Revised Regulatory Framework for NBFCs

Over the years, the NBFCs have grown considerably in terms of their technological sophistication, operations, and size. Many of them have also started venturing to newer financial services areas with new products. Considering the significant growth, RBI has felt in recent years that a revised regulatory framework for NBFCs is needed to ensure transparency in their operations. The IL&FS crisis of 2018 has also led to RBI devise a new framework for NBFCs to avoid such situations in the future.

Last week the RBI proposed a new discussion paper on the regulatory framework for NBFCs. The paper started with giving a brief introduction of NBFCs and then moved on to discuss the need for a review of the existing policies. Following the explanation of existing norms, it has proposed the new framework for NBFC. Let’s understand the vital changes proposed in the new discussion paper by RBI.

Changes Proposed by RBI

• The rules were presented as a preventive measure to prevent the collapse due to large loan defaults which could form a chain of financial losses.
• Existing and new Non-Banking Financial institutions will be classified under four categories: Base Layer (NBFC – BL), Middle Layer (NBFC – ML), Upper Layer (NBFC – UL), and Top Layer (NBFC – TL). The category for the NBFC to be decided based on its potential risk and systematic importance in the financial system.
• All NBFCs with a capital size of Rs. 1000 crore will come under the NBFC Base Layer or NBFC – BL category. These will consist of India’s non-systematically important NBFCs, around 9200 non-deposit-taking lenders, and non-operative financial holding companies.
• The net owned fund requirement of obtaining a new NBFC License has been raised to Rs. 20 Crores from the earlier limit of 2 crores. This has been done considering GDP growth in the last two decades.
• It was also proposed that the transition to a new regulatory framework should be over the time period of next five years.
• The existing loan NPA classification term has been changed from 180 days to 90 days. That is, if a loan is defaulting for a period of 90 days it will be treated as NPA.
• NBFCs with assets valuation under Rs. 1000 Crores will fall under the category of NBFC – BL. Around 9200 of India’s current 9425 non-deposit NBFCs fall under this category. These include many P2P lending platforms, non-operative financial holding companies, and NBFC Account Aggregators.
• The non-deposit taking financial lenders classified as systematically important and the deposit-taking registered NBFCs will come under the middle layer or NBFC – ML.
• So far, RBI has not suggested any changes to the capital requirement for NBFC – ML. It remains the same as 15% with a minimum tier – 1 of 10%. Although NBFCs with 10 or more branches must adopt a core banking solution.
• Certain restrictions on lending by NBFC – ML was also introduced, like restrictions on lending to companies with intention of buyback of securities.
• The NBFC-UL or upper layer includes almost 30 systematically important institutions and will be regulated like the banks. These NBFCs will be required to implement differential standard asset provisioning with a large exposure framework as applied to banks by RBI.
• NBFC-UL will be introduced to the common equity tier – I of 9% by RBI. They will also be subjected to requirements of mandatory listing by RBI.

According to Sources of a News Website, a chief executive of a large NBFC said that the impact of these new proposed regulations will be limited to the large NBFC. As per the website, the official said,

“At present, NBFCs follow Ind-AS accounting standards that require risk-based provisioning. However, on the other issues like core equity tier-I capital requirements and its impact, we are consulting lawyers to figure out its impact”

The NBFC – TL or top layer has so bar been kept as empty. An NBFC from the upper layer could be moved to NBFC- TL if RBI feels that there is an unattainable systematics risk spillover increase for the NBFC – UL. Such NBFC will be subjected to higher capital charges that’ll include capital conservation buffers. RBI will have intensive supervisory engagement with NBFCs from Top Layer.

Why the New Regulatory Framework is Introduced?

The new framework is intended to increase the scrutiny of the NBFCs or shadow banks and allows them to engage in niche sectors or markets to maintain flexibility in their operations. The changes aim to avert a crisis like Infrastructure Leasing and Financial Services in 2018. IL&FS which used to one of the largest NBFCs collapsed in 2018 due to a series of payments defaults. This situation prompted financial experts to call for a new set of regulations concerning NBFCs in India.

To avoid similar liquidity crises like 2018 that led to squeezed funding to other NBFCs and lenders due to mistrust, RBI came up with this proposal. In all likelihood, this proposal will be passed and will become a new set of regulations for NBFCs.

What Does it Mean for New Investors?

For businessmen and investors looking to obtain NBFC registration in India, this should come as a piece of good news. Though the norms have become stricter, a more regularised and streamlined lending process will ensure the smooth functioning of the NBFC. However, some issues such as the higher capital limit required for opening a new NBFC could become a hurdle for investors with lower capital to open an NBFC.

Such investors should immediately reach to a legal and financial advisory firm to look for their options or invest immediately in opening a new NBFC before these new regulations come into force. Taking legal advisory on the new regulatory framework for NBFCs is also necessary for understanding all the new regulatory norms for NBFC. In simple words, the business promoters and investors must immediately contact their financial and legal advisors to consult and discuss these new regulations.