Reserve Bank of India announces Scale Based Regulation: A Revised Regulatory Framework for NBFCs

The Reserve Bank of India (“RBI”) on October 22, 2021, has announced a revised regulatory framework for NBFCs that categorises NBFCs basis their scale of business and activity (“Regulations”).

Applicability: October 01, 2022, except the ceiling on IPO funding by NBFCs which shall come into effect from April 01, 2022.

Key highlights: Regulatory structure for NBFCs shall comprise of four layers based on their size, activity, and perceived riskiness; details of which, are as under:

• Base Layer: NBFCs in the lowest layer shall be known as NBFC – Base Layer (NBFC-BL), which shall consist of:

1. Non-deposit taking NBFCs below the asset size of ₹1000 crore; and
2. NBFCs undertaking the following activities:

• • NBFC-Peer to Peer Lending Platform (NBFC-P2P);
  • NBFC-Account Aggregator (NBFC-AA);
  • Non-Operative Financial Holding Company (NOFHC); and
  • NBFCs not availing public funds and not having any customer interface.
• Middle Layer: NBFCs in the middle layer and upper layer shall be known as NBFC – Middle Layer (NBFC-ML), which shall consist of:

1. All deposit-taking NBFCs (NBFC-Ds), irrespective of asset size;
2. non-deposit taking NBFCs with asset size of ₹1000 crore and above; and
3. NBFCs undertaking the following activities:

• • Standalone Primary Dealers (SPDs);
  • Infrastructure Debt Fund – Non-Banking Financial Companies (IDF-NBFCs);
  • Core Investment Companies (CICs);
  • Housing Finance Companies (HFCs); and
  • Infrastructure Finance Companies (NBFC-IFCs)
• Upper Layer: The Upper Layer (NBFC-UL) shall comprise of those NBFCs which are specifically identified by the Reserve Bank as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology as provided in the Appendix to this circular. The top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective of any other factor.
• Top Layer: This layer can get populated if the Reserve Bank is of the opinion that there is a substantial increase in the potential systemic risk from specific NBFCs in the Upper Layer. Such NBFCs shall move to the Top Layer from the Upper Layer. The top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective of any other factor.
• Mandatory Listing and Disclosure Requirements: NBFC-UL shall be mandatorily listed within 3 years of identification as NBFC-UL. Disclosure requirements shall be put in place on the same lines as applicable to a listed company even before the actual listing, as per Board approved policy of the NBFC.
• International Capital Adequacy Assessment Process (ICAAP): The Regulations inter alia require NBFC-ML and NBFC-UL to make a realistic and thorough internal assessment of the need for capital, commensurate with the risks in their business on similar lines as ICAAP prescribed for commercial banks under Pillar 2 (Master Circular – Basel III Capital Regulations dated July 01, 2015). The internal capital assessment shall factor in credit risk, market risk, operational risk and all other residual risks as per methodology to be determined internally. NBFCs are required to ensure that a board-approved policy is put into place in this regard, taking into account the said requirements.
• Net Owned Fund Requirements: The net owned fund requirements for NBFCs in the NBFC-ICC, NBFC MFI and NBFC-Factors (for all layers in the regulatory structure) have been enhanced to Rs. 10 Crore. The Regulations prescribe a glide path until 31st March 2027 to meet the enhanced net owned fund requirements.
• NPA Classification: The extant NPA classification norms are changed to overdue period of more than 90 days for all categories of NBFCs and the same will need to be adhered to, in a phased manner by 31^st March, 2026.

• Concentration of credit/ investment limits:

For NBFCs in the middle and the upper layer, the regulations provide for merger of lending and investment limits into a single exposure limit as percentage of Tier 1 capital (as against the owned funds earlier) in the manner following:

1. Single borrower/ party (25%)
2. Single group of borrowers/ parties (40%)

NBFC-UL are required to follow these norms until Large Exposure Framework is put in place for them. Extant instructions on concentration norms for different categories of NBFC, other than the changes indicated above will continue to remain applicable.

• Sensitive Sector Exposure (SSE): Exposure to the capital market (direct and indirect) and commercial real estate shall be reckoned as sensitive exposure for NBFC-ML and NBFC– UL. The NBFCs will need to fix board-approved internal limits for SSE separately for capital market and commercial real estate exposures. While the Board is free to determine various sub-limits within the overall SSE internal limits, the following are specifically prescribed:

1. A sub-limit within the commercial real estate exposure ceiling is fixed internally for financing the land acquisition.
2. Ceiling on IPO Funding.

As regards NBFC-UL, in addition to the limits specified above, the Board of NBFC-UL shall also be required to determine internal exposure limits on other important sectors to which credit is extended. Further, NBFC-UL is required to put in place an internal Board approved limit for exposure to the NBFC sector.

• Ceiling on IPO Funding: A ceiling of ₹1 crore per borrower has now been introduced for financing subscription to Initial Public Offer (IPO). NBFCs however, can fix more conservative limits. The aforesaid shall come into effect from April 01, 2022.
• Enhanced disclosure requirements: While disclosure requirements for NBFCs in the base layer have been expanded, inter alia, to include types of exposure, related party transactions, loans to Directors/ Senior Officers and customer complaints; NBFCs in the Middle and the Upper Layer, in addition to the existing regulatory disclosures, will be required to disclose the following in their Annual Financial Statements, effective March 31, 2023:

1. Corporate Governance report containing composition and category of directors, shareholding of non-executive directors, etc.
2. Disclosure on modified opinion, if any, expressed by auditors, its impact on various financial items and views of management on audit qualifications.
3. Items of income and expenditure of exceptional nature.
4. Breaches in terms of covenants in respect of loans availed by the NBFC or debt securities issued by the NBFC including incidence/s of default.
5. Divergence in asset classification and provisioning above a certain threshold as required by the Reserve Bank.

• Regulatory Restrictions on lending: For NBFC-BL, NBFC-ML and NBFC-UL, restrictions on grant of loans and advances for/to the following have been specified:

1. Directors and relatives of directors
2. Officers and relatives of Senior Officers

With respect to loan proposals involving real estate, disbursals by NBFC-ML and NBFC-UL can be made only after the borrower has obtained requisite clearances from the government authorities.

• Regulatory guidelines for NBFCs under Top Layer: NBFCs falling in the Top Layer of the regulatory structure shall, inter alia, be subject to higher capital charge. Such higher requirements shall be specifically communicated to the NBFC at the time of its classification in the Top Layer. There will be enhanced and intensive supervisory engagement with these NBFCs.
• Regulation of NBFCs not availing public funds and not having customer interface: It has been noted by RBI that NBFCs not availing public funds and not having customer interface bear a different risk profile and hence deserve a differential regulatory treatment. In light of this, RBI will come out with separate regulations for such NBFCs in due course. Till such time, the extant regulations shall continue to apply.

The Bottomline:

With the deepening of the credit and the role played by NBFCs, the revised guidelines bring in significant transparency with respect to operations and functioning and enhances the governance requirements for NBFCs. While the specific regulatory measures applicable, especially with respect to NBFCs classified in the upper layer and top layers, are yet to be seen in detail, the scale based regulatory regime appears to be a welcome move in light of the potentially powerful threat that a financial failure or regulatory oversight in relation to larger NBFCs may pose to the economy.

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