Regulatory Framework for NBFCs: A RBI Revision

Sonal Pruthi

13 Feb, 2021

The paper speaks about the regulatory framework for an NBFC. RBI has been regularly changing the structure of the NBFC. It is pertinent to mention that NBFCs has seen a growth of 12% compared to the traditional banks. NBFCs have reached quarter the size of banks.

Regulatory Framework for NBFC

The regulatory framework for NBFC has been implemented from 2006. It was established with regulations about its size and restrictions on the financial service. Through this lenient regulatory framework for NBFCs, they can captivate in other geographical regions, extending its products and ease of financial business.

Evolution of NBFC

The regulatory framework for NBFC has been introduced in 1964. This was introduced in the chapter II-B of RBI Act, 1934^[1]. To regulate the NBFC, the RBI has vested the power in 1974, to inspect the NBFC and penalise them for illegal activities. In 1994, RBI introduced the regulatory framework for NBFC on the recommendation of the Shah Working Group. There is a defined regulatory framework for NBFC, which was introduced in 1998.

According to the 1998 framework, it includes-

a. The categorisation of NBFC into- public deposits accepting and non-public deposits accepting. Public Deposits Accepting is engaged in loans, investment, hire purchase and equipment leasing. Non-public deposits accepting are core investment companies that acquire 90 per cent of their total assets but not trading in these securities or shares.
b. The deposit meaning was restricted.
c. Minimum credit rating and quantum of deposits linked to the credit rating and net owned funds.
d. A prohibition from the grant of loan on the security of shares.

Regulatory Framework for NBFC in 2014

 The regulatory framework for NBFC was revised in 2014. A sceptical view was framed, and revision was based on new financial products and services introduced by NBFCs.  The fundamental changes included-

1. Minimum NOF of Rs 2 Crore.
2. Revision threshold limits of systematic importance from Rs 100 Crores to Rs 500 Crores and the inclusion of multiple NBFC within the same group.
3. Harmonisation of asset classification norms for Deposit-taking Non-Banking Financial Company (NBFC-D) and Non-Deposit taking Non-Banking Financial Company (NBFC-SI) Banks.

The objective of Revision of Guidelines for NBFC

The objective is to revisit the principles underlying the current regulatory framework and examine the need to develop a scale based approach to regulate and recommend appropriate measures in support of a robust financial system.

Revised guidelines for NBFC Framework

The NBFC guidelines for the revised regulatory framework for NBFC include:

1. A Layered Approach- This framework has been revised into the four-layer structure. The structure includes-

• The base layer-NBFC-BL
• Middle layer- NBFC-ML
• Upper layer-NBFC-UL
• Top layer.

2. A Pyramid Structure- The structure is formed in a pyramid, with least regulatory intervention. It has been classified as- non systematically important NBFC’s -NBFC-ND, NBFCP2P, and leading Platforms such as- NBFCAA, NOFHC and Type I NBFCs and then comes the third layer such as systematically important NBFC (NBFC-ND-SI), Deposit-taking NBFC (NBFC-D), HFC’s, IFCs, IDFs, SPDs, and CICs.
3. Adverse Regulatory Arbitrage- Banks can be addressed for NBFCs covering under this layer, to reduce the systematic risk spill over. The regulatory arbitrage is divided into two parts: structural arbitrage and prudential arbitrage. Where the banks in the former case maintain the SLR/CRR against time demand liabilities. In the latter case, the NBFCs enjoy the flexibility in terms of capital adequacy, asset classification and provisioning norms.

The scope includes regulatory restrictions imposed on the banks concerning lending against shares and dividend distribution.

4. Extant Regulatory Framework- The framework shall apply to the NBFC-NDs that is the extant regulatory framework. It will be applicable to base layer NBFCs. While the extant regulatory framework appropriate to the NBFCs- NDSI shall apply to the middle layer NBFCs.
5. Revision for upper layer- The modification in the lower layer of NBFCs will be equally applicable to upper layer NBFCs unless there is a conflict stated.
6. The threshold of systematic importance- Currently it is 500 Crores, and it is revised to 1000 crores.
7. NPA Classification Days have been classified those NPA days has been reduced from 180 days to 90 days.

Interpretation of the Norms

In the paper “Revised Framework for NBFC’s- a Scale Based Approach” it has been clarified that NBFCs at the base level has the least interference. The regulatory regime will get stricter as one goes up.

1. NBFC-BL- The NBFC’s at base layer classified as non-systemically NBFC (NBFC-ND/NBFC-Non Deposit Taking), Peer to Peer Lending and NBFC Non-Aggregator License, Non-operative Financial Holding, and NBFC up to asset size of Rs. 1000 Crores. Here at Base Layer, the Central Bank has revised the norms for NBFC –BL from Rs 2 Crore to 20 Crores. The harmonising of NPA is covered from 180 days to 90 days.
2. NBFC-ML includes NBFC which is currently classified as NBFC-ND-SI, Non Deposit Taking Systemically Important, Deposit taking NBFC, Housing Finance, Infrastructure Debt Funds, Standalone Primary Dealers, and Core Investment Companies. Here the linkages to their exposure limits are proposed to be changed from Owned Funds to Tier Capital. The extant credit concentration prescribed for NBFC-ML, for their lending and investment can be merged into single exposure limit 25 % for a single borrower and 40 % to the group of borrowers in the NBFC Tier I Capital.

For IPO Financing, their limit has been fixed to 1 Crore. No loans to the companies to buy back their shares. Guidelines on sale stressed asset by NBFC are that of Bank. NBFC with ten or more branches is required to undergo a Core Banking Solution. For auditor requirement the time period is three years.

3. NBFC-UL- Here 25 to 30 NBFCs are covered. The NBFC covered under this layer will work like Bank. It is identified as CIT- Common Equity Tier I Capital could be introduced for the NBFC-UL to enhance the regulatory capital. CET has been presented at 9 % at Tier I capital. The Large Exposure Framework as applicable to banks is available to NBFC.
4. NBFC-Top Layer- Here the NBFC at top layer has been kept empty in the pyramid structure.

Conclusion

It can be concluded that the regulatory framework of NBFC has been graded into the hierarchy of a pyramid. This is carried out to ease the process of NBFC Registration for future purposes and to discourage the failure of NBFCs.

Read our article:Revised Regulatory Norms for NBFCs