Re-designing Regulatory Framework for NBFCs by RBI

Re-design­ing Reg­u­la­to­ry Frame­work for NBFCs by RBI

The Non-Bank­ing Finance Com­pa­nies (NBFCs) in India, have evolved over the last fifty years to emerge as notable alter­nate sources of cred­it inter­me­di­a­tion.  The non-bank sec­tor in India is wide and encom­pass­es sev­er­al finan­cial inter­me­di­aries like the loan and invest­ment com­pa­nies, hous­ing finance com­pa­nies, the infra­struc­ture finance com­pa­nies, the asset finance com­pa­nies, core invest­ment com­pa­nies, micro finance com­pa­nies and fac­tor­ing com­pa­nies. In a broad­er sense, the NBFCs include stock bro­kers, insur­ance com­pa­nies, chit fund com­pa­nies, etc. The NBFCs are also into dis­tri­b­u­tion of finan­cial prod­ucts, act­ing as Busi­ness Cor­re­spon­dents to banks, and facil­i­tat­ing remit­tances. The NBFC sec­tor reg­u­lat­ed by the Reserve Bank has changed dynam­i­cal­ly since the time an enhanced reg­u­la­to­ry frame­work was placed on them in 1996 in the wake of fail­ure of a large sized NBFC.  The changes in the sec­tor have part­ly been reg­u­la­tion induced; the pru­den­tial reg­u­la­tions on sys­tem­i­cal­ly impor­tant NBFCs and deposit tak­ing NBFCs made them finan­cial­ly sound and bet­ter man­aged, while the light touch reg­u­la­tion on them gave them ample head room to be inno­v­a­tive, and dynam­ic.  Today, while the num­bers of reg­is­tered NBFCs have come down, from the peak of 14,077 in 2002 to 12,029 by March 2014, those in the busi­ness found a niche for them­selves, in the finan­cial fab­ric of the country.

