🚨 RBI Clarifies Principal Business Rules for NBFCs
The Reserve Bank of India (RBI) regulates Non-Banking Financial Companies (NBFCs) through a comprehensive regulatory framework designed to ensure that entities primarily engaged in financial activities operate within appropriate prudential and supervisory standards.
One important concept in this framework is the Principal Business Criteria (PBC). The criteria help determine whether the principal business of a company is financial in nature and whether the company falls within the regulatory framework applicable to NBFCs.
The RBI has consistently explained that a company is considered to be principally engaged in financial activity when financial assets constitute more than 50% of its total assets and income from financial assets constitutes more than 50% of its gross income. Both tests are required to be satisfied.
For businesses operating in the financial sector, understanding these requirements is essential because the nature of their assets and income can have direct implications for regulatory classification and compliance.
What Is the Principal Business Criteria?
The term "principal business" is not specifically defined in the RBI Act. However, the RBI established an objective asset-income test to provide consistency in determining whether a company's principal activity is financial.
Under the established PBC framework, two conditions are examined:
🔹 Financial assets should be more than 50% of total assets, subject to the applicable computation methodology.
🔹 Income from financial assets should be more than 50% of gross income.
Both conditions need to be satisfied.
This means that satisfying only one of the two tests is not sufficient to establish the company's principal business as financial activity.
The RBI has explained that the purpose of these criteria is to distinguish companies that are predominantly engaged in financial activities from companies whose primary business may be manufacturing, trading, services, real estate or another non-financial activity.
Understanding the 50% Financial Asset Test
The first part of the PBC test focuses on the company's assets.
A company should examine the composition of its balance sheet and determine the proportion represented by financial assets.
Examples of financial assets may include relevant:
- Loans and advances
- Investments in securities
- Other qualifying financial instruments
- Receivables and other assets that fall within the applicable financial-asset classification
The objective is to determine whether financial assets represent more than half of the relevant total asset base.
For example, if a company has total relevant assets of ₹100 crore and financial assets of ₹65 crore, its financial assets represent 65% of the total. The company would therefore satisfy the asset-side threshold, subject to the applicable RBI computation rules.
However, the asset test alone does not conclude the PBC analysis.
The income test must also be examined.
Understanding the 50% Income Test
The second part of the PBC framework relates to income.
The RBI requires income generated from financial assets to be more than 50% of gross income.
For example, assume a company has gross income of ₹20 crore during the relevant period and ₹13 crore is income derived from financial assets.
The financial-asset income percentage would be 65%.
The company would therefore satisfy the income-side test, subject to the applicable regulatory computation.
This demonstrates why businesses should not look only at their balance sheet.
A company may have a substantial amount of financial assets but may still need to examine whether the income generated from those assets is sufficient to satisfy the second PBC test.
Both Tests Must Be Satisfied
One of the most important aspects of the RBI framework is that both tests are required to be satisfied.
Consider two examples.
Example 1 – Asset Test Satisfied, Income Test Not Satisfied
Suppose:
Financial assets = 70% of total assets.
The asset test is satisfied.
However, suppose income from financial assets is ₹8 crore out of gross income of ₹20 crore.
Financial-asset income = 40%.
The income test is not satisfied.
Therefore, both criteria are not fulfilled.
Example 2 – Both Tests Satisfied
Suppose:
Financial assets = 70%.
And:
Financial-asset income = 60%.
In this situation, both tests exceed 50%, subject to the applicable regulatory calculation.
This is why NBFCs and companies undertaking financial activities should periodically review both their asset composition and income composition.
Why Is the PBC Important?
The PBC framework is important because regulatory classification is not determined merely by what a company calls itself.
A company may describe itself as an investment company, finance company or lending business, but the regulatory assessment depends on the applicable legal and regulatory framework.
The RBI has explained that a company principally engaged in agriculture, manufacturing, trading, services or other non-financial activities would not become an NBFC merely because it undertakes some financial activity.
This distinction provides clarity for companies that have mixed business activities.
What About Core Investment Companies?
Core Investment Companies (CICs) are subject to a separate regulatory framework.
A CIC is a specialised type of NBFC primarily involved in holding investments in group companies.
The RBI maintains separate directions and FAQs dealing with CIC eligibility and regulatory requirements.
The CIC framework contains specific conditions concerning the composition and nature of investments and net assets. Therefore, businesses that potentially qualify as CICs should not simply apply the general NBFC PBC test without examining the separate CIC framework.
The RBI's CIC FAQs specifically address situations where a holding company may or may not satisfy the CIC criteria and explain the interaction between CIC requirements and the broader NBFC framework.
