Base Layer NBFCs Amenable to NSI or SI Regulations?

Swetha Dhinesh

07 Apr, 2023

The governing body for all Non-Banking Financial companies in India is the (RBI) Reserve Bank of India. The Scale Based Regulation (SBR), which takes effect on October 22, 2021, was introduced by the RBI to help current NBFCs’ regulatory frameworks keep up with their shifting risk profiles. 
Before implementing the Scale Based Regulation Framework, NBFCs were categorised as Systemically Important (SI) or Non-Systemically Important (NSI) based on the total risk associated with their operations and the significance of those operations from an economic perspective. NBFCs are governed by Master Direction. If their asset size is up to Rs. 500 crores, they are classified as NSI, and those with 500 crores or more, are categorised as SI, depending on their asset size.

Current Regulatory Structure for NBFCs

The size, activity, and perceived riskiness of NBFCs will determine the regulatory structure in the four layers of NBFC. NBFCs in the lowest layer are referred to as NBFC-Base Layer (NBFC-BL). The terms “NBFC – Middle Layer and upper Layer shall be known as NBFC – Middle Layer (NBFC-ML) and NBFC-upper layer (NBFC-UL), respectively. The Top Layer, often called NBFC – Top Layer, is ideally anticipated to remain empty (NBFC-TL).

Base Layer 

Non-deposit taking NBFCs with assets under ₹1000 crore

The following NBFCs will always be in the Base Layer of the Regulation Structure when engaging in these activities:

• Peer-to-Peer Lending Platform for NBFCs (NBFC-P2P)
• Non-Operative Financial Holding Company (NOFHC)
• NBFC-Account Aggregator (NBFC-AA)
• NBFCs without any consumer interface and no access to public funding

Importance of NSI and SI classification

First and foremost, it’s essential to realise that the categorisation and Layer that the NBFC belongs to will influence the rules, regulations, and compliances that will apply to it. In comparison to an NBFC-NSI (Non-Systematically Important), an NBFC-SI (Systematically Important) has been subject to stricter restrictions (such as the need for board committees, concentration norms, etc.). 

Because of this, if it is stated that the subject entities must comply with or continue complying with SI Directions, then such entities must continue with strict compliance. In contrast, other entities in the same Layer (BL entities) would continue with lax norms under NSI Directions. However, if it is claimed that such subject entities are now BL and may obey NSI Directions, those companies would be released from various compliances.

Is the Base Layer Amenable to NSI or SI NBFCs?

We must first examine the purpose of the SBR Framework in order to respond to the problem statement. The following was stated in the Announcement on Developmental and Regulatory Policies dated December 4, 2020, “The regulatory framework controlling the NBFC sector is based on the notion of proportionality, allowing for the sector to access sufficient operational flexibility through calibrated regulatory measures. Let us examine whether the base layer amenable to Non-systematically Important or Systematically important NBFCs.

• The NBFC sector’s scale and interconnection have, however, significantly increased as a result of recent rapid advances. As a result, it is necessary to update the regulatory framework to reflect the shifting risk profile of NBFCs. A scale-based regulatory strategy based on the contribution of NBFCs to systemic risk is the best course of action.

• Additionally, this blog makes it clear in several places that each Layer must be governed according to the “principle of proportionality”. According to the principle of proportionality, the degree of regulation of a financial entity should be proportionate to the perceived danger the entity poses to the financial system and the scale of its activity. An NBFC should be subject to correspondingly stricter regulation as it exceeds the criteria for the specified parameters size, leverage, interconnectivity, complexity, and supervisory inputs. 

• A regulatory framework based on proportionality can be introduced. Suppose the framework is represented as a pyramid. In that case, the NBFCs are now categorised as non-systemically important NBFCs may be found near the base of the pyramid, where the least amount of regulatory involvement is necessary.

• The NBFCs now categorised as systemically significant NBFCs (NBFC-ND-SI), deposit-taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, SPDs, and CICs can be found in the subsequent tier as one progresses up. The regulatory structure for this Layer shall be stricter compared to the base layer.” 

• The regulatory framework envisages a progressive rise in the level of regulation. The existing regulatory framework for NBFC-NDs will now apply to Base Layer NBFCs. In contrast, the existing regulatory framework for NBFC-NDSI will apply to Middle Layer NBFCs, as was previously indicated.

• In addition to Category I NBFCs, NOFHC NBFC-P2P, and NBFC-AA, the Base Layer will include NBFCs now categorised as non-systemically important NBFCs (NBFC-ND). 500 crores are the current cut-off for systemic importance. This threshold needs to be adjusted to account for the rise in real GDP^[1] and general price levels after 2014.

• As a result, it is suggested that the barrier be increased to Rs. 1000 crore. 9133 of the 9425 NBFCs that do not accept deposits have assets of less than 500 crores. The present number of NBFCs in this stratum would increase by 76 to 9209 if the current threshold of systematically important were raised to 1000 crore. This layer’s NBFCs will be referred to as the NBFC-Base Layer (NBFC-BL).

Regulatory Framework 

The same regulations presently apply to NBFC-ND and will continue to apply to NBFC-BL. But, as the threshold is being raised to ₹1000 crore, improved governance and disclosure rules might be added to the legal framework. The exact regulatory adjustments will be regarding the SBR Framework released by the RBI. The aforementioned announcement makes many references to “NBFC-ND” in contrast to NBFC-ND-SI but does not define the term. 

As of October 1, 2022, NBFC-D shall mean Non-Banking Financial Companies-Base Layer, and all references to NBFC-D and NBFC-ND-SI shall mean NBFC-ML or NBFC-UL, as applicable. It is clear that current NBFC-ND-SIs will be referred to as NBFC-BL if their asset size is $500 million or more but less than ₹1000 crore (except for those who must necessarily be included in the Middle Layer). It is abundantly clear that references to NBFC-ND-SI only pertain to NBFC-ML and NBFC-UL (where applicable) and that NBFC-ND only refers to NBFC-ND-NSI.

“Regulation by proportion” is the goal of the SBR Framework. Consequently, it is impossible to argue that the regulatory goal was to create a sub-classification within the BL despite the existence of numerous levels in the form of BL, ML, UL, and TL. Such a reading would be illogical because it would make no sense to have a Middle layer and then apply SI Directions to things that lie under that Layer as well as to a specific area of the Base layer.

Conclusion

All of the NBFCs in the Base Layer (including the subject entities with asset sizes greater than Rs. 500 crores but less than Rs. 1000 crores) shall be subject to compliance with the NBFC-ND-NSI Directions, as established by the provisions of the SBR Framework. The systemic classification that existed before the object became a base layer may be all that is being referenced by the RBI List (as indicated above). The SBR framework does not mention requiring a subject entity to keep up with NBFC-SI rules. The subject entity can switch to NBFC-NSI regulations as a result.

Also Read:
Decoding the Growth of NBFCs in India
Emerging Prospects for NBFCs in the Indian Financial Landscape in 2023