Jun 08, 2024

Whether NBFCs in the middle layer (NBFC-ML) incorporated as Private Companies are required to appoint Independent Directors??

We have received the above query from several NBFC-MLs and hence thought it fit to publish our views on this subject.

In our view an NBFC-ML (whether existing as a public or private company) is required to appoint at least two independent directors on its board. Notably the prevailing contrary view in the market is that an NBFC-ML (existing as private company) is not mandated to appoint independent director(s). The rationale for both these views is as under:-

Rationale for the contrary market view: The reason for the contrary view in the market is the absence of any explicit directive / requirement under the RBI (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 (“Scale Based Regulations”) requiring and NBFC-ML to appoint independent directors on its Board. The Companies Act, 2013 (“Companies Act”) (standing as the cornerstone of corporate governance) requires only listed public companies to appoint independent directors (being at least 1/3rd of the total number of directors). Both these read together, lead some parties to the view that in the event an NBFC-ML is a private company, it need not appoint independent directors.

Rationale for our view to appoint at least 2 independent directors: Each NBFC-ML, irrespective of its public or private status, is obligated under the Scale Based Regulations, to constitute the following committees:

  1. Nomination and remuneration committee (NRC): The Scale Based Regulations require that an NBFC-ML form an NRC, which has the constitution, powers, functions and duties as laid down in section 178 of the Companies Act, 2013 (“Companies Act”). As per the Companies Act, the NRC must consist of 3 or more non-executive directors with at least half of the members being independent directors i.e. at least 2 independent directors.
  2. Audit committee – Similar to the provision for the NRC, the Scale Based Regulations also requires that an NBFC-ML constitute an audit committee, consisting of not less than 3 directors and that the Audit Committee constituted under this paragraph shall have the same powers, functions and duties as laid down in section 177 of the Companies Act. This section requires independent directors to form the majority of the members of the audit committee, i.e. at least 2 independent directors.

While under the Companies Act, the applicability of the relevant sections requiring the constitution of these committees applies only to public listed companies, the RBI, through the Scale Based Regulation, does not appear to make any distinction basis the type of company and instead extends the obligation to constitute these committees (as per Sections 177 and 178 of the Companies Act), universally to all NBFC-MLs, irrespective of their public listing status. This may be driven by the higher systemic importance of an NBFC-ML in the financial ecosystem.

Further, RBI’s Master Direction on Information Technology Governance, Risk, Controls and Assurance Practices, 2023 also requires an NBFC-ML to constitute an IT Strategy Committee, with the chairperson of this committee being mandated to be an independent director with substantial expertise in managing and guiding information technology initiatives.

Basis the above, while it may have been helpful for RBI to have mandated the requirement for independent directors expressly, for now, it would appear that an NBFC-ML may have to comply with this requirement of appointing two independent directors.





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