NBFC/CIC Classification Issue

Introduction

Non-Banking Financial Companies (NBFCs) and Core Investment Companies (CICs) have an integral position in the financial system of India, especially in bridging the credit gap in underserved and unbanked areas for the development of the country as a whole.

During the initial days NBFC's were fragmented and informally governed, but now they have evolved from that and have become well regulated institutions that have been adopting best practices in governance, risk management, and innovation. This has happened because their role in the financing infrastructure, road transport, and other critical sectors has been acknowledged by policymakers and expert committees.

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What is an NBFC?

A Non-Banking Financial Company is a company that is incorporated under the Companies Act, which is primarily engaged in lending, investing in shares, investing in bonds, or any other kind of securities. Their principal business is not agriculture, industrial production, trading in goods or any kind of real estate development, etc.

In order to identify whether a company is NBFC or not, RBI applies the '50-50 Principal Business Test which means that:

(a) The financial assets constitute more than 50% of the total assets of the company and

(b) Income from such financial assets constitutes more than 50% of the gross income then the company is deemed to be engaged in the financial activity as its prime business. They are classified as NBFCs and are required to be registered with RBI.

There are multiple requirements and regulations of NBFCs such as capital adequacy, provisioning, corporate governance, conduct standards (KYC, fair practices), and other operational norms.

What are CICs?

A Core Investment Company (CIC) is a specific category of NBFC whose business is primarily the holding of investments in group companies. Under the RBI's definition, a company is a CIC if:

• It has an asset size of ₹100 crore or more;
• It holds at least 90% of its net assets in the form of investments in equity, preference shares, bonds, debentures, debt, or loans in group companies;
• Within that 90%, at least 60% consists of equity investments in group companies (including compulsorily convertible instruments) and specified Infrastructure Investment Trust (InvIT) units as a sponsor;
• It does not trade in these investments except for block sales for dilution or disinvestment;
• It carries out no other financial activity except limited permitted activities such as investing in bank deposits, money market instruments, and providing loans or guarantees to group companies; and
• It accepts public funds.

The above conditions are laid down in the Master Direction for Core Investment Companies (Reserve Bank) Directions, 2016.

Any CICs that meet the above criteria must register with the RBI. However, the CICs with asset size below ₹100 crore or with larger assets but no public fund access are exempt from registration but still face restrictions on certain activities like public deposit acceptance.

The issue:

India's infrastructure sector frequently adopts multi-level corporate structures, often involving special purpose vehicles (SPVs) mandated by government contracts for executing large projects, which allows optimised risk allocation, streamlined project execution, and focused management of investments.

However, it also creates an unintended legal challenge that is the recurring classification of holding or investment entities as Non-Banking Financial Companies (NBFCs) or Core Investment Companies (CICs) under the Reserve Bank of India (RBI) framework.

It must be noted that the core objective of these infrastructure projects is not to derive any income from the financial assets rather the very nature of polling shares or providing any kind of loans to group companies can push these entities into regulatory definitions of NBFCs or CICs now this classification triggers extensive RBI compliance obligations prior to the requirements for significant transactions the consequence is that the infrastructure holding companies designated for the operational efficiency face the compliance burden similar to Financial institutions despite not engaging in financial intermediation in the conventional sense.

This has been a persistent issue, prompting repeated debates on whether such structures warrant regulatory relaxation.

What are the Regulations?

The regulatory framework stems from Chapter III-B of the RBI Act, 1934, supplemented by Master Directions for NBFCs and CICs which provides the following mandates for NBFCs and CICs:

1. Registration Requirements
2. Foreign direct investment in a CIC or in an unregistered investment company not classified as an NBFC is subject to the government route, requiring prior approval.
3. They must comply with capital adequacy, exposure limits, and governance standards.
4. A maximum of two layers of CICs is allowed in a group.
5. CICs cannot hold non-financial assets outside the group beyond 10% of net assets, except for essential fixed assets.

The regulatory requirements pose a serious challenge for the investors especially when the compliance processes are not just unclear but complex as well. One major uncertainty is the timing, that is whether the obligation to register arises immediately after the financial year ends or only once audited accounts are finalized.

Similarly, it is also unclear if a pending array application is enough to avoid any non-compliance, or if there is any formal registration that must be completed beforehand.

The overlap between NBFC and CIC criteria creates challenges, as a CIC being a subset of NBFC must comply with the 90:60 investment ratio for CICs without breaching the 50:50 principal business test for NBFCs, leaving scope for varied interpretations.

These financial entities primarily oversee the project operations rather than engage in direct lending, and if they have to follow such regulatory ambiguities and delays, which creates unnecessary hurdles, thereby increasing investment risks and potentially deterring capital inflows into infrastructure and related sectors.

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