Revised Regulatory Framework for NBFCs
In October 2021, the Reserve Bank of India (RBI) introduced a comprehensive regulatory framework known as ‘scale-based regulation’ (SBR) to encompass a range of regulatory aspects for Non-Banking Financial Companies (NBFCs). This framework covers various factors, including capital requirements, governance standards, and prudential regulation. The practical implementation of these guidelines commenced on October 1, 2022, except for the amendments related to the ceiling on Initial Public Offering (IPO) funding, which came into effect on April 1, 2022.
On February 23, 2022, the RBI issued guidelines detailing the implementing of core financial services solutions. Subsequently, through a circular dated April 11, 2022, the RBI provided a framework for the Compliance Function and the function of the Chief Compliance Officer for NBFCs in the upper-layer and middle-layer categories.
Continuing this series of regulatory enhancements, on April 19, 2022, the RBI issued a set of circulars addressing key areas. These circulars covered topics such as the extensive exposure framework for NBFCs in the Upper Layer, capital requirements for NBFCs in the Upper Layer, regulatory limitations on loans and advances, and disclosures within the notes to the financial statements of NBFCs. Another significant circular, issued on April 29, 2022, outlined guidelines for the compensation policy of key managerial personnel and senior management members of all NBFCs operating under the SBR framework. These guidelines apply to all NBFCs except those categorised under the ‘Base Layer’ and government-owned NBFCs. This directive took effect from April 1, 2023.
Furthermore, on June 6, 2022, the RBI released guidelines focusing on provisioning for standard assets. These guidelines were designed explicitly for NBFCs falling under the Upper Layer category, contributing to the ongoing efforts to bolster the regulatory framework and promote the stability and soundness of the NBFC sector.
NBFC Classification In Tiered Categories
The classification of Non-Banking Financial Companies (NBFCs) into distinct layers is underpinned by critical triggers: Comprehensive Risk Perception, Size of Operations, and Activities. This structure encompasses various NBFC types, segmented as follows:
Base Layer:
Non-deposit-taking NBFCs with assets below ₹1000 crore are included. NBFCs engaged in permanent activities, such as NBFC-P2Ps, NBFC-AAs, and NOFHCs, belong to this layer. Entities devoid of public funds and customer interfaces also fall here.
Middle Layer:
Despite the size, deposit-taking NBFCs (NBFC-Ds) are part of this layer. Non-deposit NBFCs with assets above ₹1000 crore, along with Standalone Primary Dealers, Infrastructure Debt Fund-NBFCs, CICs, HFCs, and NBFC-IFCs are categorised here. Deposit-taking NBFCs, Core Investment Companies, Infrastructure Finance Companies, and Housing Finance Companies may also be Middle or Upper Layer, based on factors. Standalone Primary Dealers and Infrastructure Debt Fund-NBFCs consistently remain here.
Upper Layer:
NBFCs in the Upper Layer are identified via a mix of Parameters and Scoring Methodology, with 70% weight for Parameters and 30% for Scoring. Criteria are assessed annually, using March 31 as a reference. The top 10 NBFCs by asset size are automatically Upper Layer, irrespective of other aspects.
Top Layer:
NBFCs in the Upper Layer may move to the Top Layer if potential systemic risk surges. Currently unoccupied, this layer signifies minimal systemic risk.
Other NBFC categories like Investment and Credit Companies, Micro Finance Institutions, NBFC-Factors, and Mortgage Guarantee Companies are placed based on framework criteria. Government-owned NBFCs align with the Base or Middle Layer. This tiered approach bolsters NBFC sector regulation and risk management.
