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NBFCs: Changes in the regulatory landscape

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With an objective to revise and revisit the regulatory framework governing NBFCs, RBI in its Statement on Developmental and Regulatory Policies dated December 4, 2020, proposed a scale-based regulatory approach linked to the systemic risk contribution of NBFCs.

NBFCs: Changes in the regulatory landscape
NBFCs were introduced and conceptualized with the objective of supplementing the credit intermediation function of the banks, diversifying the access to financial services, and promoting healthy competition in the financial services sector. In order to promote the growth of NBFCs in alignment with their objective, the regulatory framework for regulating the NBFCs has been designed on the fundamental principle of less rigorous regulations, as against the banking companies.
The regulatory design has been a conscious one intended to strike a balance between operational flexibility available with NBFCs to grow at a sustainable pace, and expand the outreach of the formal financial services sector in unbanked areas. Gradually with the growing nature of the NBFCs, a nuanced regulatory framework followed.
As per statistics of RBI, NBFCs were 12 percent of the balance sheet size of the banks in 2010. In 2020, this stands at 25 percent. In the last 5 years, the balance sheet size of NBFCs (including Housing Finance Companies) has doubled. It was Rs 20.72 lakh crores in the year 2015, which has increased to Rs 49.22 lakh crores in the year 2020. The other side of the phenomenal growth which NBFC sector has witnessed has been the failure of a few large NBFCs, resulting in insolvencies and liquidity stress in general in the sector.
With an objective to revise and revisit the regulatory framework governing NBFCs, RBI in its Statement on Developmental and Regulatory Policies dated December 4, 2020, proposed a scale-based regulatory approach linked to the systemic risk contribution of NBFCs. It released a discussion paper for public consultation on January 22, 2021, and basis the inputs received, introduced “Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs” in October 2021.
SBR regulatory framework categorizes NBFCs into 4 layers based on the size, activities, and perceived riskiness of the NBFCs. These 4 categories are (i) Base Layer – this will include non-deposit taking NBFCs below the size of Rs 1000 crores and NBFCs which are acting as only Peer to Peer Lending Platform, Account Aggregator, Non-Operative Financial Holding Company, or NBFCs which are not availing public funds and not having any customer interface; (ii) Middle Layer – this will consist of all deposit-taking NBFCs, all non-deposit taking NBFCs with an asset size of Rs 1000 crores and above, and NBFCs acting as Standalone Primary Dealer, Infrastructure Debt Fund, Core Investment Companies, Housing Finance Companies, and Infrastructure Finance Companies; (iii) Upper Layer – this will have NBFCs which are specifically identified by the RBI demanding increased regulatory supervision basis predetermined parameters and scoring methodology. In addition, this layer will always consist of the 10 largest NBFCs in terms of their asset size, irrespective of any other factor; and (iv) Top Layer – this layer will only consist of NBFC which in my opinion of RBI has turned into potential systemic risk.
In addition to the categorization of NBFCs into 4 different layers, basis size and the activities, SBR regulatory framework has also increased the quantum of net owned minimum fund for a few categories of NBFCs, and revised guidelines for NPA classification by NBFCs by replacing the erstwhile guidelines to an overdue period of 90 days for all categories of NBFCs. RBI has proposed a glide path for bringing aforesaid changes, in the net owned minimum fund, and NPA classification.
Guidelines have introduced several amendments in the corporate governance requirements for the NBFCs, and have also pressed for professional expertise on the board, by making it mandatory for boards of the NBFCs to have at least one member on their board with prior experience of having worked at a bank or an NBFC. Further, RBI has also introduced a ceiling of Rs 1 crore per borrower on financing for subscription to initial public offer and has also introduced a ceiling for exposure to sensitive sectors, which includes direct and indirect exposure to capital markets, and exposure to commercial real estate, including sublimit for financing the land acquisition.
SBR Regulatory Framework will assist RBI in keeping a close watch on the NBFCs and will allow RBI to take corrective action and intervene at a right time before a particular NBFC becomes a systematic risk for the economy at large. Size and asset-based classification and regulations will also ensure that there is no chilling effect on all categories of NBFCs because of rigorous regulatory supervision on a particular category of NBFCs.
The SBR regulatory framework will also sensitize the public at large to identify the risk associated with the particular NBFCs. In addition, it will be interesting to see how RBI keeps stakeholders interest as paramount when a particular NBFC is moved from Upper-Layer to Top Layer.
While the SBR framework provides a holistic view, it is anticipated that the detailed regulatory guidelines to be introduced will cover the finer aspects recognizing the immense potential of NBFCs
- The author's Veena Sivaramakrishnan is Partner and Yugal Jain is Senior Associate, Shardul Amarchand Mangaldas & Co.
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