RBI announces Revised Regulatory Framework for NBFCs

On October 22, 2021, the Reserve Bank of India announced a scale based revised regulatory framework for NBFCs with a view to have a tight oversight of the sector. As per the scale based regulatory framework for Non-Banking Financial Companies, there will be more categories of NBFCs as per their activity with stringent rules. The framework encompasses various facets of NBFC regulation covering capital requirements, prudential regulation, governance standards etc.

The need for Revised Regulatory Framework for NBFCs

The RBI^[1], in a notification, observed that the contribution of NBFCs in supporting economic activity and its role as a supplemental channel of credit intermediation with banks is well recognised. The RBI further mentioned that the sector has undergone remarkable evolution over the years in terms of size, complexity and interconnectedness. The RBI observed that various entities have grown and become significant, and therefore there was a need to align regulatory framework for NBFCs considering their changing risk profile.  

Revised Regulatory Framework for NBFCs: Layer-based structure for NBFC

The regulatory structure of the NBFCs will include 4 layers as per their size, activity and perceived riskiness.

• Base layer– Comprising non-deposit taking NBFCs below asset size of 1000 crore rupees and consist of NBFCs undertaking activities such as NBFC-P2P, NBFC-AA, NOFHC and NBFCs not availing public funds.
• Middle Layer– Comprising of all deposit taking NBFCs, non-deposit taking NBFCs with an asset size of 1000 crore rupees and more and NBFCs undertaking activities such as SPDs, IDF-NBFCs, CICs, HFCs, and NBFC-IFCs.
• Upper Layer– The top 10 eligible NBFCs in terms of asset size will reside in this layer always;
• Top Layer– This layer can get populated if regulator is of the opinion that there is a substantial increase in potential risk from specific NBFCs in upper layer.

Regulatory Changes

Regulatory changes will be as follows:

• The RBI will hike the Net Owned Fund requirement for all NBFCs to 10 crore rupees;
• They will be required to recognise loans overdue for more than 90 days as NPAs by March 2026 and over 150 days by March 2024;
• There will be a ceiling of 1 crore rupees per borrower for financing subscription to IPO.

Regulatory changes applicable to NBFC-ML and UL

• NBFCs need to make thorough internal assessment for the need for capital, commensurate with risks in business;
• The internal assessment will be similar as ICAAP prescribed for commercial banks under Pillar 2 (Master Circular- Base III Capital Regulations);

Additional Regulatory Changes to NBFC-UL

• NBFC-UL is required to maintain common equity tier 1 capital of minimum 9% of risk weighted assets;
• The upper layer NBFCs shall be subjected to leverage requirements to make sure that their growth is supported by adequate capital;
• The upper layer NBFCs shall be required to hold differential provisioning towards different classes of standard assets.

Prudential Guidelines

• The extant credit concentration limit prescribed for NBFCs separately for lending and investments will be merged into a single exposure limit of 25% in case of single borrower/party and 40% in case of single group of borrowers/parties.

The revised norms are specified in the table:

• NBFCs shall be subject to certain restrictions also in respect of:
• Granting loans and advances to directors, relatives and to entities where directors or relatives have major shareholding;
• Giving loans and advances to NBFCs Senior officers;
• NBFCs, while appraising loan proposals involving real estate, shall ensure that the borrowers obtain prior permission from relevant authorities.

Additional Regulatory Changes to NBFC-UL

• RBI decided to introduce large exposure framework for those NBFCs placed in the Upper Layer;
• NBFC UL shall put in place an internal board limit for exposure to the NBFC sector.

Governance Guidelines

Changes applicable to NBFC-BL

• NBFCs to constitute a Risk Management Committee at board or executive level;
• Disclosure requirements to be expanded to include types of exposure, related party transactions.
• NBFC-BL to have a board approved policy on extending of loans to directors, senior officers as well as relatives of directors and to entities where directors or relatives have major shareholding.

Changes applicable to NBFC-ML and NBFC-UL

• Except for directorship in subsidiary, KMP shall not hold any office in any other NBFC-ML or UL;
• An Independent director will not be in the board of more than 3 NBFCs at one go.
• There should not be any conflict arising out of their independent directors being on the board of another NBFC at the same time.
• NBFCs need to appoint a Chief Compliance Officer, and NBFCs should have a board approved policy laying down the role of such officer.
• NBFCs to put in place a board approved compensation policy;
• Further, NBFCs with more than 10 branches should adopt Core banking Solution.

Additional Changes applicable to NBFC-UL

• Competent board members to manage the affairs of the NBFC;
• NBFC-UL to be mandatorily listed within 3 years of being identified as NBFC-UL;
• NBFC-UL to report to supervisors if any independent director is removed or resigns before completion of tenure.

Regulatory Guidelines for NBFCs under the top layer

Those NBFCs that come under NBFC top layer shall be subject to high capital charge. There would be enhanced as well as intensive supervisory engagement with these NBFCs.

Revised Regulatory Framework for NBFCs: Effective Date

These guidelines will be effective from 1^st October 2022. Further, the instructions related to ceiling on IPO funding shall come into effect from 1^st April 2022.

Read our article:Regulatory Framework for NBFCs: A RBI Revision