Advanced Auditing, Assurance and Professional Ethics · Special Features of Audit of Banks & Non-Banking Financial Companies

NBFC Audit: Regulatory Framework under the RBI Act, 1934

Updated 5 October 2026

An NBFC is a company whose principal business is financing, investing or similar activity, and it is regulated by RBI under Chapter IIIB of the RBI Act, 1934. It needs a Certificate of Registration and the minimum net owned fund. To answer exam questions, identify the NBFC type, then apply registration, NOF, prudential norms and the auditor's duties.

Understand NBFC Audit: Regulatory Framework under RBI Act

A Non-Banking Financial Company (NBFC) is a company that carries on financial business such as lending, hire purchase, leasing or investing in securities. It does not hold a banking licence. So it cannot issue cheques drawn on itself or take demand deposits like a bank.

The RBI Act, 1934 gives RBI the power to regulate NBFCs. Chapter IIIB deals with provisions relating to non-banking institutions receiving deposits and with financial institutions. The idea is simple. NBFCs take public money and lend it on, so RBI controls who can enter, how much capital they hold, how they recognise bad loans and how they report.

Three controls matter for audit. First, registration: under Section 45-IA, an NBFC cannot commence or carry on the business of a non-banking financial institution without a Certificate of Registration (CoR) from RBI and without the minimum net owned fund (NOF) that RBI specifies. Second, reserve fund: under Section 45-IC, an NBFC must transfer a prescribed share of its yearly profit to a reserve fund before declaring any dividend. Third, prudential norms: RBI directions on income recognition, asset classification, provisioning, capital adequacy and exposure limits.

RBI also classifies NBFCs, for example by the activity they carry on (investment and credit company, infrastructure finance company, microfinance institution, and so on), by whether they accept public deposits, and by size under a scale-based regulatory approach (base, middle, upper and top layers). Larger and riskier NBFCs face tougher rules. Always check which category the question gives you, because the rules change with it.

The statutory auditor has duties beyond the normal audit. The NBFC Auditor's Report (Reserve Bank) Directions issued by RBI prescribe what the statutory auditor must report. Under these Directions, the auditor reports on matters such as whether the company is engaged in the business of a non-banking financial institution and holds a CoR, whether it is entitled to continue to hold that CoR, whether it meets the NOF requirement, and whether it complies with the prudential norms. Separately, Section 45MA of the RBI Act lets RBI direct a special audit of an NBFC by a chartered accountant, where it considers this necessary in the interest of depositors or in the public interest. Do not confuse the two. The special audit is an RBI-ordered audit. The reporting on CoR, NOF and prudential norms is the statutory auditor's duty under the Directions. If the NBFC is a company, the Companies Act audit still applies in full. The RBI framework adds to it, it does not replace it.