Updates Introduced by SBR Across All Regulatory Layers:
The Scale Based Regulation (SBR) framework has brought notable changes across all layers of the regulatory structure for Non-Banking Financial Companies (NBFCs). Here is an overview of the modifications in terms of Net Owned Fund (NOF) requirements:
NBFCs | Current NOF (Rs.) | By March 31 2025 (Rs.) | By March 31 2027 (Rs.) |
---|---|---|---|
NBFC-ICC | crore | crore | Ten crore |
NBFC-MFI | crore (crore in NE Region) | crore (crore in NE Region) | Ten crore |
NBFC-Factors | crore | crore | Ten crore |
NBFC-P2P, NBFC-AA, and NBFCs with no public funds and no customer interface | crore | crore | Ten crore |
NBFCs – IDF, IFC, MGCs, HFC, and SPD | No Change | No Change | No Change |
Furthermore, changes have affected the NPA (Non-Performing Assets) classification for all categories of NBFCs. The NPA classification norm has now been revised to an overdue period of more than 90 days for all NBFCs. However, NBFCs falling into the Upper Layer (NBFC-UL) and Middle Layer (NBFC-ML) categories, which are already mandated to follow the 90-day overdue norm, will remain the same in NPA classification. A glide path has been established for NBFCs in the Base Layer (NBFC-BL) to align with the 90-day NPA norm over time, as follows:
- By March 31, 2024: Overdue for 150 days
- By March 31, 2025: Overdue for 120 days
- By March 31, 2026: Overdue for 90 days
It’s important to note that this glide path does not apply to NBFCs already obligated to adhere to the 90-day NPA norm.
Another significant alteration is the introduction of a ceiling on IPO (Initial Public Offering) funding. Effective April 1, 2022, there is a stipulated ceiling of ₹ one crore per borrower for financing subscription to an IPO. However, NBFCs have the flexibility to establish even more conservative limits if deemed necessary.
Additionally, existing regulatory guidelines for NBFCs have undergone revisions based on the different layers of the SBR framework:
- NBFCs in the Base Layer (NBFC-BL) continue to be governed by the regulations applicable to NBFC-ND (Non-Deposit), with certain exceptions outlined in the framework. NBFC-P2P, NBFC-AA, and NOFHC follow the existing rules that govern them.
- NBFCs in the Middle Layer (NBFC-ML) adhere to the current regulations applicable to NBFC-ND-Systemically Important (SI), NBFC-D (Deposit), CICs (Core Investment Companies), SPDs (Standalone Primary Dealers), and HFCs (Housing Finance Companies), except for the changes specified in the framework.
- NBFCs in the Upper Layer (NBFC-UL) are subject to the regulations that apply to NBFC-ML and the modifications introduced in the SBR framework.
Irrespective of the layer, NBFCs must ensure the availability of adequate capital to meet the minimum NOF requirements per the established glide path.
Capital Guideline Revisions
Under the existing guidelines set forth by the Reserve Bank of India (RBI), all Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs) are mandated to uphold a minimum Tier I and Tier II capital ratio amounting to no less than 15 per cent of their total aggregate risk-weighted assets. The following provides an overview of the new capital guidelines introduced within the Scale Based Regulation (SBR) framework:
Introduction of Internal Capital Adequacy Assessment Process (ICAAP):
- NBFC – Base Layer (NBFC-BL): This concept does not apply.
- NBFC–Middle Layer (NBFC-ML): Similar to commercial banks under Pillar 2, NBFCs in the Middle Layer (NBFC-ML) must now implement an Internal Capital Adequacy Assessment Process (ICAAP). This internal assessment of capital needs should encompass credit risk, market risk, operational risk, and all other residual risks formulated based on internal methodologies. This requirement comes into effect on October 1, 2022.
- NBFC–Upper Layer (NBFC-UL): Both NBFCs in the Upper Layer and Middle Layer (NBFC-UL and NBFC-ML) are subject to ICAAP, as specified above. This requirement also takes effect from October 1, 2022.
Differential Standard Asset Provisioning Norms:
NBFC – Base Layer (NBFC-BL): This concept does not apply.
NBFC – Middle Layer (NBFC-ML): No change is brought to the existing provisioning norms for this layer.
