A Reserve Bank of India (RBI) discussion paper on regulation of non-banking finance companies (NBFCs) has proposed tighter regulations for large NBFCs and creation of a multilayer model in the industry.
The discussion paper has proposed a multiple layer structure to categorise NBFCs depending on their size and interconnectedness with the system.
Going by this, NBFCs in the lower layer will be known as NBFC-Base Layer (NBFC-BL). NBFCs in the middle layer will be known as NBFC-Middle Layer (NBFC-ML). An NBFC in the Upper Layer will be known as NBFC-Upper Layer (NBFC-UL) and will invite a new regulatory superstructure, the RBI said.
"An NBFC in the Upper Layer will be known as NBFC-Upper Layer (NBFC-UL) and will invite a new regulatory superstructure," the RBI said
The central bank has called for feedback on this discussion paper.
The RBI decided to tighten regulations or NBFCs to safeguard the financial system considering the growing size of certain companies and their linkages to the rest of the system.
“In view of the recent stress in the sector, it has become imperative to reexamine the suitability of this regulatory approach, especially when failure of an extremely large NBFC can precipitate systemic risks,” the RBI said.
Unbridled growth aided by less rigorous regulatory framework within an interconnected financial system can sow the seeds of systemic risk. Failure of any large and deeply interconnected NBFC is capable of transmitting shocks into the entire financial sector and causing disruption even to the operations of the small and mid-sized NBFCs, the central bank said.
Under the circumstances, the regulatory framework for NBFCs needs to be reoriented to keep pace with the changing realities, the RBI said.
According to the RBI discussion paper, the process of identification of NBFC-UL based on parametric analysis discussed above shall be conducted as a yearly exercise.
Once identified as NBFC-UL, the NBFC will be advised individually about its classification as a NBFC-UL and that it will be subjected to regulation akin to banks, the RBI said.
A time-period of eight weeks will be provided to the NBFC to enable it to chart out a plan for implementation. Within the allotted time period, the NBFC would have to put in place a board-approved policy towards the adoption of the enhanced regulatory framework, the RBI said.
If a certain NBFC, identified as NBFC-UL, does not want to feature in the upper layer, it can scale down their operations and reduce interconnectedness and complexity to ensure that they continue to function as NBFC-ML rather than NBFC-UL, the RBI said.
The methodology for assessing the NBFC-UL will be reviewed on a regular basis, which is at least once in four years, the RBI said.
NBFCs in the upper layer will have to comply with common equity Tier 1 capital regulations like commercial banks. They need to maintain a 9 percent CET1 ratio, the RBI said.
“It is felt that CET 1 could be introduced for NBFC-UL to enhance the quality of regulatory capital. It is proposed that CET 1 may be prescribed at 9 percent within the Tier I capital,” the RBI said.
Further, In addition to the CRAR requirements, NBFCs will also be subjected to a leverage requirement to ensure that the growth of the NBFC is supported by adequate capital, the RBI said.
These NBFCs will also have to comply with the 90-day NPA classification rule such as banks. The RBI discussion paper has also proposed to increase the minimum capital norms from Rs2 crore to RS 20 crore for NBFCs. Also, the threshold to identify systemically important NBFCs has been raised to Rs 1,000 crore from Rs 500 crore.