NBFC

Revised Regulatory Norms for NBFCs

NBFC Regulatory Framework

A Non-Banking Financial Company (NBFC) is registered under the company law and governed by the RBI. It is mainly engaged in those businesses to provide advances and loans, acquisition of shares, stocks, bonds, and securities issued either by the government or local authority instead related with that institution whose primary business relates to agriculture, industrial, etc. NBFCs evolved in the finance sector to provide loan credit for MSMEMs and the rural, small-scale, informal sector within India.

Growth of NBFCs in India

Non-Banking Financial Companies (NBFCs) in the dynamic financial landscape played an important role, catalyzed economic growth, and promoted small businesses. NBFCs, in recent years, have achieved massive growth in the market. Recently, in a report published by the RBI, the NBFC’s shares contribution to the Indian economy increased to 29.1% in Feb 2023 from 16.4% in December 2022.

NBFCs are at the forefront of financial inclusion within India and work as financial intermediation and have significantly played a vital role in diversifying the financial landscape by providing a range of lending services to those undeserving groups living in rural parts of India especially those small companies in forecasting the business growth. However, in recent years, NBFCS associated with other entities and imparted certain risks within the financial system. NBFCs ended the financial gaps left by the banks, which were reluctant to provide loans to these sections just because of their perceived risk.

Nowadays, digital lending with high demands for smaller loans with the easiest application request has widened the scope of NBFC. However, the NBFCs are flexible in providing loans to MSMEs comparably faster than the banks with flexibility in payment plans with low-cost EMIs. Additionally, the increase in the usage of Artificial intelligence and other blockchain financial services has somewhat improved the NBFC’s portfolio.

Revised Regulatory Norms For NBFCs

RBI in its Scale Based Regulation (SBR): namely A Revised Regulatory Framework for NBFC RBI/2021-22/112 DOR.CRE.REC.No.60/03.10.001/2021-22 has differentiated and revised the different layers and further the NBFC will be identified according to these based layers. RBI for NBFC is a scale-based regulation framework adopted to revise and create differences between NBFCs based on the asset value, activities, and involved market risks.

Recent years’ reports in the NBFC sector emphasize the crisis of IL&FS, along with many other NBFCs, a huge financial crisis that seized the financial market with a debt involved approx. INR 1 lakh crores, out of which only 62% were unresolved. There was rapid growth in the NBFC sector in the previous 10 years, but recent years have been worse for the NBFC. NBFCs cater significant complements to the mainstream banking system, and those markets are inherently presumed to be higher in risk as per big financial banks. Customers easily approach NBFC for taking loans just because of easy reach out and quick decision with less paper formalities and financial services, etc.

The RBI has compressed the regulatory gap between the banks and NBFC as per the regulation scope. In the long term, it is a very progressive step because eventually, as we look at the regulation, we put ourselves to the test and build more business models. The risk tolerance has to go up if we have to build businesses for the long-term process of scale. In the short term, there could be some impact or could be some hard burns, but in the long term, it makes evidentially more sense. The tiered approach of RBI will push the NBFC, which has a larger scale and ambitions, to back with capital in the right direction. The recent regulation where the NPA regulation is clarified by the RBI that regulation for NPA context for NBFC. They have to follow the same path as the banks have been doing. If NBFCs cross over 90 90-day time period, then NBFCs have to necessarily recognize an NBFCS account as an NPA.

The RBI has decided to tighten its grip on NBFCs upper layer (large NBFC) and mandates to keep aside the loan amount of 0.25-2% for standard assets for the different categories based on assets such as SME, real estate, and housing loans. Under this provision, RBI wants NBFC to be treated like other banks’ norms. Now, the NBFC have to keep aside their minimum percentage of funds in order to cover the anticipated losses in terms of lending. NBFC need to set aside 0.25% of assets in the case of individual housing loans and MSME loans. 0.75% of funds have to be set aside for real estate residential projects and a further 1% for commercial real estate loans. 0.4% amount to be kept aside for all standard loans related to medium enterprises.

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Although RBI has categorized NBFC into 4 tiers of layers: base, middle, upper, and topmost layer, the base layer will attract a very light touch of regulations under the RBI while progressive NBFC towards the next layers, such as the middle and upper will aggregate tightened regulations. The topmost layers are still empty, and in the opinion of RBI, any NBFC has a higher risk of exposure within the upper layer. Then, RBI will shift the NBFC to the topmost layer to scrutinize and monitor to comply with regulations. The intent is to safeguard the interest of investors involved and create a stable-based market. This change will provide the customer with a digital interface to get access to financial products and helps in keeping records for internal or regulatory purpose, etc. Thus, RBI felt that the essence of the revised regulations for NBFCs should be regulated according to their asset value, nature of the activity, and possible risk exposures.

