December 15, 2024
Ayush Agrahari
Abstract
When dealing with public money, a lapse in governance or regulation can have widespread consequences, impacting not just creditors but the entire economy. This article discusses the difference between Financial Service Providers (FSPs) and Non-Banking Financial Companies (NBFCs), focusing on their regulatory frameworks, roles, and the Corporate Insolvency Resolution Process (CIRP) under the Insolvency and Bankruptcy Code (IBC), 2016. FSPs such as NBFCs were initially not included in insolvency proceedings due to their connection with public funds, but this changed after the DHFL crisis. The introduction of FSP Rules in 2019 now allows for insolvency proceedings for NBFCs with assets exceeding ₹500 crores, ensuring financial stability and providing creditors with a structured resolution mechanism. The article emphasizes the significance of this inclusion in protecting stakeholders in the financial sector.
Keywords: Financial Service Providers, Corporate Insolvency Resolution Process, National Company Law Tribunal, Insolvency and Bankruptcy Code (IBC), 2016
What are FSPs and NBFCs?
A Financial Service Provider (FSP) is different from a corporate person. A corporate person is a company formed under the Companies Act or any previous company law. It could be a limited liability partnership but it shall not include financial service providers.
A financial service provider is a person engaged in the business of providing financial services in terms of authorization issued or registration granted by a financial sector regulator as defined under section 2(17) of the IBC[1]. Financial regulators regulate the financial sector and include RBI, SEBI, IRDAI, PFRA, and others as may be notified by the government. The financial service providers render services like accepting deposits, insurance, loans, retirement benefit plans, small saving instruments, etc. Some of the big names in the FSP industry are Bajaj Finance Limited, Tata Capital Financial Services Ltd, and Mahindra & Mahindra Financial Services Limited.
An NBFC (Non-Banking Financial Corporation) as defined under Section 451(c) of the RBI Act [2] is a non-banking company that carries the business of financial institutions. It is registered under the Companies Act, 1956[3]. They are engaged in the business of providing loans, acquiring shares/stocks/bonds/debentures/securities and receiving deposits in some cases. Some examples of NBFCs are Bajaj Finserv, Muthoot Finance Ltd, etc.
A bank is different from an NBFC because they are government-authorized for providing banking services. In contrast, NBFCs are a company providing banking services without holding a bank license and NBFCs are not allowed to collect deposits except for a few of them as allowed by the government. Further, NBFCs are also not allowed to extend loans to the real estate sector.
What is CIRP and When was it Initiated?
A company becomes insolvent when it’s unable to settle its debt to creditors or operational creditors. The process by which the insolvency of a corporate body is done is called the Corporate Insolvency Resolution Process or CIRP. CIRP is a recovery mechanism for the creditors so that when a corporate body like a Public Limited Company(PLC) or a Limited Company (Ltd.) becomes inefficient in paying their debts, the creditor or the company itself can approach the NCLT (National Company Law Tribunal) to initiate CIRP for the recovery of debts. After the initiation of CIRP, it is evaluated whether the company would be able to repay the defaulted debts or not. If not, then it is put into liquidation or restructuring. The procedures to be followed for the CIRP are defined under Part 2, Chapter 2 of the Insolvency and Bankruptcy Code, 2016[4].
Why were FSPs Excluded?
The definition of corporate persons against whom the CIRP can be initiated does not include FSPs. NBFCs are not specifically mentioned in the IBC. However, in Randhiraj Thakur v. Jindal Saxena Financial Services (P.) Ltd,[5] the NCLAT (National Company Law Appellate Tribunal) recognized NBFCs as FSPs and hence excluded them from the IBC. Also, the CIRP can be initiated against all the entities except those included under Section 3(16) of IBC, and those businesses that are actively engaged in providing financial services.
These entities were not covered for insolvency proceedings because they dealt with and involved public money. Initiating proceedings against FSPs could lead to:
- Financial instability as this may cause a chain reaction of defaults, bank runs and insolvencies.
- Liquidity problems for banks as people can lose confidence in entities and rush to withdraw their money.
- And, this can have a broader impact, due to the ripple effect on the economy, decreased lending, business and jobs.
What led to its inclusion?
1. M/S Jindal Saxena Financial Services pvt. ltd. vs Randhiraj Thakur
In this case, the National Company Law Appellate Tribunal (NCLAT) recognized NBFCs as FSPs, which set a precedent for their exclusion from traditional insolvency proceedings. This ruling highlighted the regulatory gap that existed prior to the inclusion of FSPs under the IBC, emphasizing the need for a structured resolution process for entities dealing with public funds.
2. Infrastructure Leasing and Financial Services vs Union of India & Ors, 2020
The Infrastructure Leasing & Financial Services (IL&FS) crisis highlighted systemic risks associated with NBFCs. The company defaulted on its debt obligations, which triggered a liquidity crisis affecting numerous banks and financial institutions. This scenario illustrated how the failure of a single NBFC could lead to widespread economic repercussions, reinforcing the argument for including FSPs within insolvency frameworks to mitigate such risks.
3. Reserve Bank of India v. Dewan Housing Finance Limited, 2019
It started with the downfall of one of the biggest mortgage lenders in India, Dewan Housing Finance Limited (DHFL). DHFL is an NBFC engaged in services like housing finance, insurance products, asset management and fixed deposit services having more than 77000 deposit holders to its credit.
