Regulating NBFCs: RBI proposes bank-like norms for the top 30

The Reserve Bank of India (RBI) plans to usher in a four-layered regulatory and supervisory framework for non-banking finance NBFCs as it embarks on the path of a scale-based regulation in the backdrop of the recent stress in the sector.

In its discussion paper on “Revised Regulatory Framework for NBFCs -- a Scale-Based Approach”, RBI said its proposed framework could be visualised as a pyramid, comprising NBFCs grouped in four layers -- Base Layer (BL), Middle Layer (ML), Upper Layer (UL) and a possible Top Layer (TL).

There will be least regulatory intervention for NBFCs in BL. As one moves up the pyramid, the regulatory regime will get stricter.

The framework proposes to prescribe Bank-like regulations for the top 25 to 30 NBFCs in the country.

Base Layer

About 9,209 NBFCs will be in the Base Layer (BL), which can consist of NBFCs, currently classified as non-systemically important NBFCs (NBFC-ND/Non-Deposit taking), Peer to Peer lending platforms, Account Aggregators, Non-Operative Financial Holding Company, and NBFCs up to ₹1,000 crore asset size.

As low entry point norms raise the chances of failure arising from poor governance of non-serious players, the central bank plans to revise these norms for NBFC-BL from ₹2 crore to ₹20 crore.

RBI proposes harmonising the extant NPA (non-performing asset) classification norm of 180 days to 90 days for NBFC-BL.

Middle layer

NBFCs in the Middle Layer (ML) can consist of entities, currently classified as NBFC-ND-SI/Non-Deposit taking-Systemically Important, deposit-taking NBFCs, Housing Finance Companies, Infrastructure Finance Companies, Infrastructure Debt Funds, Standalone Primary Dealers and Core Investment Companies.

While no changes are proposed in capital requirements for NBFC-ML, RBI said the

linkage of their exposure limits are proposed to be changed from Owned Funds to Tier I capital, as is currently applicable for banks.

The extant credit concentration limits prescribed for NBFC-ML for their lending and investment can be merged into a single exposure limit of 25 per cent for the single borrower and 40 per cent for a group of borrowers anchored to the NBFC’s Tier 1 capital.

NBFC-ML: IPO financing

While underscoring that Initial Public Offer (IPO) financing by individual NBFCs has come under scrutiny, more for their abuse of the system, the paper proposed to fix a ceiling of ₹1 crore per individual for any NBFC. NBFCs are free to select more conservative limits.

Further, a sub-limit within the commercial real estate exposure ceiling should be fixed internally for financing the land acquisition.

Restrictions on lending

As per the framework, a few restrictions should be extended to NBFCs in ML, including not allowing them to provide loans to companies for buy-back of shares/securities.

Guidelines on sale of stressed assets by NBFCs will be modified on similar lines as that for banks.

The paper suggested that NBFCs with ten and more branches shall mandatorily be required to adopt Core Banking Solution.

The paper recommended a uniform tenure of three consecutive years applicable for statutory auditors of the NBFC. It suggested that a functionally independent Chief Compliance Officer should be appointed.

Compensation Guidelines for NBFCs along the lines of banks can be considered to address issues arising out of excessive risk-taking caused by misaligned compensation packages.

Per the paper, making some of the disclosures prescribed for banks applicable to NBFCs would bring greater transparency and at the same time, provide a better understanding of the entity to the stakeholders.

Upper Layer

This layer can consist of NBFCs which are identified as systemically significant among them and will invite a new regulatory superstructure.

This layer will be populated by NBFCs which have a large potential of systemic spill-over of risks and can impact financial stability.

There is no parallel for this layer currently, as this will be a new layer for regulation.

The regulatory framework for NBFCs falling in this layer will be bank-like, albeit with suitable and appropriate modifications. It is expected that a total of not more than 25 to 30 NBFCs will occupy this layer.

It is felt that CET (Common Equity Tier) 1 capital could be introduced for NBFC-UL to enhance the quality of regulatory capital. It is proposed that CET 1 may be prescribed at 9 per cent within the Tier I capital.

To tune the regulatory framework for NBFC-UL to greater sensitivity, the paper suggested that NBFCs in this layer should be prescribed differential standard asset provisioning on banks’ lines.

Given the higher systemic risk posed by NBFC-UL, the Large Exposure Framework (LEF) as applicable to banks, can be extended with suitable adaptation.

Since NBFCs lying in the Upper Layer have the ability to cause adverse systemic risks, the regulatory tools can be calibrated on the lines of the private banks; that is, such NBFCs should be subject to the mandatory listing requirement and should follow the consequent Listing Obligations and Disclosures Requirements.

Top Layer

Considered supervisory judgment might push some NBFCs from out of the upper layer of the systemically significant NBFCs for higher regulation/supervision. These NBFCs will occupy the top of the upper layer as a distinct set.

Ideally, this top layer of the pyramid will remain empty unless supervisors view specific NBFCs.

In other words, if certain NBFCs lying in the upper layer are seen to pose extreme risks as per supervisory judgement, they can be put to significantly higher and bespoke regulatory/ supervisory requirements.