Recognising the contribution of non-banking financial companies (NBFCs) to the banking system and the need to review the existing regulatory framework due to their changing risk profile, the Reserve Bank of India (RBI) in its October 2021 notification introduced a scale-based regulatory framework for NBFCs (SBRF). The SBRF regulates matters such as capital requirements, prudent regulation and governance standards. All NBFCs are to be categorised into one of four scale-based layers.
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The base layer is for non-deposit taking NBFCs with assets below INR 10 billion, peer-to-peer lending platforms (P2P), account aggregators (AA), non-operative financial holding companies and NBFCs not using public funds and with no consumer interface. The middle layer includes all deposit taking NBFCs irrespective of asset size, non-deposit taking NBFCs with assets of INR 10 billion and above, standalone primary dealers, infrastructure debt fund NBFCs, core investment companies, housing finance companies and infrastructure finance companies. The upper layer is for NBFCs that the RBI considers are in need of enhanced scrutiny. The top ten NBFCs ranked by asset size will always be in the upper layer. The top layer will ideally remain empty, however the RBI may move NBFCs to the top layer from the upper layer if it considers the NBFCs pose a substantial systemic risk.
The minimum net owned fund requirement for NBFCs acting as investment and credit companies, microfinance firms or factors increases to INR 100 million, to be in place by 31 March 2027. The minimum requirement remains at INR 20 million for P2Ps, AAs and NBFCs not using public funds and with no customer interface. Debts overdue to any NBFC for more than 90 days will be classified as non-performing assets (NPA) and NBFCs must ensure that the overdue period for classification as NPAs is not more than: (a) 150 days by 31 March 2024; (b) 120 days by 31 March 2025; and (c) 90 days by 31 March 2026.
At least one director of a NBFC must have relevant experience in a bank or NBFC. Upper and middle layer NBFCs must carry out rigorous internal assessments to ensure their capital provisions cover business risks. The internal capital adequacy assessment process is similar to that as prescribed for commercial banks. A single borrower exposure limit of 25%, and 40% for a group of borrowers is prescribed for upper and middle layer NBFCs. Exposure of upper layer and middle layer NBFCs to capital markets and commercial real estate will be considered as sensitive sector exposure (SSE), requiring NBFCs to set internal limits approved by their boards. NBFCs are required to set sub-limits within the commercial real estate ceiling limit for financing land acquisition. The RBI has prescribed an individual borrower limit of INR 10 million for financing subscriptions to IPOs.
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To enhance regulatory capital quality, upper layer NBFCs must maintain common equity tier 1 capital equal to at least 9% of their risk-weighted assets. Such NBFCs will be subject to leverage requirements and a requirement to make differential provisioning for different classes of standard assets to be prescribed by the RBI. Upper layer NBFCs will be governed by a large exposure framework to be introduced by RBI, which will take into consideration their large exposure to counterparties and groups of connected counterparties, and set ceilings.
The SBRF prescribed additional changes to corporate governance such as the constitution of risk management committees, disclosure requirements, loans to directors, their relatives and senior officers, a restriction on key managerial personnel holding office, including directorships, in any other middle or upper layer NBFC except directorships in a subsidiary, compensation guidelines, the qualifications of board members and listing requirements for upper layer NBFCs. The SBRF is effective from 1 October 2022, except for the directions on the IPO funding ceiling, which come into effect from 1 April 2022.
The unchecked growth of NBFCs in size and number, their operations and interconnectivity with banks and other financial entities under the light regulatory framework posed a risk to the whole banking system. The RBI has introduced these stringent regulations to support a resilient financial system by strengthening corporate governance. NBFCs now have to comply with the SBRF, but the length of the transition periods should ensure a smooth implementation.
Nishtha Arora is a senior associate and Soumyajit Mitra is an associate partner at SNG & Partners
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