2.   In a coun­try like India where large sec­tions of the pop­u­la­tion are still unbanked, there is space for sev­er­al forms of finan­cial inter­me­di­a­tion.  With­out sound­ing clichéd, I would say, the NBFCs have emerged as a very impor­tant and sig­nif­i­cant seg­ment, financ­ing small and medi­um enter­pris­es, sec­ond hand vehi­cles, and oth­er pro­duc­tive sec­tors of the econ­o­my and have very effec­tive­ly tried to bridge the gaps in cred­it inter­me­di­a­tion.  They have played a sup­ple­men­tary role to banks in finan­cial inter­me­di­a­tion and a com­pli­men­ta­ry role in the finan­cial inclu­sion agen­da of the Reserve Bank. NBFCs bring the much need­ed diver­si­ty to the finan­cial sec­tor there­by diver­si­fy­ing the risks, increas­ing liq­uid­i­ty in the mar­kets there­by pro­mot­ing finan­cial sta­bil­i­ty and bring­ing effi­cien­cies to the finan­cial sector.
3. Although reg­u­lat­ed, NBFCs sec­tor is con­sid­ered as the shad­ow bank­ing sec­tor.  This is because they are light­ly reg­u­lat­ed, there are pock­ets with­in the sec­tor that are not sub­ject­ed to reg­u­la­tion and or super­vi­sion and they are also allowed to con­duct activ­i­ties that may not fall under reg­u­la­tion.  I am refer­ring to the Prin­ci­pal Busi­ness Cri­te­ria (PBC) for reg­is­tra­tion which allows NBFCs the free­dom to con­duct oth­er activ­i­ties, beyond finan­cial activ­i­ties, from their bal­ance sheets. There are sev­er­al large enti­ties, under­tak­ing finan­cial busi­ness, but do not come with­in the def­i­n­i­tion of the NBFC. Here, I am refer­ring to sev­er­al cor­po­rate trea­suries. Exam­ples of light touch reg­u­la­tion are as fol­lows: The reg­is­tered NBFCs are not super­vised as inten­sive­ly as banks; the report­ing require­ments are very lit­tle as com­pared to banks; cap­i­tal and oth­er pru­den­tial require­ments on banks based on Basle III have not been required of the NBFCs; there are no or less pre-emp­tions in the form of CRR or SLR for NBFCs; nor is pre­scrip­tion of pri­or­i­ty sec­tor lend­ing require­ments; Unlike banks, there are no restric­tions on the num­ber of NBFCs that can be set up by a sin­gle Group nor is there any restric­tion on the num­ber of branch­es of NBFCs; and cor­po­rate gov­er­nance guide­lines have not been as strin­gent as that for banks.  There are also no reg­u­la­tions on con­nect­ed lend­ing for NBFCs.
4. NBFCs today have grown con­sid­er­ably in size, form and com­plex­i­ty and oper­a­tions in a vari­ety of mar­ket prod­ucts and instru­ments, tech­no­log­i­cal sophis­ti­ca­tion, entry into areas such as pay­ment sys­tems, cap­i­tal mar­kets, deriv­a­tives and struc­tured prod­ucts. Some of the NBFCs are oper­at­ing as con­glom­er­ates hav­ing busi­ness inter­ests spread to sec­tors like insur­ance, broking, mutu­al fund and real estate. The inter-con­nect­ed­ness with oth­er finan­cial inter­me­di­aries has increased with increased access to pub­lic funds through NCDs, CPs, bor­row­ings from banks and finan­cial insti­tu­tions. NBFCs being finan­cial enti­ties are exposed to risks aris­ing out of coun­ter­par­ty fail­ures, fund­ing and asset con­cen­tra­tion, inter­est rate move­ments and risks per­tain­ing to liq­uid­i­ty and sol­ven­cy. Risks of the NBFCs sec­tor can hence be eas­i­ly trans­mit­ted to the finan­cial sec­tor or the NBFCs can get affect­ed by adverse devel­op­ments in the finan­cial sec­tor.  We can eas­i­ly draw ref­er­ence to the 2008 finan­cial cri­sis when the NBFCs sec­tor came under pres­sure due to the fund­ing inter-link­ages between NBFCs and Mutu­al Funds. The rip­ple effects of the tur­moil in the West­ern economies led to liq­uid­i­ty issues and redemp­tion pres­sures on Mutu­al funds which in turn led to fund­ing issues for NBFCs as Mutu­al Funds were unable to roll over the cor­po­rate debt papers of NBFCs. Many had to down­size their bal­ance sheets or enter into dis­tressed sale of their loan port­fo­lios. A slew of mea­sures had to be tak­en then, both con­ven­tion­al and uncon­ven­tion­al to assist the NBFCs.

Evo­lu­tion of Regulation

5. Reg­u­la­tion has gen­er­al­ly kept pace with the dynamism dis­played by the sec­tor. His­tor­i­cal­ly, more specif­i­cal­ly from the 1960s, some form of reg­u­la­tion exist­ed on deposit accep­tance by NBFCs.  How­ev­er, reg­u­la­tion was tight­ened after 1996, with amend­ments to the RBI Act, by plac­ing entry point norms and stricter and more detailed reg­u­la­tions on man­ner, form and quan­tum of deposit accep­tance. Fur­ther, in 1999 cap­i­tal require­ment for fresh reg­is­tra­tion was enhanced from‘25 lakh to‘200 lakh. When the reg­u­la­to­ry gaps and arbi­trage between banks and NBFCs became sig­nif­i­cant in 2006, they were sought to be bridged by iden­ti­fi­ca­tion of sys­tem­i­cal­ly impor­tant non-deposit accept­ing NBFCs and plac­ing pru­den­tial reg­u­la­tions on such NBFCs. At the same time, NBFCs were allowed to expand their activ­i­ties to offer­ing new­er prod­ucts and services.