The Factors involved in RBI Revised Regulatory Frameworks are as follows-

Re-classified Non-Banking Financial Companies-

Existing  different categories of NBFC like as Core Investment Companies, Microfinance Institutions, Systemically Important/ Non-Systemically Important, Deposit-taking/Non-deposit taking, etc., The RBI has re-classified the NBFC into a 3-level scale system.

  • Classification based on layer into 4 tiers- Base Layer, Middle Layer, Upper Layer, and Top Layer
  • Classified as per Asset valuation and possible market risk
  • Based on activities taken into consideration while classifying NBFC.

Enhanced Governance 

 Accordingly, the requirement in the NBFC financial world, RBI formulated and amended a unified governance structure which will comply according to different layer-wise-

  • The governance among different layers will be varied and will based on NBFCS meetings.
  • Constitution for internal committees and their assessments.
  • RBI formulated Disclosure required additionally for both the upper and middle layer NBFC. 

Classification of the NBFCs

Classification of the NBFCs

The NBFCs shall be classified based on size, perceived risks, etc. They are classified into four different layers-

  1. NBFC Base Layer
    a) Non-deposit taking NBFCs below the asset value size of 1000 crore.
    b) NBFCs which are engaged in the activities as mentioned below-
    1. Peer-to-peer lending platform is also known as NBFC P2P
    2. NOFHC or the non-operative financial holding company
    3. NBFC-AA or NBFC Account Aggregator
    4. Those NBFCs which are not availing the public funds or do not own any customer interface.
  2. NBFC Middle Layer– This layer should consist of the following-
    1. For all the NBFCs that take deposits, asset size is irrelevant here
    2. NBFCs that are non-deposit-taking and whose asset size values rupees 1000 crores.
    3. The NBFCs undertake the activities of standalone primary dealers, Core investment companies, Housing finance companies, etc.
  3. NBFC Upper Layer– This layer will contain the NBFCs identified by the Central Bank of India specifically, who warrant the enhanced regulatory requirement based on the set of parameters or the scoring methodology.
  4. NBFC top Layer- Ideally, this layer is supposed to remain empty. But if there is a remarkable increase in the potential systemic risk from the NBFCs in this layer, then it might get populated.

The classification has also been done of the NPAs relating to the NBFCs falling in the base layer from 180 days to 90 days overdue. This new framework aims to protect financial stability.

The rationale of the Policy

We need to understand the reasons for this regulation of the NBFCs. The premise was that NBFCs had more operational flexibility and less rigorous supervision. The NBFCs have had a comparatively free hand in building regional and sectoral expertise, which brought to the market a good variety of financial services and products which contributed to the prevailing fintech revolution in India in the area of digital lending.

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However, because of the financial sector’s vulnerability during COVID-19, which impacted the economic condition of the whole world, the need was largely felt for tighter regulatory control of the non-banking financial companies to avoid systemic shocks. If the expansion is unbridled and is followed by a regulatory framework which is less stringent, then it might grow the seeds for systemic danger as per the draft proposal.

Suppose an NBFC experiences financial stress because of the lend short business model etc.. In that case, the shock is felt throughout the financial sector, including mutual funds, institutional investors and banks which cause disruptions. The Securities and Exchange Board of India amended the standards of Mutual Funds because of the debt investments by MFs in NBFC debt paper, which resulted in many bond defaults. It further resulted in many NBFCs facing liquidation or defaults.

The Central Bank of India is now exploring ways to link the systemic importance of NBFCs to a scale-based framework with proportional regulatory measures. The main idea of proportionality conceives a more rational or streamlined approach for allocating the supervisory resources of the RBI. The NBFCs, which pose huge systemic risks, can be regulated more rigorously.

In the graded approach of the Discussion Paper, the primary elements which were examined are given below-

Operations Size– If the balance sheet of the non-banking financial companies is large, then it will need more monitoring, irrespective of other factors.

The Nature of Activity- As far as the nature of the activity is concerned, the emergence of the geographically specialized NBFCs implies that some are going to participate in these activities with more systemic influence as compared to others. The non-deposit-taking NBFCs like Type I NBFCs don’t pose a greater systemic risk because they don’t accept public funds, but companies like housing finance companies or Core Investment companies (CIC) have such type of business models which involve a high level of financial risk.

Comprehensive Risk Perception– If the NBFC satisfies complexity, interconnectivity and specific size, it must be regulated with the proportionate risk it causes to the financial system. 

