NBFC

Revised Regulatory Norms for NBFCs

A Non-Banking Financial Company (NBFC) is registered under the company law and governed by the RBI. It is mainly engaged in those businesses to provide advances and loans, acquisition of shares, stocks, bonds, and securities issued either by the government or local authority instead related with that institution whose primary business relates to agriculture, industrial, etc. NBFCs evolved in the finance sector to provide loan credit for MSMEMs and the rural, small-scale, informal sector within India.

Growth of NBFCs in India

Non-Banking Financial Companies (NBFCs) in the dynamic financial landscape played an important role, catalyzed economic growth, and promoted small businesses. NBFCs, in recent years, have achieved massive growth in the market. Recently, in a report published by the RBI, the NBFC’s shares contribution to the Indian economy increased to 29.1% in Feb 2023 from 16.4% in December 2022.

NBFCs are at the forefront of financial inclusion within India and work as financial intermediation and have significantly played a vital role in diversifying the financial landscape by providing a range of lending services to those undeserving groups living in rural parts of India especially those small companies in forecasting the business growth. However, in recent years, NBFCS associated with other entities and imparted certain risks within the financial system. NBFCs ended the financial gaps left by the banks, which were reluctant to provide loans to these sections just because of their perceived risk.

Nowadays, digital lending with high demands for smaller loans with the easiest application request has widened the scope of NBFC. However, the NBFCs are flexible in providing loans to MSMEs comparably faster than the banks with flexibility in payment plans with low-cost EMIs. Additionally, the increase in the usage of Artificial intelligence and other blockchain financial services has somewhat improved the NBFC’s portfolio.

Revised Regulatory Norms For NBFCs

RBI in its Scale Based Regulation (SBR): namely A Revised Regulatory Framework for NBFC RBI/2021-22/112 DOR.CRE.REC.No.60/03.10.001/2021-22 has differentiated and revised the different layers and further the NBFC will be identified according to these based layers. RBI for NBFC is a scale-based regulation framework adopted to revise and create differences between NBFCs based on the asset value, activities, and involved market risks.

Recent years’ reports in the NBFC sector emphasize the crisis of IL&FS, along with many other NBFCs, a huge financial crisis that seized the financial market with a debt involved approx. INR 1 lakh crores, out of which only 62% were unresolved. There was rapid growth in the NBFC sector in the previous 10 years, but recent years have been worse for the NBFC. NBFCs cater significant complements to the mainstream banking system, and those markets are inherently presumed to be higher in risk as per big financial banks. Customers easily approach NBFC for taking loans just because of easy reach out and quick decision with less paper formalities and financial services, etc.

The RBI has compressed the regulatory gap between the banks and NBFC as per the regulation scope. In the long term, it is a very progressive step because eventually, as we look at the regulation, we put ourselves to the test and build more business models. The risk tolerance has to go up if we have to build businesses for the long-term process of scale. In the short term, there could be some impact or could be some hard burns, but in the long term, it makes evidentially more sense. The tiered approach of RBI will push the NBFC, which has a larger scale and ambitions, to back with capital in the right direction. The recent regulation where the NPA regulation is clarified by the RBI that regulation for NPA context for NBFC. They have to follow the same path as the banks have been doing. If NBFCs cross over 90 90-day time period, then NBFCs have to necessarily recognize an NBFCS account as an NPA.

The RBI has decided to tighten its grip on NBFCs upper layer (large NBFC) and mandates to keep aside the loan amount of 0.25-2% for standard assets for the different categories based on assets such as SME, real estate, and housing loans. Under this provision, RBI wants NBFC to be treated like other banks’ norms. Now, the NBFC have to keep aside their minimum percentage of funds in order to cover the anticipated losses in terms of lending. NBFC need to set aside 0.25% of assets in the case of individual housing loans and MSME loans. 0.75% of funds have to be set aside for real estate residential projects and a further 1% for commercial real estate loans. 0.4% amount to be kept aside for all standard loans related to medium enterprises.

Although RBI has categorized NBFC into 4 tiers of layers: base, middle, upper, and topmost layer, the base layer will attract a very light touch of regulations under the RBI while progressive NBFC towards the next layers, such as the middle and upper will aggregate tightened regulations. The topmost layers are still empty, and in the opinion of RBI, any NBFC has a higher risk of exposure within the upper layer. Then, RBI will shift the NBFC to the topmost layer to scrutinize and monitor to comply with regulations. The intent is to safeguard the interest of investors involved and create a stable-based market. This change will provide the customer with a digital interface to get access to financial products and helps in keeping records for internal or regulatory purpose, etc. Thus, RBI felt that the essence of the revised regulations for NBFCs should be regulated according to their asset value, nature of the activity, and possible risk exposures.

The Factors involved in RBI Revised Regulatory Frameworks are as follows-

Re-classified Non-Banking Financial Companies-

Existing  different categories of NBFC like as Core Investment Companies, Microfinance Institutions, Systemically Important/ Non-Systemically Important, Deposit-taking/Non-deposit taking, etc., The RBI has re-classified the NBFC into a 3-level scale system.

• Classification based on layer into 4 tiers- Base Layer, Middle Layer, Upper Layer, and Top Layer
• Classified as per Asset valuation and possible market risk
• Based on activities taken into consideration while classifying NBFC.

Enhanced Governance 

 Accordingly, the requirement in the NBFC financial world, RBI formulated and amended a unified governance structure which will comply according to different layer-wise-

• The governance among different layers will be varied and will based on NBFCS meetings.
• Constitution for internal committees and their assessments.
• RBI formulated Disclosure required additionally for both the upper and middle layer NBFC. 