Need for Revi­sions to Regulations

6. Con­sid­er some of the data that is avail­able with the Reserve Bank¹. The total num­ber of NBFCs as on March 31, 2014 were 12,029 of which deposit tak­ing NBFCs were 241 and non-deposit tak­ing NBFCs with asset size of‘100 crore and above were 465, non-deposit tak­ing NBFCs with asset size between‘50 crore and ‘100 crore were 314 and those with asset size less than ‘50 crore were 11,009. The total assets of the report­ing NBFCs have grown phe­nom­e­nal­ly over the last few years. These assets which stood at‘5,60,035 crore as at end March 2009, grew to ‘14,41,422 crore as at end March 2014. In the last year, the total assets of the NBFC sec­tor have grown by 13.36%, while the assets of the bank­ing sec­tor have increased by 5.36% for the cor­re­spond­ing peri­od. The Return on Assets (ROA) as on March 2014 in case of NBFCs was on an aver­age 2.4%, while the ROA for Sched­uled Com­mer­cial Banks was 0.8%.  Return on Equi­ty (ROE) for NBFC in March 2014 was 12% as com­pared to 9.5% for sched­uled com­mer­cial banks. The trend in the impor­tant finan­cial ratios for NBFCs-ND-SI and NBFCs‑D is giv­en in the tables below:

Table 1
NDSI ( assets size above ‘500 crore )	MAR-12	MAR-13	MAR-14
Gross NPA Ratio (%)	2.1	2.1	2.5
Net NPA Ratio (%)	1.3	1.1	1.5
Return on Assets (%)	1.8	1.9	2.1
Return on Equity (%)	7.7	8.5	9.3
Lever­age Ratio	3.2	3.3	3.3
Source  : Reg­u­la­to­ry Returns

Table 2
NBFC‑D	MAR-12	MAR-13	MAR-14
Gross NPA Ratio (%)	2.2	2.4	3.1
Net NPA Ratio (%)	0.5	0.8	1.0
Return on Assets (%)	2.7	2.7	2.6
Return on Equity (%)	15.3	15.6	14.8
Lever­age Ratio	4.6	4.7	4.7
Source  : Reg­u­la­to­ry Returns

7. Sources of funds have also increased.  The total bor­row­ings by the report­ing NBFCs grew from‘3,75,072 crore as at end March 2009 to‘9,98,379 crore as at end March 2014. There has been siz­able growth, very high lever­age, increas­ing depen­dence on pub­lic fund­ing and increas­ing inter­con­nect­ed­ness, while the reg­u­la­tions on NBFCs are lighter than that for the rest of the finan­cial sector.
8. There was there­fore a need felt to com­pre­hen­sive­ly review the reg­u­la­to­ry frame­work for NBFCs.  Sev­er­al Com­mit­tees both inter­nal and exter­nal have made sig­nif­i­cant rec­om­men­da­tions.  I am refer­ring to the Work­ing Group Report on the Issues and Con­cerns in the NBFC Sec­tor chaired by Smt. Usha Tho­r­at ex –Deputy Gov­er­nor of the Reserve Bank and in which there were par­tic­i­pants from the indus­try as well.  The Nachiket Mor Com­mit­tee on Com­pre­hen­sive Finan­cial Ser­vices for Small Busi­ness and Low Income House­holds had also sev­er­al rec­om­men­da­tions for the NBFC sec­tor.  The revised reg­u­la­to­ry frame­work has drawn sig­nif­i­cant­ly from these stud­ies.  While review­ing the rec­om­men­da­tions for adop­tion, the Bank has been mind­ful of the fact that the revi­sions should not impede the dynamism dis­played by NBFCs in deliv­er­ing inno­va­tion and last mile con­nec­tiv­i­ty for meet­ing the cred­it needs of the pro­duc­tive sec­tors of the economy.