Key rules to remember

Registration requirement: No NBFC may commence or carry on business without (a) Certificate of Registration from RBI and (b) the minimum NOF specified by RBI; This is the rule in Section 45-IA of Chapter IIIB. Cite it as a pre-condition for carrying on business. The current NOF amount is set by RBI. Use the figure given in the question.
Net Owned Fund (NOF): Owned fund = (Paid-up equity capital + Free reserves, as per latest balance sheet) − (Accumulated balance of loss + Deferred revenue expenditure + Other intangible assets). NOF = Owned fund − excess, over 10% of the owned fund, of investments in shares of subsidiaries, companies in the same group and all other NBFCs; This is the definition of net owned fund in Section 45-IA. The 'owned fund' is the amount you get after the first set of deductions. It is not yet the NOF. NOF is the figure after the investment adjustment. The investment deduction applies only to the amount that exceeds 10% of that owned fund, and it covers investments in shares of subsidiaries, group companies and other NBFCs. Free reserves are reserves available for distribution as dividend. They exclude revaluation reserves and similar non-distributable items, so leave those out when the question gives a reserves figure that includes them. Compulsorily convertible preference shares are counted along with paid-up equity capital as per RBI's clarification and Directions, not the section text. Use that treatment if the question mentions them. Check each step against the definition if the question gives details.
Reserve fund transfer: Transfer to reserve fund = at least 20% of net profit disclosed in the profit and loss account, every year, whether or not a dividend is declared. No dividend may be declared before the transfer is made; Applies to NBFCs under Section 45-IC. The transfer is mandatory each year. It is not an option that depends on the dividend. The fund is created and disclosed separately. Appropriation from it is allowed only with prior RBI approval.
Prudential norms: asset classification: Standard asset → Sub-standard (NPA beyond the RBI-specified overdue period) → Doubtful (sub-standard for the specified period) → Loss asset; The overdue periods and provision percentages come from RBI directions. Quote them as given in the question, and do not rely on memory if figures differ.
Auditor's reporting to RBI: The NBFC Auditor's Report (Reserve Bank) Directions prescribe the statutory auditor's report: CoR held, entitlement to continue to hold it, NOF compliance, and compliance with prudential norms. Section 45MA is separate: it lets RBI direct a special audit of an NBFC by a chartered accountant in the interest of depositors or in the public interest; The reporting content comes from the Directions issued by RBI, not from Section 45MA. State the points in plain words. Section 45MA deals with a special audit ordered by RBI. This reporting is also separate from the Companies (Auditor's Report) Order.

How to solve NBFC Audit: Regulatory Framework under RBI Act questions

Use this method for any question on the NBFC regulatory framework. It keeps your answer in provision, facts and conclusion form.

1Read the facts and decide whether the entity is a company engaged in financial business as its principal business. If not, the NBFC framework may not apply.
2Identify its category: deposit-taking or not, activity type, and size layer under the scale-based approach. Note the category in the first line of your answer.
3State the registration rule from Section 45-IA of Chapter IIIB: Certificate of Registration and minimum NOF are needed to carry on business. Compare the NOF figure in the question with the requirement.
4Compute NOF if figures are given. Start with paid-up equity capital and free reserves as per the latest balance sheet. Add compulsorily convertible preference shares, if any, as per RBI's clarification and Directions. Deduct accumulated losses, deferred revenue expenditure and intangible assets to get the owned fund. Then deduct investments in shares of subsidiaries, group companies and other NBFCs that exceed 10% of the owned fund, if any.
5Apply the relevant control: reserve fund transfer, dividend restriction, or prudential norms on classification and provisioning.
6Link to the auditor's duty. The NBFC Auditor's Report (Reserve Bank) Directions prescribe what the statutory auditor reports: CoR held, entitlement to continue holding it, NOF compliance and prudential norms. If the question mentions an RBI-ordered special audit, cite Section 45MA. Mention the Companies Act duty that runs alongside.
7Conclude clearly. Say whether the NBFC complies, what breach exists and what the auditor should do, such as reporting or modifying the opinion.

Quickest way: Four-check scan for NBFC questions

When to use it: Use this when you have about eight to ten minutes for a short case-based question or MCQ.

Check 1, Entity: is it a company with financial activity as principal business? Mark its category.
Check 2, Licence and capital: does it hold a Certificate of Registration and the minimum NOF? Recompute NOF if numbers are given, including the deduction for investments in excess of 10% of the owned fund.
Check 3, Profit use: was the reserve fund transfer made before dividend? If not, flag the breach.
Check 4, Auditor: name the RBI reporting duty (the NBFC Auditor's Report (Reserve Bank) Directions set the content: CoR held and entitlement to continue, NOF, prudential norms) and the effect on the audit report. If the facts mention a special audit directed by RBI, cite Section 45MA. Write your conclusion in one line.

