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NBFCs have emerged as one of the systemically important components of the financial system showing consistent year-on-year growth. They play a critical role in development areas such as infrastructure, transport, employment generation, wealth creation opportunities, and provide financial security to the weaker sections of society.
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Their contribution to the economy has grown from 8.4% in 2006 to 14 % as per the 2015 survey, which is further expected to grow in the coming years. The public sector banks have already faced a loss of their appetite to further lending, providing NBFCs with a golden opportunity to multiply its presence. Here we will discuss, new NBFC Regulatory Framework.
The growth rate of NBFC Registration in India can be clearly attributed to their lower cost of establishment, better products, wider reach, strong risk management capabilities, better control over bad debts, and a better understanding of their customer needs. The personal loan sector or the home loan sector, which was the core area of the retail banks, now are possessed with the NBFCs coming into the larger picture.
While the banking system is concentrating on large businesses and segments as their prime customers, the NBFC is striving to cover more and more retail customers as well as small and medium enterprises, credibility to their wider reach and efficiency.
NBFCs, in order to realize their full potential in the economy, must learn to differentiate between the thin line of under-regulation and over-regulation. For the same reasons, RBI has introduced a pool of reforms in the NBFC Regulations. The idea is to promote the development of the NBFC sector as well as keeping a strict watch over any non-compliance. The Reserve Bank of India came forward with the revised regulatory framework for the operating as well as new NBFCs in 2014. The NBFC Regulatory framework is focused to provide special attention to those NBFCs, which can pose a serious threat to the financial system and to bring operational freedom for the small NBFCs.
Accordingly, as the foremost step towards the new framework, the non-deposit accepting NBFCs having total assets less than INR 500 crore are subject to lighter regulation. Non- deposit accepting NBFCs having total assets of more than INR 500 crore have been subjected to a more stringent set of regulations considering them as systemically important.
All non-deposit accepting NBFCs have been relieved of capital adequacy norms and credit concentration norms, thereby bringing operational flexibility to around 11,500 NBFCs having an asset size of more than INR 100 crore but less than INR 500 crore. Another customization in the regulations has been introduced based on the NBFCs access to public funds and customer interface.
As per the revised framework, the definition of the “public funds’ has also undergone a change. The new definition of public funds has been amended to ‘exclude funds raised by the issue of instruments compulsorily convertible into equity shares within a period not exceeding five years from the date of issue’. As far as asset classification, accounting principles and provisioning requirements in respect of NBFC-ND is considered, no change has been implemented.
For the NBFCs which have no public funds and no customer interface, complying with the governance requirements such as Fair Practices Code, Anti-Money Laundering, etc. have been done away with, thereby simplifying the compliance burden.
The new NBFC Regulatory Framework also lays down certain guidelines in the area of Corporate Governance. All non-deposit accepting NBFCs are mandatorily required to rotate the partners of their statutory audit firms every three years. Moreover, going into effect on 31st March 2015 a policy will be put in place for ascertaining the ‘fit and proper criteria’ for directors along with additional disclosure requirements.
The Revised NBFC Regulatory framework aims at creating a cadre of the population, which is better informed of its ability to obtain credit and a rating which better explains the repayment capabilities.
The need of the hour is that the NBFCs shall realize the importance of alternate data and shall also make an investment in technology to establish advanced credit scoring model incorporating the social graph, personal network, employment history and educational background of the borrower into their credit scoring rules.
The global financial crisis of 2008 made visible the true magnitude of the shadow banking sector. Despite certain regulatory supervision, NBFCs are considered as shadow banks. During the G-20 summit in 2010, the financial stability and strengthening regulation and supervision of the shadow banking sector have been well highlighted. Accordingly, the RBI, along with various other regulators, has been continuously working towards improving the NBFC Regulatory Framework to curb shadow banking activities that pose a risk to financial stability.
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Major challenges faced by NBFCs & their solutions
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