Section 45-IA(1)(b) of the Reserve Bank of India Act, 1934, empowers the RBI to lay down the Net Owned Fund (NOF) requirement as a precondition for obtaining or continuing to hold a Certificate of Registration by a non-banking financial company (NBFC). The concept and definition of NOF, therefore, emanate from this provision.
Definition of NOF
The RBI Act provides that “Net Owned Fund” comprises:
(a)The total of paid-up equity capital and free reserves as reflected in the latest audited balance sheet of the company, after deducting:
1. The accumulated balance of loss,
2. Deferred revenue expenditure, and
3. Other intangible assets; and
(b) Further reduced by amounts representing:
The value of investments in:
- Subsidiaries,
- Companies belonging to the same group, and
- Other NBFCs, in the form of shares (equity or preference); and
The book value of:
- Debentures, bonds, loans, advances (including those under lease or hire purchase arrangements), and deposits placed with:
- Subsidiaries, and
- Group companies
- companies in the same group, to the extent such amount exceeds ten per cent of (a) above.
To the extent such exposure exceeds 10% of the amount computed in clause (a). Over the years, the NOF requirement has evolved from a modest Rs. 25 lakh to Rs. 10 crore — a 40-fold increase — underlining the growing emphasis on financial robustness in the NBFC sector.
Deductions and Reductions in NOF Calculation
The computation of NOF includes three statutory deductions and two specific reductions:
Deductions (from owned funds):
1. Accumulated losses,
2. Deferred revenue expenditure, and
3. Other intangible assets.
Reductions (further subtracted, if they exceed 10% of net owned funds):
These include:
Investments in shares (equity or preference) of:
1. Subsidiaries,
2. Group companies,
3. Other NBFCs, and
Book value of debt exposures such as:
1. Loans, debentures, bonds, advances, hire purchase or lease finance, and deposits with:
2. Subsidiaries and group companies.
The total of these two reductions is compared to 10% of the figure arrived at after the above deductions. Any excess is reduced from the owned funds to arrive at the final NOF.
Example: Assume an NBFC has adjusted owned funds of Rs. 150 crore. It has invested Rs. 80 crore in the equity of a group company. As per the formula, 10% of Rs. 150 crore is Rs. 15 crore. Therefore, the excess Rs. 65 crore (Rs. 80-10% * 100) would be reduced while arriving at the net owned funds.
Nature of Investments and Exposures Considered
Investments in Shares of Group Entities and NBFCs
Investments in shares (both equity and preference) of:
1. Subsidiary companies,
2. Companies classified as part of the same group (as per the definition under the RBI Act, which still refers to the now-repealed Section 370 of the Companies Act, 1956), and
3. Other NBFCs, form part of the first reduction category.
Though newer regulations (like the SBR Directions) provide a broader definition of “group companies,” the definition used under the RBI Act prevails due to statutory consistency, despite changes under the Companies Act, 2013.
Debt Exposures to Subsidiaries and Group Companies
The second reduction pertains to debt instruments such as:
1. Debentures,
2. Bonds,
3. Loans and advances, and
4. Financial leases or hire purchase transactions.
The reduction is calculated based on the book value, i.e., the amount recorded in the books of account. This implies:
1. If the investment in debentures was made at a premium or discount, the actual recorded value is considered.
2. If provisioning or impairment has been applied to a loan, only the net outstanding balance after such adjustments is taken for reduction.
Interestingly, while share investments in other NBFCs are reduced from NOF, debt exposures to other NBFCs are not part of the reduction list. This is because share investments can lead to duplication of capital across NBFCs, whereas loans do not directly inflate the capital of the borrowing NBFC.
Quality and Liquidity of NOF – Why It Matters
The NOF requirement is designed as a financial safeguard — ensuring that companies undertaking financial activities maintain adequate backing to absorb losses, meet liabilities, and manage risks. For upper-layer and middle-layer NBFCs, this is complemented by capital adequacy requirements. For base-layer NBFCs, leverage limits ensure similar prudence.
There are two significant considerations:
- Liquidity of NOF: While not mandated to be liquid, a portion of the NOF should ideally be accessible to handle exigencies.
- Realisability of Assets: If NOF is tied up in illiquid or non-realisable assets, its utility in fulfilling the protective objective is lost.
Thus, while statutory reductions already filter out certain undesirable exposures, the overall composition and health of assets representing the NOF remain vital for regulatory and operational resilience.
When Should NOF Be Maintained?
The NOF requirement is not a one-time condition. It must be satisfied:
1. At the time of applying for registration with the RBI, and
2. Continuously, throughout the existence of the NBFC.
If the NOF falls below the prescribed limit due to operational losses or provisioning adjustments, the NBFC must initiate immediate steps to infuse fresh capital. It is not advisable to operate close to the regulatory threshold — adequate capital buffers help mitigate compliance and reputational risks.
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