The fall of the company began in 2019 when it started defaulting on repayment of loans at multiple instances. Not only that, it also became a company with poor management and governance along with financial irregularities. Certain other factors like the Infrastructure and Financial leasing [a1] crisis also added to this condition, owing more than one lakh crore to the creditors. RBI had to jump in and take the matters into their own hands.
The Reserve Bank of India (RBI) was designated as the regulator for Non-Banking Financial Companies (NBFCs) under a notification from the Ministry of Corporate Affairs on November 18, 2019. This notification was issued under Section 227 of the Insolvency and Bankruptcy Code (IBC), 2016.[6] Following this, the RBI filed for insolvency proceedings against Dewan Housing Finance Corporation Limited (DHFL), which the National Company Law Tribunal (NCLT) accepted on December 3, 2019.
The Insolvency & Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application of Adjudicating Authority) Rules, 2019 (FSP Rules) clarified that only financial service providers (FSPs) notified by the central government under Section 227 of the IBC would be subject to these insolvency procedures. The FSP Rules closely resemble the Corporate Insolvency Resolution Process (CIRP) but include a few exceptions.
Section 227 allows the central government, after consulting relevant financial regulators, to notify specific FSPs for insolvency and liquidation processes. Importantly, the rules apply specifically to NBFCs and housing finance companies with assets exceeding ₹500 crore. The Financial Resolution and Deposit Insurance Bill, 2017 was introduced by the government in 2017 for the resolution of FSPs but it was withdrawn in 2018 due to a huge backlash against certain controversial clauses in it.
Process of Resolution
For the initiation of the CIRP process against an NBFC, these steps are followed:
- Insolvency of an NBFC can only be initiated when an ‘appropriate regulator’ files for an application before the NCLT or any adjudicating authority in accordance with Rule 6 of the FSP Rules.[7]
- If the application is accepted for resolution, an “administrator” is appointed (Rule 9 of the FSP Rules)[8]. The administrator does the same work as that of an Interim resolution professional, a resolution professional or a liquidator, from the duration of his appointment to the end of the CIRP. During this period the management of the company ceases to have any control over the activities of the company.
- After the initiation, to assist the administrator in the performance of the insolvent NBFC operations, an advisory committee consisting of 3 to 4 members can be appointed within 45 days of commencement.
- The interim moratorium on the FSP begins from the date of submission of the application by the regulator till the completion of CIRP, as prescribed under section 14 of the IBC, 2016.[9]
- When a moratorium is imposed on the FSP, no legal proceedings can be started or continued against the same.
- Licenses of the NBFC can’t be cancelled from the date of filing of the application till its resolution is completed.
- Then, the resolution plan proposed shall have a statement explaining how the debtor is planning to stay afloat. First, the resolution plan has to be approved by a committee of creditors, then it has to get a No-Objection Certificate (NOC) from the regulator. If no objection is raised within 45 days, the NOC is deemed to be granted. The NOC on the proposed plan is granted on ‘fit and proper’ criteria.
- If a situation of liquidation under Section 33 of the IBC [10]or dissolution under Section 54 of the IBC[11] arises then an opportunity has to be provided to the appropriate regulator for being heard.
Conclusion
The Ministry of Corporate Affairs took a commendable step by bringing Financial Service Providers (FSPs) under the ambit of the Insolvency and Bankruptcy Code (IBC). While the success of the rules notified in 2019 remains to be seen, this initiative marks significant progress in creating a safety net for the financial services sector. Earlier attempts, such as the withdrawn FRDI Bill, faltered due to contentious provisions, including the proposed “bail-in” clause for banks. Nevertheless, this move represents a crucial first step toward offering much-needed relief and stability to stakeholders in the financial services industry.
A Way Forward
The incorporation of NBFCs under the FSP framework through the IBC represents a significant milestone in India’s financial regulatory landscape. Through cases like DHFL and IL&FS, we’ve witnessed how this inclusion has strengthened depositor protection, enhanced financial system stability, and promoted better corporate governance. The structured resolution mechanism has not only safeguarded the interests of thousands of stakeholders but has also contributed to faster economic recovery during financial crises. By establishing clear oversight and accountability measures, this regulatory framework has fostered greater public confidence in financial institutions while creating a more resilient and transparent financial ecosystem that benefits both individual investors and society at large.
[1] The Insolvency and Bankruptcy Code, No. 31 of 2016, , §2(17) (Ind.)
[2] The Reserve Bank of India Act, No. 2 of 1934, § 451(c) (Ind.)
[3] The Companies Act 1956, No. 1 of 1956 (Ind.)
[4] The Insolvency and Bankruptcy Code, No. 31 of 2016 (Ind.)
[5] Randhiraj Thakur v. Jindal Saxena Financial Private Limited and Another (2018) S.C.C. 508 (India).
[6] The Insolvency and Bankruptcy Code, No. 31 of 2016, , § 227 (Ind.)
[7] The Insolvency & Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application of Adjudicating Authority) Rules, 2019, Gazette of India, pt. V sec.227, Rule 6 (Nov. 15, 2019).
[8] The Insolvency & Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application of Adjudicating Authority) Rules, 2019, Gazette of India, pt. V sec.227, Rule 9 (Nov. 15, 2019).
[9] The Insolvency and Bankruptcy Code, No. 31 of 2016, , § 14 (Ind.)
[10] The Insolvency and Bankruptcy Code, No. 31 of 2016, , § 33 (Ind.)
[11] The Insolvency and Bankruptcy Code, No. 31 of 2016, , § 54 (Ind.)