Common mistakes in NBFC Audit: Regulatory Framework under RBI Act

Treating an NBFC as a bank and applying banking company rules.
Both lend money and both are regulated by RBI, so students merge the two frameworks.
Fix: Remember that an NBFC has no banking licence and cannot accept demand deposits. It is governed by Chapter IIIB of the RBI Act, while banks are governed by the Banking Regulation Act, 1949.
Deducting the whole amount of investments in subsidiaries, group companies and other NBFCs instead of only the excess over 10% of the owned fund.
Students read 'deduct investments' and subtract the full figure without applying the 10% limit.
Fix: First compute the owned fund. Then deduct only the part of the investments in shares of subsidiaries, group companies and other NBFCs that exceeds 10% of that owned fund.
Forgetting deductions when computing NOF.
They stop after capital plus reserves.
Fix: Always deduct accumulated losses, deferred revenue expenditure and intangible assets. Then deduct investments in shares of subsidiaries, group companies and other NBFCs to the extent they exceed 10% of the owned fund.
Treating the reserve fund transfer as optional or as something that depends on a dividend, and declaring dividend without it.
Students treat the transfer as a discretionary appropriation tied to the dividend decision.
Fix: State that under Section 45-IC the transfer of at least 20% of net profit is mandatory every year, whether or not a dividend is declared, and that no dividend may be declared before it is made. The auditor should report a failure to comply.
Saying registration is needed only for deposit-taking NBFCs.
Confusion between registration and deposit acceptance rules.
Fix: State that registration under Section 45-IA is the general rule for NBFCs, subject to exemptions recognised by RBI. Deposit acceptance needs additional conditions.
Describing the auditor's RBI duty as only a report on registration and NOF, or tying it to the Companies (Auditor's Report) Order, or saying Section 45MA is the source of the statutory auditor's reporting duty.
Students mix the CARO reporting with the RBI reporting, remember only the registration point, and link every NBFC audit duty to Section 45MA.
Fix: Say that the NBFC Auditor's Report (Reserve Bank) Directions prescribe the statutory auditor's report on the CoR held, entitlement to continue holding it, NOF compliance and prudential norms. Section 45MA is about a special audit that RBI may direct in the interest of depositors or in the public interest.
Writing only the RBI Act duties and ignoring the Companies Act audit.
The topic title focuses on RBI, so the statutory audit seems to disappear.
Fix: Say that the Companies Act audit continues in full, and RBI directions add specific reporting duties.

Worked examples

Example 1

Sunrise Finance Ltd is a company whose principal business is giving loans and hiring out vehicles. At the year end its paid-up equity capital is ₹1,50,00,000, free reserves are ₹60,00,000 (these exclude any revaluation reserve), accumulated losses are ₹10,00,000, deferred revenue expenditure is ₹5,00,000 and intangible assets are ₹15,00,000. It has no compulsorily convertible preference shares. Compute its owned fund, which is the figure before the investment adjustment. As auditor, what should you check before concluding on registration compliance?

Show the solution

Principal business is financing, so the company falls within the NBFC framework under Chapter IIIB of the RBI Act, 1934.
Free reserves are reserves available for distribution as dividend. Revaluation reserves are not included, and the ₹60,00,000 given here already excludes them.
Capital plus free reserves = ₹1,50,00,000 + ₹60,00,000 = ₹2,10,00,000.
Deductions = accumulated losses ₹10,00,000 + deferred revenue expenditure ₹5,00,000 + intangibles ₹15,00,000 = ₹30,00,000.
Owned fund = ₹2,10,00,000 − ₹30,00,000 = ₹1,80,00,000. This is the owned fund, not yet the NOF. NOF is the figure after deducting investments in excess of 10% of the owned fund.
Check that the company holds a valid Certificate of Registration from RBI. Check for investments in shares of subsidiaries, group companies and other NBFCs that exceed 10% of the owned fund (₹18,00,000 here). The excess would reduce the owned fund to arrive at NOF. Then compare the NOF with the amount currently required by RBI.

Answer: The owned fund is ₹1,80,00,000. This is before the investment adjustment, so it is not yet the NOF. The auditor must confirm the Certificate of Registration, deduct any investments in excess of ₹18,00,000 to arrive at NOF, compare that NOF with RBI's current requirement, and report any shortfall.