Classification of the NBFCs

The NBFCs shall be classified based on size, perceived risks, etc. They are classified into four different layers-

1. NBFC Base Layer–
   a) Non-deposit taking NBFCs below the asset value size of 1000 crore.
   b) NBFCs which are engaged in the activities as mentioned below-
   1. Peer-to-peer lending platform is also known as NBFC P2P
   2. NOFHC or the non-operative financial holding company
   3. NBFC-AA or NBFC Account Aggregator
   4. Those NBFCs which are not availing the public funds or do not own any customer interface.
2. NBFC Middle Layer– This layer should consist of the following-
   1. For all the NBFCs that take deposits, asset size is irrelevant here
   2. NBFCs that are non-deposit-taking and whose asset size values rupees 1000 crores.
   3. The NBFCs undertake the activities of standalone primary dealers, Core investment companies, Housing finance companies, etc.
3. NBFC Upper Layer– This layer will contain the NBFCs identified by the Central Bank of India specifically, who warrant the enhanced regulatory requirement based on the set of parameters or the scoring methodology.
4. NBFC top Layer- Ideally, this layer is supposed to remain empty. But if there is a remarkable increase in the potential systemic risk from the NBFCs in this layer, then it might get populated.

The classification has also been done of the NPAs relating to the NBFCs falling in the base layer from 180 days to 90 days overdue. This new framework aims to protect financial stability.

The rationale of the Policy

We need to understand the reasons for this regulation of the NBFCs. The premise was that NBFCs had more operational flexibility and less rigorous supervision. The NBFCs have had a comparatively free hand in building regional and sectoral expertise, which brought to the market a good variety of financial services and products which contributed to the prevailing fintech revolution in India in the area of digital lending.

However, because of the financial sector’s vulnerability during COVID-19, which impacted the economic condition of the whole world, the need was largely felt for tighter regulatory control of the non-banking financial companies to avoid systemic shocks. If the expansion is unbridled and is followed by a regulatory framework which is less stringent, then it might grow the seeds for systemic danger as per the draft proposal.

Suppose an NBFC experiences financial stress because of the lend short business model etc.. In that case, the shock is felt throughout the financial sector, including mutual funds, institutional investors and banks which cause disruptions. The Securities and Exchange Board of India amended the standards of Mutual Funds because of the debt investments by MFs in NBFC debt paper, which resulted in many bond defaults. It further resulted in many NBFCs facing liquidation or defaults.

The Central Bank of India is now exploring ways to link the systemic importance of NBFCs to a scale-based framework with proportional regulatory measures. The main idea of proportionality conceives a more rational or streamlined approach for allocating the supervisory resources of the RBI. The NBFCs, which pose huge systemic risks, can be regulated more rigorously.

In the graded approach of the Discussion Paper, the primary elements which were examined are given below-

Operations Size– If the balance sheet of the non-banking financial companies is large, then it will need more monitoring, irrespective of other factors.

The Nature of Activity- As far as the nature of the activity is concerned, the emergence of the geographically specialized NBFCs implies that some are going to participate in these activities with more systemic influence as compared to others. The non-deposit-taking NBFCs like Type I NBFCs don’t pose a greater systemic risk because they don’t accept public funds, but companies like housing finance companies or Core Investment companies (CIC) have such type of business models which involve a high level of financial risk.

Comprehensive Risk Perception– If the NBFC satisfies complexity, interconnectivity and specific size, it must be regulated with the proportionate risk it causes to the financial system. 

Regulatory Provisions

NBFC-NSI			NBFC-SI			HFC
Without public funds and a customer interface	With customer interface and public funds	Assets between 500-1000 crores		Asset size above or equal to 1000 crores	Top 10 or identified as such		Not in the top 10	Top 10 or identified as such
BL	BL	BL		ML	UL		ML	UL

NOF-

1. Without public funds and customer interface- BL- No change, that is rupees 2 crores
2. With customer interface and public funds- BL, Assets between 500-1000 crores- BL, Asset size above or equal to 1000 crores- ML, Top 10 or identified as such- UL- Rs 5 crores by March 31, 2025, Rs 10 crores by March 31, 2027
3. Not in top 10- ML, Top 10 or identified as such- UL- No change, i.e. Rs 15 crores by March 31, 2022, Rs 20 crores by March 31, 2023

Concentration Limits

• The previous limits were as a %age of the owned funds; the new or revised limits are basis Tier 1 capital.
• In the revised framework, there is a single limit for aggregate exposure to a group/single entity, but in the previous framework, there were sub-limits for investment and lending.
• The extant instructions on the concentration norms for varied categories other than the limit changes shall remain applicable.
• According to para 70 of the SSA Directions, the securitization exposures of the lenders shall be governed by the large Exposures framework, but the LEF is applicable to the Upper layer only.

Existing limits (as a percentage of owned funds)

	Lending	Investment	Total
Single borrower/party	15	15	25
A single group of borrowers/parties	25	25	40

Revised limit

	Total Exposure
Single borrower/party	25
A single group of borrowers/parties	40

The NBFCs which are in the BL or base layer should adhere to the 90 day NPA norm as under-

NPA	Timeline
>150 days overdue	March 31, 2024
>120 days overdue	March 31, 2025
>90 days overdue	March 31, 2026

Internal Capital Adequacy Assessment Process –

Under this proviso, NBFCs are duly required to keep an internal assessment of their capital in proportionate to business risk like-wise the banks compete under Master Circular- Basel III Capital Regulations. NBFCs are required to develop and use the best-skilled management risk techniques, etc. 

FAQ’s