NBFC – Upper Layer (NBFC-UL): NBFCs categorised in the Upper Layer (NBFC-UL) must adhere to differential standard asset provisioning norms for various asset categories. These provisions, effective from October 1, 2022, are as follows:
- Individual housing loans and loans to Small and Micro Enterprises (SMEs): 0.25 per cent
- Housing loans extended at teaser rates: Initially 2.00 per cent, decreasing to 0.40 per cent after one year from the reset of rates to higher levels (provided the accounts remain ‘standard’)
- Advances to Commercial Real Estate – Residential Housing (CRE – RH) Sector: 0.75 per cent
- Advances to the Commercial Real Estate (CRE) Sector (other than CRE-RH): 1.00 per cent
- Restructured advances: As stipulated in the applicable prudential norms for restructuring advances
Housing finance companies follow the mentioned provision matrix per the Master Direction – Non-Banking Financial Company – Housing Finance Company (Reserve Bank) Directions, 2021. Hence, no alterations are expected in the provision rates for any NBFC-HFC company that falls under the category of NBFC-UL, as identified by RBI.
Common Equity Tier 1 Capital:
- NBFC – Base Layer (NBFC-BL): This concept does not apply.
- NBFC – Middle Layer (NBFC-ML): No change applies to the current guidelines.
- NBFC – Upper Layer (NBFC-UL): Effective from October 1, 2022, NBFCs classified in the Upper Layer (except for Core Investment Companies) are mandated to maintain a Common Equity Tier 1 (CET 1) capital of at least 9 per cent of their risk-weighted assets. The RBI will specifically outline the determination of which NBFCs fall under the NBFC-UL category. The CET 1 ratio is calculated as standard equity tier 1 capital divided by total risk-weighted assets.
Leverage:
- NBFC – Base Layer (NBFC-BL): This concept does not apply.
- NBFC – Middle Layer (NBFC-ML): No change is applicable regarding leverage.
- NBFC – Upper Layer (NBFC-UL): Apart from the Capital to Risk-Weighted Assets Ratio (CRAR), NBFCs classified in the Upper Layer will also be subjected to a leverage requirement. The RBI will subsequently establish a suitable ceiling for leverage as and when necessary. Further clarification on this matter is anticipated.
Revisions in Prudential Guidelines:
Within the Scale-Based Regulation (SBR) framework, the Reserve Bank of India (RBI) has introduced specific prudential guidelines to manage risk exposure for Non-Banking Financial Companies (NBFCs). Below is an overview of the prudential guidelines prescribed within the SBR framework:
Differential Standard Asset Provisioning Norms:
- NBFC–Base Layer (NBFC-BL): This does not apply to this layer.
- NBFC – Middle Layer (NBFC-ML): No change is made to the existing regulations for this layer.
- NBFC – Upper Layer (NBFC-UL): NBFCs classified under the Upper Layer (NBFC-UL) must adhere to significant exposure framework limits provided by the April 19, 2022 RBI circular. The limits for exposure to and by NBFC-UL are as follows (expressed as a percentage of eligible capital base*):
- Single Counterparty: 20%, with an additional 5% permissible with Board approval and another 5% if the exposure pertains to Infrastructure loan/investment (Single counterparty limit not exceeding 25%).
- Group of Connected Counterparties: 25%, with an additional 10% allowed for Infrastructure loan/investment exposure.
- *Eligible capital base refers to Tier 1 Capital.
- *IFC stands for Infrastructure Finance Company.
- This regulation takes effect on October 1, 2022.
Lending and Investment Exposure Limits:
- NBFC–Base Layer (NBFC-BL): This concept does not apply to this layer.
- NBFC – Middle Layer (NBFC-ML): No change is made to the existing regulations for this layer.
- NBFC – Upper Layer (NBFC-UL): NBFCs in the Upper Layer (NBFC-UL) are to follow the merged lending and investment exposure limits specified in the SBR regulation. The revised limits are expressed as a percentage of Tier 1 Capital and take effect on October 1, 2022:
- Single group of borrowers/parties: 25%
- Single group of borrowers/parties: 40%
Sensitive Sector Exposure (SSE):
- NBFC–Base Layer (NBFC-BL): This concept does not apply to this layer.
- NBFC – Middle Layer (NBFC-ML): No alteration to existing regulations, except for NBFC-UL.
- NBFC – Upper Layer (NBFC-UL): Starting from October 1, 2022, NBFCs in the Middle Layer and Upper Layer are required to establish board-approved internal limits for Sensitive Sector Exposure (SSE), differentiating between capital market and commercial real estate exposures. Housing Finance Companies (HFCs) will follow the current regulations.