Regulatory Provisions

NBFC-NSINBFC-SIHFC
Without public funds and a customer interfaceWith customer interface and public fundsAssets between 500-1000 croresAsset size above or equal to 1000 croresTop 10 or identified as suchNot in the top 10Top 10 or identified as such
BLBLBLMLULMLUL

NOF-

  1. Without public funds and customer interface- BL- No change, that is rupees 2 crores
  2. With customer interface and public funds- BL, Assets between 500-1000 crores- BL, Asset size above or equal to 1000 crores- ML, Top 10 or identified as such- UL- Rs 5 crores by March 31, 2025, Rs 10 crores by March 31, 2027
  3. Not in top 10- ML, Top 10 or identified as such- UL- No change, i.e. Rs 15 crores by March 31, 2022, Rs 20 crores by March 31, 2023

Concentration Limits

  • The previous limits were as a %age of the owned funds; the new or revised limits are basis Tier 1 capital.
  • In the revised framework, there is a single limit for aggregate exposure to a group/single entity, but in the previous framework, there were sub-limits for investment and lending.
  • The extant instructions on the concentration norms for varied categories other than the limit changes shall remain applicable.
  • According to para 70 of the SSA Directions, the securitization exposures of the lenders shall be governed by the large Exposures framework, but the LEF is applicable to the Upper layer only.

Existing limits (as a percentage of owned funds)

 LendingInvestmentTotal
Single borrower/party151525
A single group of borrowers/parties252540

Revised limit

 Total Exposure
Single borrower/party25
A single group of borrowers/parties40

The NBFCs which are in the BL or base layer should adhere to the 90 day NPA norm as under-

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NPATimeline
>150 days overdueMarch 31, 2024
>120 days overdueMarch 31, 2025
>90 days overdueMarch 31, 2026

Internal Capital Adequacy Assessment Process –

Under this proviso, NBFCs are duly required to keep an internal assessment of their capital in proportionate to business risk like-wise the banks compete under Master Circular- Basel III Capital Regulations. NBFCs are required to develop and use the best-skilled management risk techniques, etc. 

FAQ’s

  1. What are the new norms for NBFCs Upper Layer?

    NBFCs, under new norms, are required to hold a reserve of 0.25% for loans like home and SME businesses. According to new norms, especially on interest rate mortgages, CBFCs should initially hold at 2% of the amount and a further 0.4% one year after the rate resets.

  2. What are the norms for NBFCs in RBI Upper Layer?

    Under the norms for the NBFCs duly provided by the Reserve Bank of India, it is mandatory for NBFCs to keep a reserve of at least 0.25% for their funded amount, especially outstanding in the event of home loans and small and medium enterprises, etc.

  3. What are the new rules for NPA?

    NPA is more likely to be defined as a loan asset that cannot create an income for the bank, like interest or any principal repayment forms. Accordingly, according to the RBI-based prudential norms, the banks are now barred from listing such NPA into their book interest on an accrual basis.

  4. What new norms have been introduced for NPA for NBFCs?

    Presently, the RBI has issued norms to be followed by the NBFCs-ND having an asset value of less than INR 500 crores to classify their assets after an overdue time period of 180 days. Rest other NBFCs are entitled to classify such assets within 90 days. 

  5. What are the new categories of NBFCs?

    The Reserve Bank of India has classified those NBFCs under Asset Finance Companies (AFC), LCs (Loan companies), and investment companies (ICs) are further classified and merged into a new special category known as Investment and Credit Companies (NBFCs-ICC).  

  6. What are the new provisioning norms of RBI?

    According to the RBI's new provisioning norms, loans and advances are classified into different asset classifications depending on their performance ground. Such classification includes standard, substandard, doubtful, and loss assets. The RBI classifies Every category on the increasing level of associated risks.

  7. What are the provision norms for NBFCs?

    Within the new provision norms for NBFCs, NBFCs no longer earn bad credit on a monthly basis but earn credit on a daily basis. NPA can be set up only for the account regular in nature after the borrowers pay off all their arrears, etc. 

  8. What are the new provisions for NBFCs?

    Under RBI, new provisions for NBFCs specified that companies who wish to work as NBFCs must comply with the registration process of incorporation under the Companies Act 2013 and hold a minimum net owned fund of INR 2 crores. 

  9. What are provisioning norms?

    The provisioning norms of RBI are to make and ensure that the banks are maintaining a proper reserve to absorb the potential losses and maintain market stability. 

  10. What are the RBI exposure norms for NBFCs?

    The exposure norms under RBI for an NBFC to a single entity shall not be more than 20% of its available capital base. Later, in case the board of the same NBFC approves, then 5% more exposure can be allowed. 

  11. What are the exposure norms for NBFCs in the RBI master circular?

    The Reserve Bank of India for NBFCs has provided the exposure norms in its master circular issued on April 19 and raised the banks with an exposure limit to a single NBFC 20%, which might be further increased to 25% based on exceptional circumstances on the based board decision of bank, etc. 

  12. What are the disclosure norms for NBFCs?

    The RBI has made it mandatory for the NBFCs to disclose the information based on their financial statements per applicable rules and regulations and accounting standards and comply with prudential guidelines. The RBI is intended to encourage and promote NBFCs to reveal their financial status so that the associated persons can easily know about the performance if required. RBI's crux is to safeguard the interests. 

  13. What is the exposure limit of banks in RBI?

    The exposure limit set up for the banks under RBI direction is increased from 25% of its eligible capital base to a further 30 % so as to meet their corporate funds, etc. 

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