NBFC

Prudential Norms for NBFC Non-Deposit Taking

The RBI, which is the top financial agency, is required to regulate and oversee non-banking financial enterprises and requires them to follow prudential norms. These norms are meant to protect NBFC’s stability, solvency, and soundness financially. This blog will discuss the prudential norms for non-deposit-taking NBFCs. we discuss Prudential Norms for NBFC Non-Deposit Taking.

Non-Banking Financial Companies

According to Section 45-I (F) of the RBI Act of 1934¹, a “Non-Banking Financial Company” is defined as 

• A “Financial Institution” is a company; 
• The non-banking institution is a company whose primary business is to receive deposits under any scheme of arrangement or in any other way or to lend money in any manner;
• Other non-banking institutions, or a class of such institutions, as specified by the RBI

Prudential Norms

A combination of laws and rules known as prudential norms is intended to reduce the risks that banks and non-banks take on and to ensure the safety and soundness of both specific institutions and the system as a whole. Prudent regulatory examples include lending restrictions, minimum capital adequacy standards, liquidity ratios, etc.

How Come NBFCs Exist?

• Non-Deposit NBFC is a capable financial intermediary that is legally protected in every transaction it engages in and is subject to regulation.
• Increasing financial resources & accelerating like a little bank.
• Customised service and faster payment.
• Effective syndication and innovative products.

The Indian Financial System Has Three Elements, I.e., 

• Financial instruments and assets.
• Financial Instruments
• Financial Markets

Prudential Guidelines for NBFC Non-Deposit Taking

• Leverage Ratio

At no point in time will the leverage ratio of a relevant NBFC (other than NBFC-MFIs and NBFC-IFCs) be greater than 7. They must retain a minimum of 12% Tier I capital for NBFCs whose primary business is lending against gold jewellery (such loans must account for 50% or more of their financial assets). 

• Income recognition
  • Recognised accounting standards must serve as the foundation for income recognition. Income, including interest, discounts, rental fees, hire costs, and other non-performing assets (NPA) charges, must only be reported when it is realised. Any such income recognised prior to the asset-losing performance and not yet realized must be reversed. For loans where an interest repayment moratorium has been granted, interest revenue may be recognised on an accrual basis for accounts that are still categorized as “standard.”
  • The capitalised interest corresponding to the interest accrued during such a moratorium period need not be reversed if loans with a moratorium on interest payments (permitted at the time the loan was sanctioned) become NPA after the moratorium period has expired.

• Income from investments
  • Dividend income on shares of corporate bodies and units of mutual funds shall be computed on a cash basis, provided that dividend income on shares of corporate bodies shall be computed on an accrual basis once the applicable NBFC’s right to payment has been established. The corporate body declared the dividend in its annual general meeting.
  • Earnings from corporate bonds and debentures, as well as those from government securities and bonds, must be accounted for on an accrual basis, provided that the interest rate on these instruments is predetermined and that the interest is paid on time and is not delinquent.
  • Income from corporate or public sector obligations whose principal repayment and interest payments have been guaranteed by the federal or state government is to be accounted for on an accrual basis.

• Accounting Standards

If they do not conflict with the RBI’s directions, the accounting standards and guidance notes issued should be followed. In accordance with the Companies (Indian Accounting Standards) Rules, 2015, NBFCs that are required to implement Indian Accounting Standards (Ind AS) must prepare their financial statements in accordance with Ind AS as announced by the Government of India and must adhere to the regulatory requirements. 

The disclosure guidelines outlined in these instructions continue to be applicable for notes to accounts. Insofar as they do not conflict with any of these instructions, other NBFCs must adhere to the published Accounting Standards (AS). 

• Accounting of Investment
• The Board of Directors is responsible for developing and enforcing the company’s investment policy, which must include standards for categorising short-term and long-term investments.
• The Board of the company shall provide the criteria for classifying investments into current and long-term investments in the investment policy; 
• Securities investments shall be classified into current and long-term investments at the time of making each investment. 
• And guidelines are there in the event of an inter-class transfer.
• Guidelines on quoted current investments and their categorisation are there to adhere to.
• The breakup value or cost, whichever is smaller, shall be applied to unquoted equity shares that are current investments.
• Unquoted preference shares that are current investments must be valued at face value or cost, whichever is lower. 
• Government-guaranteed bonds or investments in unquoted government securities must be valued at carrying cost. 
• Current investments that are unquoted in mutual fund units are valued at the net asset value that the mutual fund has disclosed for each specific plan. 
• The carrying cost value of commercial papers must be used. 
• Long-term investments must be valued in line with the ICAI-issued Accounting Standard. 

