The global financial crisis sharply brought into light the role of non-banking financial companies (NBFCs) and the relative ease for “shadow banking” entities in India to conduct the business of lending. For instance, unlike banks, NBFCs could take pledges of shares of a company exceeding the lower of 30% of the NBFC’s paid-up share capital or 30% of the company’s share capital, and while banks had to declare an asset as “non-performing” at the end of 90 days, for NBFCs this period was 180 days and 12 months in certain cases. Similarly, guidelines for restructuring of advances by NBFCs were only issued in January 2014.
The increasing exposure of banks to the NBFC sector was another glaring issue, raising concerns of regulatory arbitrage and systemic risk.
Despite the relative lack of action, the Reserve Bank of India (RBI) has been considering and deliberating the overhaul of the regulatory framework for NBFCs. Based on a report and recommendations submitted in August 2011 by the Working Group on the Issues and Concerns in the NBFC Sector, the RBI placed draft guidelines for public comments on its website in December 2012. While no further action was taken on these draft guidelines, based on the recommendations and report of the Working Group to Review the Existing Prudential Guidelines on Restructuring of Advances by Banks/Financial Institutions, the RBI issued guidelines on restructuring of advances by NBFCs in January 2014.
Over the past few years, the RBI had provided subtle indications that it is in the process of aligning the regulatory framework for banks and NBFCs so as to prevent regulatory arbitrage and the domination of credit markets by loosely regulated “shadow banks”. In November 2014, the RBI overhauled the regulatory framework for NBFCs bringing about many seminal changes in the way NBFCs conduct business. While some are transitional – for instance, the declaration of assets as non-performing after 90 days will only commence from 2018 – others have a sooner application, such as 31 March 2015 for the application of tightened “fit and proper criteria” for directors of all systemically important and deposit-taking NBFCs.
All NBFCs with a “net owned fund” (NOF) below ₹20 million (US$325,000) are required to increase their NOF is a graded manner to ₹10 million by March 2016, and to ₹20 million by March 2017. In case of non-compliance, proceedings for cancellation of certificate of registration would be commenced. In view of the NBFC sector’s growth, the threshold for NBFCs to be considered as “systemically important” has been increased from ₹1 billion to ₹5 billion.
The requirements for declaration of loan assets of NBFCs as non-performing have also been harmonized in a graded manner. From 31 March 2018, NBFCs will be required to declare loan assets if these are overdue for more than three months. For lease rental and hire-purchase assets, the 12-month overdue period will be reduced to nine months from 31 March 2016, six months from 31 March 2017, and three months from 31 March 2018. For other assets, the six-month overdue period will be reduced to five months from 31 March 2016, four months from 31 March 2017, and three months from 31 March 2018.
Under the revised regulatory framework, non-deposit-taking NBFCs that have not accessed any public funds and which do not have a customer interface (such as group holding companies) are exempt from certain compliances such as prudential or conduct of business regulations or “know-your-customer” norms.
Enhanced corporate governance disclosures, such as registrations/licences obtained from other financial sector regulators, assigned credit ratings penalties levied by any regulator, extent of financing of parent company products, and details of securitization and assignment transactions, are now required from all non-deposit-taking systemically important NBFCs and all deposit-taking NBFCs. The last disclosure is a tried and tested method for NBFCs to clean up their balance sheets.
The revised regulatory framework is a much needed and welcome move from a financial stability perspective. Contrary to popular perceptions, this move does not unduly disadvantage NBFCs by aligning their regulatory framework with that of banks. The intent of the revised regulatory framework appears to be to bring some but not complete alignment with the regulatory framework for banks so as to reduce regulatory arbitrage that could in turn lead to systemic financial instability.
The introduction to the revised framework also notes the need to amend the prevailing framework for NBFCs “without impeding the dynamism displayed by NBFCs in delivering innovation and last mile connectivity for meeting the credit needs of the productive sectors of the economy”. A case in point would be that the RBI has not extended to NBFCs the 30% limitation on pledges applicable to banks. It remains to be seen whether the RBI has any further changes in mind for the regulatory framework for NBFCs.
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