Direct Tax Services
Select Your Location
NBFCs, like banks, provide financial services to individuals and businesses throughout the nation. NBFCs in India have a significant objective of providing a diverse range of loan products and services to individuals and businesses all around country. The problem of NBFC systemic risk has been discussed, particularly in India, where there’s been a number of major NBFC collapses, and the subject of inter-connectivity between NBFCs and the rest of the financial sector has become apparent. The RBI has noted the necessity to reassess the regulatory framework in consideration of the evolving risk profile of NBFCs in its Statement on Development and Regulatory Policies dated December 4, 2020. In the last several years, the regulatory framework for NBFCs has undergone a number of modifications, making it all more comprehensive. Furthermore, the sector’s phenomenal expansion, along with the NBFCs’ regulatory arbitrage, has created a systemic danger. As a result, regulators have deemed it essential to strengthen regulatory standards for NBFCs that control a significant portion of the market. The proposed discussion paper’s goal is to reconsider the broad principles that underlie the existing regulatory framework and analyze the necessity to develop a scale-based approach of minimum capital requirements for NBFC, to regulate from the viewpoint of “systemic significance,” as well as to suggest suitable regulatory measures in support of a strong and determined financial system.
In response to the declaration mentioned above, the RBI issued a Discussion Paper on January 22, 2021, requesting comments from industry players. The present article examines the RBI’s main recommendations.
Table of Contents
There are minimum capital requirements for NBFC firms under Section 45-IA of the RBI Act, 1934. The RBI has set rigorous minimum capital criteria for such shadow banks to guarantee risk reduction in the event of a capital crisis or a lack of liquidity. This was also done with the customer’s best interests in mind and to help the market develop.
In an integrated financial system, the unrestricted development of the NBFC sector, combined with a poor regulatory environment, may create the conditions of systemic risk. In the current environment, the collapse of any big and deeply linked NBFC has the potential to send shocks across the financial system, disrupting even the operations of small and mid-sized NBFCs.
The suggested framework of minimum capital requirements for NBFC calls for a scale-based method of regulation. This basically implies that regulatory and supervisory resources will be concentrated mainly on firms that have become too-large-to-fail (TBTF) as a result of their systemic interconnectivity with other financial market players. The principle of proportionality will be used to determine the level of regulation.
The suggested classification for minimum capital requirements for NBFC from the research is summarised in the figure under:-
CICs, however, is expected to be scrutinised more closely, potentially as a result of a recent major NBFC default. CICs, together with NBFCs presently categorised as systemically important NBFCs (NBFC-ND-SI), deposit-taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, and SPDs, are suggested to be considered Middle Layer NBFCs (NBFC-ML). Despite the fact that CICs and SPDs would go under the Middle Layer of the regulatory pyramid, the present regulations that apply to them will remain in effect.
The proposed framework of minimum capital requirements for NBFC also recommended that the NOF be increased to Rs. 20 crores. Furthermore, in attempt to guarantee a seamless transition, the RBI will set a well-defined timetable for current NBFCs, perhaps, covering 5 years. On the issue of instructions, the higher NOF requirements will be imposed instantly for new registrations.
All NBFCs, even the ones that are not strategically significant, would be eligible for NPA designation based on 90 DPD.
The classification of NBFCs is based on an annual assessment. The study characterises between 2 given parameters, i.e. quantitative and qualitative parameters:
To calculate leverage, divide the NBFC’s individual score by the sample’s average leverage. Even if it fails to fulfil the parametric criteria the following year, an NBFC-UL will be exposed to increased regulatory obligations comparable to those imposed on banks for at least four years after its previous appearance in the category.
NBFCs with assets of up to Rs 1000 crores would be covered under the base layer. The following table summarises the key proposals for this layer:
The present laws mandate NPA categorization of assets with more than 180 DPDs; however, this is recommended to be decreased to 90 DPDs to align with regulatory recommendations for other types of NBFCs.
The Board must have the following qualifications:
i. A sufficient level of experience and education
ii. Not less than one director should have retail lending experience for a bank or a non-bank financial institution.
For the Risk Management Committee,
i. the overall function and duties will be specified,
ii. The composition may be at the Board or Executive level, depending on the Board’s decision.
Once the guidelines have been finalised, the laws for the sale of stressed assets will be aligned with those of banks.
Further disclosures on risk types, linked party transactions, and consumer complaints will be prescribed.
Along with the recommendations for the base layer, numerous new regulatory requirements are suggested for this category. For NBFC-ML, no modifications to capital requirements are suggested.
Internal Capital Adequacy Assessment must be conducted according to a board-approved policy that considers all risks.
It is recommended that the existing credit concentration limitations for NBFCs for lending and investment be combined into a single exposure limit of 25% for a single borrower and 40% for a group of borrowers linked to Tier 1 capital rather than Owned Funds.
As per the proposed minimum capital requirements for NBFC, the auditors must be rotated on a regular basis. – Auditors will be ineligible for re-appointment for a period of 6 years upon completing a three-year continuous audit term (two tenures).
• Appointment of a Chief Compliance Officer who would be functionally independent.
• Additional CG and Disclosure Requirements, along with a Secretarial Audit Requirement
It is suggested that no KMP of an NBFC holds office in any other NBFC-ML, NBFC-UL, or subsidiaries and that an Independent Director cannot be a director in more than 2 NBFCs (NBFC-ML and NBFC-UL) at the same time.
Internal board-approved limitations and sufficient transparency would be needed to access sensitive exposures, and NBFCs will be obliged to conduct dynamic vulnerability assessments. Internally, a sub-limit within the commercial real estate exposure ceiling must be set for land acquisition finance.
