Introspection of RBI’s new requirement for greater inspection

-Finserv Division

finserv@vinodkothari.com

The Union Budget 2019 had many odd talking points, especially for the banking and financial sector. From proposed recapitalization of public sector banks, relief in levy of Securities Transaction Tax (STT), proposing changes in factoring laws to increased supervision of NBFCs among others, this year’s budget created mixed emotions. One of the major changes that took everyone by surprise was granting exceptional power to the Reserve Bank of India for regulating and supervising non-banking financial companies (NBFC). One can say much of it is inspired by the ILFS saga.

In this article, we intend to pick up one such insertion in the Reserve Bank of India Act, 1934 which, we think, has escaped critic’s eye, that is section 45NAA. This, according to the author, is likely to have an overarching impact not only on the NBFCs but also on their non-financial group companies if any.

Insertion of section 45NAA

While much have been said about the other insertions in the RBI Act, that is, RBI’s right to remove directors or supersede the Board of the NBFC or initiative resolution of the NBFCs, one section which has been devoid of the much deserved attention is section 45NAA.

The section allows the RBI to inspect or audit of the books of all the group companies of an NBFC, including the non-financial entities in the group.

The text of the law has been provided below:

“45NAA. (1) The Bank may, at any time, direct a non-banking financial company to annex to its financial statements or furnish separately, within such time and at such intervals as may be specified by the Bank, such statements and information relating to the business or affairs of any group company of the non-banking financial company as the Bank may consider necessary or expedient to obtain for the purposes of this Act.

(2) Notwithstanding anything to the contrary contained in the Companies Act, 2013, the Bank may, at any time, cause an inspection or audit to be made of any group company of a non-banking financial company and its books of account.”

In other words, the RBI will be able to assess and inspect the books of non-financial institutions like manufacturing or service companies, even though its jurisdiction implicitly lies within the domain of financial institutions.

Despite being a recent addition to the NBFC sector, extended auditing power by the RBI is a prevalent norm in banking. The following is an excerpt of Section 29A from the Banking Regulation Act[1], 1949, which provides the power to the RBI on similar lines:

“(2) Notwithstanding anything to the contrary contained in the Companies Act, 1956(1 of 1956), the Reserve Bank may, at any time, cause an inspection to be made of any associate enterprise of a banking company and its books of account jointly by one or more of its officers or employees or other persons along with the Board or authority regulating such associate enterprise.”

However, there is a slight difference between the aforesaid provisions. On one hand, section 45NAA pertaining to NBFCs refer to the books of accounts of ‘group companies’ whereas, section 29A pertaining to banks refer to ‘associate enterprises’. To gauge the similarities between the sections, one has to look into the definition of the terms. The following is an excerpt from Section 45NAA-

(a) “group company” shall mean an arrangement involving two or more entities related to each other through any of the following relationships, namely:––

(i) subsidiary— parent (as may be notified by the Bank in accordance with Accounting Standards);

(ii) joint venture (as may be notified by the Bank in accordance with Accounting Standards);

(iii) associate (as may be notified by the Bank in accordance with Accounting Standards);

(iv) promoter-promotee (under the Securities and Exchange Board of India Act, 1992 or the rules or regulations made thereunder for listed companies);

(v) related party;

(vi) common brand name (that is usage of a registered brand name of an entity by another entity for business purposes); and

(vii) investment in equity shares of twenty per cent. and above in the entity;

(b) “Accounting Standards” means the Accounting Standards notified by the Central Government under section 133, read with section 469 of the Companies Act, 2013 and subsection (1) of section 210A of the Companies Act, 1956.”

Further, the relevant extract of section 29A of the Banking Regulations Act, relating to associate enterprises, is reproduced herein below-

“associate enterprise” in relation to a banking company includes an enterprise which–

(i) is a holding company or a subsidiary company of the banking company; or

(ii) is a joint venture of the banking company; or

(iii) is a subsidiary company or a joint venture of the holding company of the banking company; or

(iv) controls the composition of the Board of Directors or other body governing the banking company; or

(v) exercises, in the opinion of the Reserve Bank, significant influence on the banking company in taking financial or policy decisions; or

(vi) is able to obtain economic benefits from the activities of the banking company.

Despite some similarities in the two definitions, scope of “group companies” appear to be wider given the inclusion of related parties (defined under Ind AS-24[2]) and entities using a common brand or registered name. The meaning of the term “related party” has been obtained from Ind AS 24 and the same has numerous connotations including subsidiary, associates or entities upon which the reported entity has significant power of influence.

Undoubtedly, this is based on the learnings from the large number of scams that surfaced lately, especially the ones involving financial sector entities, but the amount of the power that has been bestowed upon the RBI is enormous. The intention is to allow RBI free access to all areas if it suspects anything foul happening in an NBFC.

Conclusion

A greater scrutinizing power bestowed to the RBI through section 45NAA has both positive, and, otherwise connotations. The power can be extended to inspect into corporate malpractices like accounting frauds, restrictive investment practices and undisclosed related party transactions through subsidiaries and associates that the RBI has reason to suspect. On the other hand, it also gives RBI discretionary powers to intervene and effect changes in private, non-financial companies on trivial grounds of misconduct, which is not always desirable. Control and corruption are opposite sides of the same coin. The coin has been flipped. Only time will show, on which side it lands.

[1] https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/BANKI15122014.pdf

[2] http://www.mca.gov.in/Ministry/pdf/Ind_AS24.pdf