From Bottleneck to Breakthrough: RBI Eases NOF Funding via FDI

Introduction

Non-Banking Financial Companies (“NBFCs” or “Investee") are an important component of India’s financial system. They are registered with the Reserve Bank of India(“RBI”) and play a key role in extending credit facilities across sectors. The significance of NBFCs can be gauged from the fact that the credit extended by them accounted for 13.6% of India’s GDP in the financial year 2023–24.^[1]Given their critical role in facilitating credit and supporting the country's robust financial ecosystem, the requirement for NBFCs to maintain a minimum Net Owned Fund (“NOF”), a key criterion for retaining their registration with RBI, presents a considerable challenge^[2]. However, through a recent amendment cum clarification issued by RBI via the Master Direction-Foreign Investment in India, 2025 (“FI Direction 2025”)^[3],RBI has clarified that an Investee whose proposed activities are regulated by a financial sector regulator may receive foreign investment specifically for the purpose of meeting the minimum NOF requirement prescribed by such financial sector regulator in which the Investee is operating.

The Bottleneck: High NOF Thresholds and Legal Challenge

The compliance burden on NBFCs has intensified in recent years. RBI’s Circular dated October 22, 2021^[4](“Circular 2021”) mandated an increase in the minimum NOF requirement for NBFCs from the existing INR 2 crore to INR 5 crore by March 31, 2025, and to INR 10 crore by March 31, 2027.

On March 29, 2025, a federation of NBFCs challenged this requirement before the Madras High Court in Federation of Indian Asset Financiers Associations & Anr. v. RBI &Union of India ^[5]. The petitioners, representing NBFCs operating in the ‘base layer’ of RBI’s four-tier NBFC classification (with assets less than INR 1,000 crore and no public funds), argued that they posed no systemic risk and should not be subject to the same capital thresholds as larger NBFCs. They contended that RBI failed to distinguish between smaller and larger NBFCs and relied on Internet and Mobile Association of India v. RBI^[6]to argue that regulatory measures must satisfy the test of proportionality (which means a restriction on a fundamental right must have a valid object, be reasonably connected to that object, and be the least restrictive way to achieve it effectively).

The RBI, meanwhile, justified its approach, highlighting that Circular 2021 was notified in October2021 and implemented a year thereafter, affording NBFCs sufficient time for compliance. It also underscored that its regulatory measures are informed by rigorous financial expertise and deserve deference from the judiciary. The Madras High Court disposed of the petition, while leaving the door open for the petitioners to approach the RBI for a possible extension of the timeline for minimum NOF compliance.

The Breakthrough: FI Direction 2025 and FDI Relief

Against the above backdrop, FI Direction 2025 has provided a significant breather. It grants general permission for foreign investment into entities engaged in regulated financial activities, but strictly for meeting NOF requirements. This effectively removes the bottleneck for NBFCs caused due to the Circular 2021.

The FI Direction 2025 significantly improves the ease of minimum NOF requirement for NBFCs at the registration stage. For instance, NBFCs applying for RBI registration must maintain a minimum NOF of INR 2 crore. Prior to FI Direction 2025, foreign investment for this purpose required Department of Economic Affairs, Government of India approval, resulting in avoidable delays. With the new regime, a foreign investor may now directly capitalise an Investee for NOF compliance, streamlining the process. That said, this relief is tightly circumscribed. Funds cannot be diverted for business expansion, operational expenses, or other investments. Moreover, if the registration is denied, the investment must be repatriated, ensuring that the FDI route is not exploited to bypass regulatory safeguards.^[7]

While FI Direction 2025restricts foreign investment use to NOF compliance, a more flexible approach could reduce capital inefficiencies. For instance, if RBI denies registration or a license to an Investee, RBI might allow the Investee to use the funds for other bona fide purposes, provided the Investee proposes this within one month of rejection and the regulator certifies the intended use. This would balance preventing FDI misuse while supporting genuine business needs despite licensing challenges.

Conclusion

The FI Direction 2025marks a significant step forward for NBFCs in meeting minimum NOF requirements by streamlining the foreign investment process and addressing previous regulatory bottlenecks. Introducing a provision to allow flexible utilization of foreign funds in cases of licensing rejection, subject to regulatory approval, could further enhance this regulatory reform, balancing capital efficiency with safeguards against misuse and supporting sustainable growth in India’s financial services sector.

References

[1] RBI-NBFCs report on trends-2023-24, dated December 26, 2024, available at <<https://www.fidcindia.org.in/wp-content/uploads/2024/12/RBI-NBFCs-REPORT-ON-TRENDS-2023-24-26-12-24.pdf>>

[2] FAQ no. 4 of the RBI’s FAQs on NBFC dated April 23, 2025, available at <<https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=1167>>

[3] RBI Master Directions on Foreign Investment, 2025, available at <<https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200>>

[4] RBI Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs, available at<<https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=12179&Mode=0>>

[5] W.P.No.11218of 2025

[6] Writ Petition (Civil) No.528 of 2018

[7] Para5.2.7 of the RBI Master Directions on Foreign Investment, 2025, available at<<https://www.rbi.org.in/scripts/bs_viewmasdirections.aspx?id=11200>>

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