In recent years, the Reserve Bank of India (RBI) has been tightening the rules for non-banking finance companies (NBFCs).
What invited the extra scrutiny from the RBI was the collapse of infrastructure behemoth Infrastructure Leasing & Financial Services (IL&FS) in 2018 and subsequent failures of leading NBFCs like Reliance Capital, Dewan Housing Finance Corp and SREI.
This triggered a debate on the need for better supervision of NBFCs. The regulator took a stance that NBFCs cannot grow beyond a size and need to limit their scope of activities within a limit. The RBI pitched that NBFCs which want to grow their business big need to apply for bank permits. The regulator brought in a layers-based approach to monitor big NBFCs.
While mid and small sized NBFCs are facing difficulties in meeting these guidelines, especially considering the economic downturn, large NBFCs with deep-pockets have complied with the fresh rules without much problems.
Here’s a timeline to understand how the regulator has been tightening the norms on NBFCs in the last two years:
2022
April 19: RBI introduces detailed guidelines under the large exposure framework for NBFCs. As per the norms, the upper layer of NBFCs will have to limit single counterparty and Group exposures at 25 percent of its capital base. For Group exposures, an additional 10 percent exposure can be allowed if the loans are being extended toward the infrastructure sector.
For infrastructure finance companies in the upper layer category, the single and Group exposures are capped at 25 percent and 35 percent, respectively. These directions will be effective from October 1.
April 19: RBI issues detailed guidelines on capital requirement for upper layer of NBFCs. As per the norms, NBFCs are required to maintain common equity tier-I ratio of 9% (CET-I) as against 8% for banks. The CET-I for NBFCs includes revaluation reserve at a 55% discount which was earlier included in Tier-II capital, as per a note by ICRA dated April 19.
Incrementally, upper layer NBFCs would have to comply with CET-I requirements apart from meeting the stipulated Tier-I and overall capital adequacy ratios.
April 19: RBI issues detailed guidelines on regulatory restrictions for NBFCs on loans and advances. The central bank directed NBFCs in the upper layer and middle layer to tighten their credit policy on loans to directors and entities in which their directors, shareholders or other stakeholders have interest. Unless sanctioned by the Board, NBFCs shall not grant loans and advances aggregating Rs 5 crore to these stakeholders.
Similarly, all loans less that Rs 5 crore to these counterparties and other senior employees of the company has to be reported to the Board and adequately disclosed in annual financial statements. RBI has further reiterated the due diligence required for appraising real estate loans as was guided in the scaled based regulation framework. These guidelines are to be met by relevant NBFCs by October 1.
April 19: RBI issues updated guidelines on additional disclosures that NBFCs have to make in their notes to account while reporting financial results. Some of the key additions include disclosure of complaints, information on corporate governance, breach of covenants and disclosure of divergence in asset classification and provisioning. These additional disclosures shall be made for annual financial statements for year ending March 31, 2023, and onwards.
April 11: RBI mandates NBFCs in the middle and upper layer to incorporate a Board approved policy and a compliance function, including the appointment of a Chief Compliance Officer by April 1, 2023 and October 1, 2023, respectively.
February 23: RBI issues circular on implementation of ‘Core Financial Services Solutions by NBFCs. As per the circular, NBFCs shall be mandatorily required to implement ‘Core Financial Services Solution (CFSS), akin to the Core Banking Solution (CBS) adopted by banks.
The CFSS shall provide for seamless customer interface in digital offerings and transactions relating to products and services with anywhere, anytime facility, enable integration of NBFCs’ functions, provide centralised database and accounting records, and be able to generate suitable MIS, both for internal purposes and regulatory reporting.
For middle and upper layer of NBFCs, the implementation must occur before September 30, 2025. However, upper layer NBFCs shall ensure that the CFSS is implemented at least in 70 percent of ‘Fixed point service delivery units’ on or before September 30, 2024.
2021
December 14: RBI issues prompt corrective action (PCA) framework for NBFCs. PCA is amongst the most stringent set of restrictions that RBI puts on lenders when they breach regulatory requirements related to non-performing assets and capital adequacy ratio. Once lenders enter the PCA framework, they face restrictions on paying dividends, branch expansion and taking large exposures, among others.
The central bank gave NBFCs time till October 1 to comply with PCA norms. A separate circular will also be issued for applicability of PCA to government run NBFCs in due course, RBI said. The framework will be reviewed after three years of operation, it added.
November 15: RBI introduces internal ombudsman scheme for select NBFCs. The directions, effective within six months of issuance of circular, covers appointment, tenure, role and responsibilities, procedural guidelines, and oversight mechanism for the ombudsman.
“All complaints that are partly or wholly rejected by the NBFC will be reviewed by the IO (internal ombudsman) before the final decision of the NBFC is conveyed to the complainant. The IO will not entertain any complainants directly from members of public,” the RBI said.
November 5: RBI issues guidelines on co-lending by banks and NBFCs to priority sector. Banks and NBFCs need to formulate board approved policies for entering into the co-lending model (CLM) and place the approved policies on their websites, the RBI said.
As per the rules, the two partner lending institutions need to enter into an agreement that should specify terms and conditions of the arrangement, the criteria for selection of partner institutions, the specific product lines and areas of operation.
Banks can claim priority sector status in respect of their share of credit while engaging in the CLM adhering to the specified conditions, the central bank said. However, the CLM will not be applicable to foreign banks with less than 20 branches, it added.
October 22: RBI issues revised regulatory framework on scale-based regulation for NBFCs. This framework enlists different facets of regulation of NBFCs pertaining to capital requirements, governance standards, and prudential regulation, among others. Under this regime, NBFCs are divided into four layers on the basis of their size, activity, and perceived risk.
These norms will be effective from October 1.
June 24: RBI issues dividend declaration guidelines for NBFCs. As per the norms, in order to become eligible to declare dividend, an NBFC needs to meet the applicable regulatory capital requirement for each of the last three financial years including the financial year for which the dividend is proposed.
Standalone primary dealers should maintain a minimum capital adequacy ratio of 20 percent and additionally the net NPA ratio of NBFCs need to be less than six percent in each of the last three years. These guidelines shall be effective for declaration of dividend from the profits of FY22 and onwards.
April 27: RBI issues guidelines for appointment and functioning of auditors in banks and NBFCs. The RBI rules primarily focus on key areas including the appointment process of auditors, the tenure, eligibility, independence among other aspects.
February 3: RBI issues risk based internal audit guidelines for NBFCs. In order to ensure smooth transition from the existing system of internal audit to risk based internal audit, the concerned NBFCs will have to constitute a committee of senior executives with the responsibility of formulating a suitable action plan.
“The committee may address transitional and change management issues and should report progress periodically to the Board and senior management,” the regulator said. The board of NBFC will be primarily responsible for overseeing their internal audit functions, it added.
Apart from these key regulatory mandates, the RBI had also extended special liquidity windows for NBFCs on regular intervals to ensure smooth business continuity, especially during Covid-19. The central bank also allowed some category of lenders to tag loans extended to NBFCs as priority sector loans if the non-banks lend to the underserved category.
Thus, while the debate over supervision of NBFCs rages, the RBI is slowly but surely tightening screws of big NBFCs, bringing their regulation on par with that of banks.
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