MC Explains | All you need to know about NBFCs and scale-based regulations

In October, 2021, the RBI put in place a four-layered regulatory structure for NBFCs. These layers are based on their size, activity, and perceived riskiness.

On September 14, the Reserve Bank of India (RBI) announced a list of non-banking finance companies (NBFCs) in the upper layer under scale-based regulations (SBRs) for 2023-24.

The RBI had announced the SBR on October 22, 2021. The framework categorises NBFCs in the base layer, middle layer, upper layer and top layer.

Also, the regulation gives the methodology to identify NBFCs in the upper layer, according to their asset size and scoring methodology.

Here is an explainer.

What is scale-based regulation?

In October, 2021, the RBI put in place a four-layered regulatory structure for NBFCs. These layers are based on their size, activity, and perceived riskiness.

The central bank said the SBR framework encompasses different facets of regulations, covering capital requirements, governance standards, and prudential regulations.

The regulations classified NBFCs in the lowest layer as NBFC - Base Layer (NBFC-BL), in the middle layer and the upper layer as NBFC - Middle Layer (NBFC-ML) and NBFC - Upper Layer (NBFC-UL), respectively.

The Upper Layer comprises those NBFCs specifically identified by the RBI as those warranting enhanced regulatory requirements based on a set of parameters.

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To begin with, which companies are there in the list?

According to the RBI, the list of NBFCs in the upper layer are LIC Housing Finance, Bajaj Finance, Shriram Finance, Tata Sons Pvt Ltd, L&T Finance, Piramal Capital & Housing Finance, Cholamandalam Investment and Finance, and Indiabulls Housing Finance.

This list also includes Mahindra & Mahindra Financial Services, Tata Capital Financial Services, PNB Housing Finance, HDB Financial Services, Aditya Birla Finance, Muthoot Finance and Bajaj Housing Finance.

Which company is removed from the list?

The central bank has removed Shanghvi Finance from the upper layer list. The RBI did not give any specific reason for the removal. Earlier, the list had 16 NBFCs. Now, there are 15.

Which NBFC is not included in the list?

Despite qualifying for identification as NBFC-UL, according to the scoring methodology, TMF Business Services Ltd (formerly Tata Motors Finance Limited) is not being included under the current review due to its ongoing business reorganisation, the RBI said.

“In terms of the framework, once an NBFC is classified as an NBFC-UL, it shall be subject to enhanced regulatory requirement, at least for five years, from its classification in the layer, even in case it does not meet the parametric criteria in the subsequent year/s,” RBI said in a release.

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Why are these regulations important?

The RBI said that, in the last few years, there have been rapid developments, which have led to a significant increase in the size and interconnectedness of the NBFC sector.

“There is, therefore, a need to review the regulatory framework in line with the changing risk profile of NBFCs. It is felt that a scale-based regulatory approach linked to the systemic risk contribution of NBFCs could be the way forward,” the central bank said.

Analysts said the SBRs were put in place after the default of IL&FS and DHFL, which had a spill-over effect on the other large and small NBFCs.