Internal Exposure Limits:
- NBFC–Base Layer (NBFC-BL): This concept does not apply to this layer.
- NBFC – Middle Layer (NBFC-ML): This regulation does not apply to this layer.
- NBFC – Upper Layer (NBFC-UL): By October 1, 2022, NBFCs categorised in the Middle Layer and Upper Layer must institute board-approved internal exposure limits for significant sectors (excluding sensitive sectors) to which credit is extended.
Regulatory Restrictions on Loans:
- NBFC – Base Layer (NBFC-BL): For NBFCs in the Base Layer, a Board-approved policy is required for granting loans to directors, senior officers, and relatives of directors. Loans beyond a specific threshold must be reported to the board. Aggregate-sanctioned loans and advances must also be disclosed in the Annual Financial Statement.
- NBFC – Middle Layer (NBFC-ML) & NBFC – Upper Layer (NBFC-UL): Starting from October 1, 2022, NBFCs in the Middle Layer and Upper Layer must adhere to specific conditions for granting loans and advances. These include loans to directors, relatives of directors, firms associated with directors, companies with director or relative interests, and more. Loans to Senior Officers and the real estate sector have additional reporting requirements.
Governance Guideline Revisions:
To bolster governance frameworks for NBFCs, the RBI has introduced a range of governance guidelines within the SBR framework. The following is an overview of the governance guidelines under the SBR framework:
Key Managerial Personnel (KMP):
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML): KMPs cannot hold positions in other NBFCs within the Middle Layer or Upper Layer (NBFC-ML or NBFC-UL), except for directorship in NBFC-BLs. A timeline of two years from October 1, 2022, is provided for compliance with this norm.
Compensation of KMP and Senior Management:
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML) & NBFC – Upper Layer (NBFC-UL): NBFCs must establish a Board-approved compensation policy covering fixed/variable pay structures, remuneration committees, and malus/clawback provisions. Complying with statutory mandates and rules is essential.
Compliance Function and Chief Compliance Officer (CCO):
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML) & NBFC – Upper Layer (NBFC-UL): By April 1, 2023, NBFCs in the Middle and Upper Layers must establish an independent compliance function and appoint a CCO. Policies for this must be in place by October 1, 2023.
Independent Director (ID):
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML) & NBFC – Upper Layer (NBFC-UL): IDs can’t be on the Board of more than three NBFCs (NBFC-ML or NBFC-UL) concurrently. Ensuring no conflicts from simultaneous directorships is vital, with a two-year compliance period.
Removal of Independent Directors:
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML): Not applicable.
- NBFC – Upper Layer (NBFC-UL): NBFCs in the Upper Layer must report to the RBI if any ID is removed/resigns before their average tenure ends. This reporting wasn’t mandatory previously.
Additional Governance Matters:
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML): Not applicable.
- NBFC – Upper Layer (NBFC-UL): Extra governance matters include delineating committee roles, instituting a whistleblower mechanism, practising good corporate governance in subsidiaries, and adhering to detailed reporting requirements.
Qualification of Board Members:
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML): Not applicable.
- NBFC – Upper Layer (NBFC-UL): Starting from October 1, 2022, NBFCs in the Upper Layer must ensure that board members possess relevant qualifications and experience aligned with their business type.
Risk Management Committee (RMC):
- NBFC – Base Layer (NBFC-BL): RMCs may exist at the board or executive level.
- NBFC – Middle Layer (NBFC-ML): RMCs are mandated at the board level.
- NBFC–Upper Layer (NBFC-UL): RMCs are also required at the board level.
Listing and Disclosures:
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML): Not applicable.
- NBFC – Upper Layer (NBFC-UL): NBFCs identified for the Upper Layer must get listed within three years and institute a board-approved policy within three months, along with a detailed implementation plan for complying with new regulations.
Experience of Board of Directors:
- NBFC – Base Layer (NBFC-BL): Not applicable.
- NBFC – Middle Layer (NBFC-ML): Not applicable.
- NBFC – Upper Layer (NBFC-UL): By October 1, 2022, at least one board director should have relevant banking or NBFC experience.