Recent Revi­sions to Reg­u­la­to­ry Framework

9. The broad prin­ci­ples fol­lowed in fram­ing the revised guide­lines was to review the reg­u­la­tions from the per­spec­tive of the man­date of the Reserve Bank, viz., finan­cial sta­bil­i­ty, depos­i­tor pro­tec­tion and cus­tomer pro­tec­tion.  Hence, a) the focus has been on address­ing risks where they exist, b) address gaps in reg­u­la­tion, c) reduce com­plex­i­ties and make reg­u­la­tions sim­ple and easy to fol­low, d) har­monise reg­u­la­tions with­in the sec­tor and with that of banks to a lim­it­ed extent, e) acknowl­edge that there may be pock­ets with­in the sec­tor that do not require to be strin­gent­ly reg­u­lat­ed and f) give ade­quate time to the NBFCs to adjust to the revised reg­u­la­to­ry frame­work so that there are no dis­rup­tions in business.
10. Out of the 12,029 NBFCs reg­is­tered with us, only 241 are deposit tak­ing. Out of the remain­ing 11,788 non — deposit tak­ing NBFCs, there are many NBFCs who do not access pub­lic funds and so are not inter­linked. These do not pose much risk to finan­cial sta­bil­i­ty. Hence, a sim­pli­fied reg­u­la­to­ry frame­work will suit them.
11. Today, there are var­i­ous types of NBFCs and reg­u­la­tion varies depend­ing on the type of NBFCs. This has unnec­es­sar­i­ly com­pli­cat­ed the struc­ture. As a pre­cur­sor to let NBFCs under­take any of the per­mit­ted activ­i­ties, than be con­strained by the spe­cif­ic seg­ment of reg­is­tered activ­i­ty, we thought it fit first to har­monise the reg­u­la­tions among var­i­ous types of NBFCs so that no reg­u­la­to­ry arbi­trage will be pos­si­ble. Thus har­mon­i­sa­tion with banks has also been war­rant­ed for those NBFCs which are in good com­pe­ti­tion with banks.
12.   Thus the approach for redesign­ing the reg­u­la­tion has been “a lighter reg­u­la­to­ry frame­work on NBFCs oth­er than for those with large asset sizes and deposit accept­ing, har­mon­i­sa­tion of reg­u­la­tion across var­i­ous types of NBFCs, har­mon­i­sa­tion with that of banks to some extent for NBFCs with large asset sizes, and for all deposit accept­ing NBFCs, cre­at­ing a lev­el play­ing field that does not undu­ly favour or dis­favour any insti­tu­tion and to pro­vide ade­quate time to man­age tran­si­tion”. Let me now explain the changes in more detail.

Har­mon­is­ing Min­i­mum Cap­i­tal Requirement

13. Har­mon­is­ing the min­i­mum cap­i­tal require­ment for all NBFCs at‘200 lakh.  The min­i­mum cap­i­tal require­ment of‘200 lakh was set in from April 1999.  How­ev­er, there are sev­er­al thou­sand lega­cy NBFCs reg­is­tered pri­or to this date, the cap­i­tal of which is below this lev­el.  With the changed pro­file of NBFCs, their entry into new­er busi­ness­es, the cap­i­tal of ‘200 lakh in itself is gross­ly inad­e­quate.  The gen­er­al increase in the price lev­el since 1999 by itself would call for an increase in the cap­i­tal require­ments nec­es­sary to func­tion as NBFCs.  Besides, as the Usha Tho­r­at Com­mit­tee has point­ed out that any finan­cial inter­me­di­ary must nec­es­sar­i­ly invest in tech­nol­o­gy to be effi­cient and com­pet­i­tive and reap economies of scale, all of which requires enhance­ment of cap­i­tal.  A high­er cap­i­tal require­ment also ensures that seri­ous play­ers enter this space. Besides, reg­is­tra­tion with the Bank con­fers a legit­i­ma­cy to the NBFC as a reg­u­lat­ed enti­ty and gives a sense of com­fort to the lenders to the NBFCs.  It is there­fore nec­es­sary to begin by har­mon­is­ing this lev­el across the sec­tor.  An easy to fol­low roadmap for com­pli­ance by March 2017 has been pro­vid­ed so that NBFCs have the required time for plan­ning cap­i­tal aug­men­ta­tion.  Need­less to say, non-com­pli­ance to the roadmap could invite adverse reg­u­la­to­ry action.