Accordingly, group holding companies should carefully determine whether the CIC framework applies to them.
Importance for Existing NBFCs
For an existing NBFC, monitoring PBC should not be treated as a one-time exercise.
Business models can change over time.
For example, an NBFC may:
🔹 Increase its investment in non-financial assets.
🔹 Diversify into other business activities.
🔹 Change its lending portfolio.
🔹 Dispose of financial assets.
🔹 Generate significant income from non-financial activities.
Such changes can affect the composition of both assets and income.
Therefore, management should periodically evaluate whether the business continues to operate within the applicable regulatory framework.
Role of Financial Statements and Audit
The PBC analysis relies heavily on reliable financial information.
The RBI has historically referred to the company's last audited balance sheet for assessing the asset and income pattern for principal business determination.
This makes accurate accounting and classification particularly important.
Management and finance teams should ensure that:
✅ Financial assets are correctly identified.
✅ Income from financial assets is properly classified.
✅ Gross income is accurately determined.
✅ Balance-sheet figures reconcile with accounting records.
✅ Supporting schedules are maintained.
✅ Regulatory calculations are documented.
Auditors and professional advisors can also play an important role in reviewing the computation and identifying inconsistencies before regulatory filings or supervisory review.
Common Compliance Mistakes
Some businesses may make the mistake of focusing only on the 50% asset threshold.
Others may calculate financial income incorrectly or fail to distinguish financial income from other revenue.
Common areas requiring attention include:
- Incorrect classification of assets
- Incorrect income classification
- Failure to reconcile financial statements
- Ignoring changes in business activity
- Applying general NBFC rules to specialised entities without checking the relevant framework
- Inadequate documentation of regulatory calculations
- Treating compliance as a one-time exercise
A documented PBC calculation can help the company demonstrate how it reached its conclusion.
Practical Compliance Checklist for NBFCs
Businesses can consider the following checklist:
📌 1. Review the Asset Composition
Prepare a detailed schedule of total assets and identify the financial assets included in the calculation.
📌 2. Review Income Sources
Analyse income generated from financial assets separately from other business income.
📌 3. Calculate Both Ratios
Calculate the financial-assets-to-total-assets ratio and financial-income-to-gross-income ratio.
📌 4. Check the Applicable Regulatory Category
Determine whether the company falls under the general NBFC framework or a specialised category.
📌 5. Review CIC Applicability
If the entity is primarily a group holding company, examine whether the separate CIC framework is relevant.
📌 6. Maintain Supporting Documentation
Keep working papers, schedules, financial statements and calculations supporting the PBC assessment.
📌 7. Conduct Periodic Reviews
Do not wait until year-end to identify a regulatory issue. Changes in business activity during the year should be monitored.
A Strategic Compliance Approach
Regulatory compliance should be integrated into the company's regular financial reporting process.
Instead of calculating PBC only when required, management can establish a periodic monitoring mechanism.
For example, the finance team may review:
Financial Assets → Total Assets → Financial Income → Gross Income → Applicable RBI Framework
This approach can help identify changes in the company's business profile at an early stage.
For growing financial companies, this becomes increasingly important because expansion into new products or non-financial activities can change the balance between financial and non-financial operations.
Why Professional Review Matters
The PBC calculation may appear straightforward because it uses a 50% threshold. However, determining which assets and income should be included in the relevant calculations can require careful consideration of the applicable RBI framework.
A professional review can help businesses:
- Understand the applicable regulatory category
- Review asset classification
- Analyse income sources
- Prepare compliance working papers
- Identify potential regulatory gaps
- Maintain appropriate documentation
- Coordinate accounting and regulatory reporting
For NBFCs, compliance should be viewed as an ongoing governance responsibility rather than merely a filing requirement.
Conclusion
The RBI's Principal Business Criteria provide an important framework for determining whether a company's principal activity is financial in nature.
The central principle is clear: the company generally needs to satisfy both the financial-assets test and the financial-income test, with financial assets exceeding 50% of the relevant total assets and income from financial assets exceeding 50% of gross income.
At the same time, Core Investment Companies are governed by a separate regulatory framework, and companies operating as group holding entities should examine the specific CIC requirements before determining their compliance position.
NBFCs should therefore regularly review their balance sheets, income patterns, business activities and regulatory classification. Maintaining accurate financial records and documented PBC calculations can support better regulatory compliance and reduce the risk of avoidable issues.
As financial regulation continues to evolve, businesses should keep their compliance processes aligned with the latest RBI directions applicable to their specific category.
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