Example 2

Greenline Capital Ltd, an NBFC, reports a net profit of ₹80,00,000 for the year. The Board proposes a dividend of ₹30,00,000 and has transferred ₹10,00,000 to a reserve fund. Assume the ₹10,00,000 was transferred out of the profit disclosed in the profit and loss account before the dividend is declared. What is the auditor's concern, and what is the shortfall?

Show the solution

Under Section 45-IC of the RBI Act, an NBFC must transfer at least 20% of its net profit, as disclosed in the profit and loss account, to a reserve fund every year. The transfer is mandatory whether or not a dividend is declared. No dividend may be declared before it is made.
Timing assumption: the ₹10,00,000 transfer is made out of the profit disclosed in the profit and loss account and before the dividend is declared. So the only issue is the amount, not the sequence.
Minimum transfer = 20% × ₹80,00,000 = ₹16,00,000.
Actual transfer = ₹10,00,000.
Shortfall = ₹16,00,000 − ₹10,00,000 = ₹6,00,000.
The transfer is short even if the dividend were dropped, because the 20% transfer does not depend on the dividend. Since the minimum transfer has not been made, the proposed dividend of ₹30,00,000 also cannot be declared. The auditor should ask management to correct the transfer, and if it is not corrected, should report the non-compliance and consider the effect on the audit report.

Answer: The transfer is short by ₹6,00,000 (₹16,00,000 required against ₹10,00,000 made, assuming the transfer was made from the profit and loss account profit before the dividend). The 20% transfer is mandatory every year under Section 45-IC, whether or not a dividend is declared. No dividend may be declared until the minimum transfer is made, and the auditor should report the breach if it is not corrected.

Exam tips

Always open your answer by naming the category of NBFC. It signals to the examiner that you applied the right layer of rules.
In NOF questions, show every deduction on a separate line. Marks are given for steps even if the final figure is slightly off.
Write provisions in plain words and use RBI directions for figures. If the question gives a percentage or a period, use that figure and do not substitute your memory.
For case MCQs, test the entity first. Many wrong options assume a bank or a non-company entity when the facts show a company NBFC.
Close each written answer with the auditor's action: report, qualify or communicate. That is the conclusion examiners look for.

Practice questions from Special Features of Audit of Banks & Non-Banking Financial Companies

NBFC Audit: Regulatory Framework under RBI Act: frequently asked questions

Which section of the RBI Act requires an NBFC to register?

Section 45-IA requires an NBFC to obtain a Certificate of Registration from RBI and to hold the minimum net owned fund specified by RBI. Without both, the company cannot commence or carry on the business of a non-banking financial institution.

What is net owned fund in simple terms?

It is the real capital cushion of the NBFC. As defined in Section 45-IA, you take paid-up equity capital plus free reserves as shown in the latest balance sheet, and then deduct accumulated losses, deferred revenue expenditure and intangible assets. That gives the owned fund. You then deduct investments in shares of subsidiaries, group companies and other NBFCs to the extent they exceed 10% of the owned fund. Compulsorily convertible preference shares are counted with paid-up equity capital as per RBI's clarification and Directions.

What is the difference between bank audit and NBFC audit?

A bank is regulated under the Banking Regulation Act, 1949 and has a branch-based audit with a central auditor. An NBFC is regulated under Chapter IIIB of the RBI Act, 1934 and audited as a company. It has extra reporting to RBI, because the NBFC Auditor's Report (Reserve Bank) Directions prescribe what the statutory auditor reports on CoR, NOF and prudential norms. Separately, Section 45MA lets RBI direct a special audit of an NBFC in the interest of depositors or in the public interest.

Does the Companies Act audit still apply to an NBFC?

Yes. If the NBFC is a company, the full statutory audit under the Companies Act applies. The RBI framework adds further duties and reports on top of it.