Loans and advances for/to the aforementioned are subject to limitations:
A. Share/security buybacks
B. Actions that result in Ozone Depleting Substances
C. Directors & their relations
D. Officers and the relatives of Senior Officers
E. Real estate – only when project clearances and other permits have been obtained.
NBFC IPO financing would be limited to Rs. 1 crore. There is currently no limitation for NBFCs; however, banks have a ceiling of Ts. 10 lakh for IPO funding.
Core Banking Solution for NBFCs is required for NBFCs with more than 10 branches.
A series of additional rules will be applicable to NBFC-UL supplementary to the laws that apply to NBFC-ML:
Within Tier I capital, CET 1 might be prescribed at 9%.
NBFCs would be subjected to a leverage requirement in addition to the CRAR regulations.
Differential Provisioning is used in the same way as banks do for conventional assets.
For Concentration standards-
A. The Large Exposure Framework (LEF) will apply to banks with appropriate modifications.
B. Implementation transition time
Corporate Governance rules would be along with the same principles as those in place for private sector banks. Further governance rules include requiring members of the board to be qualified, as well as giving thorough information on group companies, which would include consolidated financial status and details of related party activities.
Adequate phase-in time must be allowed for the required listing. Furthermore, as part of the overall implementation strategy for NBFC-UL, disclosure requirements will take effect prior to the actual listing.
The removal of an Independent Director must be approved by the Board of Directors (supervisors).
The top layer is presently vacant and would be filled if the RBI determines that there’s been an unsustainable growth in systemic risk spillovers from individual NBFCs in the Upper Layer. This Layer’s NBFCs would be subject to greater capital charge, as well as Capital Conservation Buffers. The supervisory involvement with these NBFCs will be expanded and intensified.
On November 10, 2014, an asset size of Rs 500 crores was established to differentiate between SI and NSI NBFCs. The restrictions were set in accordance with the recommendations of the Working Group on Issues and Concerns in the NBFC Sector, which was led by Smt. Usha Thorat.
The RBI intends to raise the threshold from Rs 500 crores to Rs 1000 crores after more than 6 years.
The RBI’s statistics show that the number of NSI businesses will increase from 9133 to 9209, demonstrating this metric’s inherent scepticism. That is, just 76 companies would be moved from the SI category to the BL classification.
The regulator proposes raising the NOF requirement for NBFCs from Rs 2 crores to Rs 20 crores, a tenfold increase. The fundamental objective is to create a slower entry barrier and to guarantee that NBFCs have sufficient initial capital to spend on technology, labor, and infrastructure. This steep increase in the entry point criterion, on the other hand, will keep smaller NBFCs out of the game. Smaller NBFCs, especially those with a geographic or industry emphasis, have played an essential role in financial inclusion.
The regulatory framework of minimum capital requirements for NBFC is being completely overhauled. Whereas the new legal framework should’ve been expected to keep smaller NBFCs out of the spotlight, it is worth noting that just 76 businesses are moving from SI to NSI classification as a result of the suggested modification. The whole point of scalar regulation would’ve been to have fewer entities to control to focus attention where required. Furthermore, the concept of scalar regulation implies that there should be more regulation at higher levels of the pyramid and less regulation at the bottom. There are no obvious signs of decreased regulation at the base level.
Read our article:Regulatory Framework for NBFCs: A RBI Revision
Akansha is a Delhi-based lawyer who is actively involved in publishing articles on a plethora of aspects of Indian and International laws. She holds Master in law (LL.M) focused on Business Laws from Amity University, Noida. Having expertise in the same, she has authored several publications on legal topics related to corporate, M&A and commercial laws.
Many investors use fixed deposits as their primary investment vehicle. Investors with a high-ri...
The main idea of CDS, which was initially to give banks a way to transfer credit exposure, has...
Black money has been the subject of heated political debate in India for a long time. Successiv...
The Apex Court pronounced a judgement in the case titled Tata Motors Vs The Brihan Mumbai Elect...
Since economies are moving towards digitalisation and making it feasible to conduct transaction...
The Alternative Investment Funds (AIFs) Pro-rata and Pari-Passu Rights Proposal Consultation Pa...
The Financial Action Task Force, i.e. FATF (the Force), is the global money laundering and terr...
Advance tax refers to the payment of the tax liability before the end of the relevant financia...
On 11.12.15, the Hon’ble Delhi High Court (HC) pronounced a landmark judgement in the case ti...
Money laundering can be defined as the process of illegal concealment of the origin of money ob...
Are you human?: 2 + 5 =
Easy Payment Options Available No Spam. No Sharing. 100% Confidentiality
One of the rating agencies, Care edge ratings, stated that there would be no NBFCs within its rated universe that w...
22 Dec, 2021
RBI relaxes norms on securitization transaction for NBFCs. This move will ease the stress in the NBFC sector in Ind...
18 Dec, 2018
Red Herring Top 100 Asia enlists outstanding entrepreneurs and promising companies. It selects the award winners from approximately 2000 privately financed companies each year in the Asia. Since 1996, Red Herring has kept tabs on these up-and-comers. Red Herring editors were among the first to recognize that companies such as Google, Facebook, Kakao, Alibaba, Twitter, Rakuten, Salesforce.com, Xiaomi and YouTube would change the way we live and work.
Researchers have found out that organization using new technologies in their accounting and tax have better productivity as compared to those using the traditional methods. Complying with the recent technological trends in the accounting industry, Enterslice was formed to focus on the emerging start up companies and bring innovation in their traditional Chartered Accountants & Legal profession services, disrupt traditional Chartered Accountants practice mechanism & Lawyers.
Stay updated with all the latest legal updates. Just enter your email address and subscribe for free!
Chat on Whatsapp
Hey I'm Suman. Let's Talk!