC 571 

10 (1984) 2 SCC 91

52

hold   that   when   a   person   is   converted   to   Christianity   or   other

religion, the original caste remains under eclipse and that as soon

as during his life time he is reconverted to the original religion, the

eclipse disappears and the caste automatically revives. 

Is the argument of Conflict, a mirage?

9. It was argued on behalf of the State that without pointing out

any area of conflict between the two enactments the NBFCs cannot

invoke either Article 246 or Article 254.

9.1 But the above argument has no substance. Once it is admitted

that the RBI Act is traceable to an entry in List­I, Article 246(1)

comes into play. In any case, there are also areas of conflict. The

Kerala Act, for instance, empowers the debtor under Section 8(1) to

deposit the money due to money lender, into a Civil Court. Section

8(2) empowers the Civil Court to pass orders recording full or part

satisfaction of the loan.

9.2 But   the   jurisdiction   of   the   Civil   Court   stands   ousted   by

Section 34 of the Securitisation Act, 2002. By virtue of a notification

bearing   No.   S.O.856(E)   dated   24th  February,   2020,   issued   in

exercise of the powers conferred by Section 2(1)(m)(iv), the Central

53

Government have specified such NBFCs as defined in Section 45­I(f)

of the RBI Act having assets worth rupees one hundred crore and

above to be entitled for enforcement of security interest in secured

debts of Rupees fifty lakhs and above. This Notification was issued

in supersession of the earlier notifications. Therefore, it is clear that

certain NBFCs are entitled to enforce security interest without the

intervention of the Civil Courts and the remedy of the borrower lies

only before the Debt Recovery Tribunal. This is one major area of

conflict, which can be readily pointed out. 

9.3 We have taken the above example only as a sample, for testing

the validity of the argument of the learned counsel for the State and

we find that the question of conflict does not go to the rescue of the

State.

Overriding Effect

10.     Section 45­Q which we have extracted elsewhere confers

overriding effect upon Chapter III­B, over 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.  

54

10.1   Though it was contended by the learned counsel appearing

for   the   State   of   Gujarat   that   the   Gujarat   Act   exempts   NBFCs

registered under the RBI Act from seeking registration under the

Gujarat Act, we do not think that the same would go to the rescue

of State of Gujarat. Under Section 5(2) of the Gujarat Act, NBFCs

registered under the RBI Act are deemed to have been registered

under the Gujarat Act. Therefore, all other provisions of the Gujarat

Act are sought to be applied to NBFCs operating in the State of

Gujarat. The other provisions of the Gujarat Act include the  (i)

power of search and seizure;  (ii)  requirement to maintain certain

books   and   registers   and   to   furnish   statements;   and  (iii)  the

mandate not to dispose of any article taken from a debtor as a

pawn, pledge or security, before a period of two years from the date

stipulated for final payment, etc. The Gujarat Act also empowers

the Civil Court under Section 30 to reopen certain transactions and

to   limit   the   interest   recoverable.   Section   32   of   the  Gujarat  Act

empowers the borrower to deposit the money before a Civil Court

and the civil Court to assume jurisdiction of the adjudication of the

dispute.

55

10.2  Interestingly,   Gujarat   Act,   2011   tacitly   recognizes   the

regulation of NBFCs under the RBI Act.  Yet the State got the assent

of only the Governor.

Conclusion

11    In view of the above, 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.

Therefore, all the appeals filed by NBFCs against the judgment of

the Kerala High Court are allowed.  Likewise the appeals filed by the

State of Gujarat against the judgment of the Gujarat high Court are

dismissed. 

11.1  As a consequence, Transfer Petition (Crl.) No.359 of 2015,

shall   also   stand   allowed   and   the   First   Information   Report   filed

against the officer of the NBFC for violation of the provisions of the

Kerala Act shall stand quashed. 

11.2   An   application   for   impleadment   has   been   filed   by   one

Mr. Davidson Dharmaraj in Civil Appeal No.5238 of 2012, claiming

that he has lodged a criminal complaint against the appellant and

56

its   officers   in   the   Civil   Appeal,   namely   M/s.   Muthoot   Finance

Private Limited, for alleged offences under the Indian Penal Code,

but relying upon the provisions of the Tamil Nadu Pawn Brokers

Act   and   the   rules   framed   there   under   and   that   any   decision

rendered in the appeals arising out of the decisions of the Kerala

and   Gujarat   High   Courts   may   have   an   impact   on   his   criminal

complaint.   Though we have not examined the provisions of the

Tamil Nadu Pawn Brokers Act and the Tamil Nadu Money Lenders

Act, the principles of law laid down herein, would apply equally to

these   State   enactments   also.   Therefore,   the   application   for

impleadment namely I.A. No.2 of 2015 is dismissed.

11.3   There will be no order as to costs.  

………………………………….J.

(Hemant Gupta)

………………………………….J.

(V. Ramasubramanian)

New Delhi

May 10, 2022

57