• Need for Policy on Demand/ Call Loans

The Board of Directors of each applicable NBFC that grants or intends to grant demand or call loans shall establish and carry out a company policy. Such policy shall, among other things, provide for:

• A deadline by which the repayment of a demand loan or call loan must be demanded or called up; 
• A requirement that the sanctioning authority at the time record specific justifications in writing the loan is approved if the deadline for demanding or calling up the loan extends beyond a year from the date of approval; and 
• The interest rate that will be charged on such loans. 
• The sanctioning authority must document precise justifications in writing at the time of sanctioning demand or call loans if no interest is specified or a moratorium is given for any amount of time. 
• Interest on such loans, as stipulated, shall be payable either at monthly or quarterly rests. 
• Such demand or call loans shall not be renewed unless the periodic review has demonstrated adequate compliance with the terms of the sanction; 
• The cut-off date for review of loan performance is not to exceed six months commencing from the date of sanction. 

• Asset Classification

Every relevant NBFC (with the exception of NBFC-MFIs) shall adhere to the asset classification norms as listed below: 

Each NBFC must categorise its lease/hire purchase assets, loans and advances, and any other forms of credit into the following classes, taking into account the degree of well-defined credit vulnerabilities and the extent of dependence on collateral security for realisation:

• Standard assets; 
• Sub-standard assets; 
• Doubtful assets; and Loss assets. 

• Provisioning for Standard Assets

Every applicable NBFC must set aside standard assets at 0.25 percent of the outstanding balance, which is not taken into account when calculating net NPAs. Instead of having to be subtracted from gross advances, the provision for standard assets must be listed separately as “Contingent Provisions against Standard Assets” on the balance sheet.

• Guidelines for the Framework for Liquidity Risk Management 

According to their most recent audited balance sheet, applicable NBFCs must abide by the liquidity risk management policies if their asset size is $100 crore or above. However, these regulations would not cover Type I NBFC-NDs, Non-Operating Financial Holding Companies, and Standalone Primary Dealers. 

The Board of each NBFC will be in charge of making sure that the rules are followed. The internal controls that NBFCs are required to implement in accordance with these standards must pass supervisory inspection. Additionally, all other NBFCs are urged to voluntarily follow similar liquidity risk management principles as a matter of caution. 

• Multiple NBFCs

Multiple NBFCs It is forbidden to consider applicable NBFCs separately from other NBFCs that belong to the same business group or were founded by the same group of promoters. To assess whether a consolidation falls within one of the two asset size categories, those with asset sizes of below 500 crores and those with asset sizes of 500 crores and above the total assets of the NBFCs in a group, including deposit-taking NBFCs, if any, must be added together. 

Each NBFC in the group that does not accept deposits must abide by the rules that apply to the two categories. Statutory Auditors must certify the asset size of each NBFC in the group in order to serve this function. 

• Disclosures 

Each applicable NBFC shall separately declare the provisions for bad and doubtful debts in the balance sheet and the provisions for investment depreciation.

• Schedules

Every relevant NBFC must add the information from the schedule in Annex III to its balance sheet as required by the Companies Act of 2013. 

• Transactions in Government Securities

Each applicable NBFC shall, as the Bank may permit, engage in transactions in Government securities through its gilt account, its demat account, or any other account. 

• Loans Secured by an NBFC’s Own Shares are Prohibited

No eligible NBFC is permitted to make a loan secured by its own stock.

RBI Compliance Requirement

A Non-Deposit Accepting NBFC must submit the following returns:

• NBS-7 – Statement of Capital Funds, Risk Asset Ratio, Risk-Weighted Assets, etc., should be submitted every three months.
• NBS-2 – The company’s returns on key financial matters should be filed every month.
• ALM Returns – Monthly statements of short-term dynamic liquidity in form NBS-ALM-1, additionally an NBS-ALM-2 6-monthly statement on structural liquidity. Another NBS-ALM-3 6-monthly declaration of interest rate sensitivity.
• Basic details – The company’s name, address, NOF, and profit and loss during the last three years.
• Branch Information Return – ND-NBFCs with assets over Rs.50 crore but under Rs. 100 crore in terms of key financial parameters should calculate and file monthly.
• Auditor’s Certificate – Statutory auditors of NBFCs with overseas investments are required to submit this certificate to the appropriate Regional Office of the RBI, attesting to the fact that the NBFC has completely complied with all RBI regulations to be submitted yearly.

Prohibitions for NBFC?

• NBFCs are not allowed to make loans secured by their own shares.
• It is forbidden for NBFCs to join partnership firms as partners.
• Furthermore, NBFCs need RBI permission in advance before opening more than 1000 branches.

 Prior Intimation to RBI?

• Before contacting the court
• Takeover, acquisition, merger, or amalgamation 
• Resulting in the acquisition or transfer of 26% or more of the voting shares
• Resulting in at least a 30% change in management
• Changing gradually over time
• One month’s worth of public notice
• All changes must be communicated in advance.

Conclusion

These prudential norms seek to strengthen the financial system, protect stakeholders’ interests, and uphold the stability and integrity of NBFCs. To function as regulated businesses and keep their license to engage in non-deposit-taking activities, NBFCs must abide by certain norms. 

FAQ

Read Our Article: Disclosures in Loan Agreement of NBFC-Mfis

1. https://www.indiacode.nic.in/bitstream/123456789/2398/1/a1934-2.pdf