Har­mon­is­ing Deposit Accep­tance Regulations

14. Deposit accep­tance by NBFCs is a lega­cy activ­i­ty and no new NBFC has been giv­en the licence to accept deposit since 1997. The stance of the Bank has been that deposit accep­tance will have to be a tight­ly reg­u­lat­ed activ­i­ty and banks are the right struc­ture to car­ry on that activ­i­ty. Fur­ther giv­en the absence of deposit insur­ance and an insti­tu­tion­al com­plaint redress mech­a­nism for the NBFC sec­tor, the Reserve Bank is not in favour of allow­ing NBFCs to accept deposits. Total deposits held by NBFCs amount to‘20,588 crore as on March 31, 2014. Out of the 241 com­pa­nies only 17 com­pa­nies have deposits greater than‘10 crore. The trend in amount of deposit and deposit pro­file is giv­en in the tables below:

Table 3
	No. of Report­ing NBFC‑D	Pub­lic deposits (‘crore)
Mar-12	246	12656
Mar-13	232	15311
Mar-14	201	20588
Source : Reg­u­la­to­ry Returns

Table 4
Pub­lic deposits	No. of NBFCs
NBFC‑D (in ‘)	Mar-12	Mar-13	Mar-14
0 to 10 cr	229	217	184
10 to 25 cr	9	7	4
25 to 50 cr	2	1	3
50 to 100 cr	1	2	1
more than 1000 cr	5	5	9
Source : Reg­u­la­to­ry Returns

15. With­in the sec­tor itself deposit direc­tions dif­fer, with Asset Finance Com­pa­nies (AFCs) being allowed to accept deposits with­out the manda­to­ry min­i­mum invest­ment grade cred­it rat­ing, and those that are rat­ed and fol­low pru­den­tial norms can go up to 4 times of the NOF in terms of quan­tum of deposits they can mobilise.  This dis­pen­sa­tion was giv­en to Asset Finance Com­pa­nies as they were financ­ing real pro­duc­tive assets, typ­i­cal­ly cap­i­tal equip­ment, com­mer­cial vehi­cles, trac­tors and auto­mo­biles.  Many of these activ­i­ties are now also car­ried out by oth­er NBFCs and the AFCs them­selves have moved out of hire-pur­chase, equip­ment leas­ing mod­el of func­tion­ing.  In such a sce­nario, there is no par­tic­u­lar rea­son for dif­fer­en­tial lim­its.  Besides, as seen from the Reg­u­la­to­ry Returns received from NBFCs, oth­er than a very few, the indus­try has not exceed­ed 1.5 times of NOF in deposit mobil­i­sa­tion. The Bank hence has har­monised deposit accep­tance reg­u­la­tions by mak­ing min­i­mum invest­ment grade cred­it rat­ing com­pul­so­ry by March 2016 and align­ing the quan­tum to indus­try lev­els at 1.5 times of NOF.  For a smooth tran­si­tion, deposits held by NBFCs‑D in excess of the revised lim­its will be allowed to run off on maturity.

Sim­pli­fy­ing the Reg­u­la­to­ry Framework

16. Reg­u­la­tion for the NBFC sec­tor over the last decade and a half has been incre­men­tal.  As and when risks have been detect­ed those were sought to be addressed. This had cre­at­ed com­plex­i­ties in their appli­ca­tion and con­se­quent­ly affect­ed com­pli­ance cul­ture. There was there­fore a need to review reg­u­la­tions com­pre­hen­sive­ly with the objec­tive of mak­ing them sim­ple and easy to fol­low.  Con­se­quent­ly, the revised reg­u­la­to­ry frame­work has brought about only two lev­els of reg­u­la­tion viz., for those above the sys­tem­i­cal­ly impor­tant thresh­old and for those below. Reg­u­la­tion for NBFCs‑D will be sim­i­lar to those applic­a­ble to sys­tem­i­cal­ly impor­tant NBFCs-ND, as pro­tec­tion of inter­est of depos­i­tors is one of the man­dates of the Reserve Bank. NBFCs‑D will addi­tion­al­ly have to fol­low the Direc­tion on deposit accep­tance, as hith­er­to. As regards the Non-Deposit tak­ing NBFCs which are not sys­tem­i­cal­ly impor­tant, they will not be sub­ject­ed to any reg­u­la­tion either pru­den­tial or con­duct of busi­ness reg­u­la­tions viz., Fair Prac­tices Code (FPC), KYC, etc., if they have not accessed any pub­lic funds and do not have a cus­tomer inter­face; those hav­ing cus­tomer inter­face will be sub­ject­ed only to con­duct of busi­ness reg­u­la­tions includ­ing FPC, KYC etc., if they are not access­ing pub­lic funds; those accept­ing pub­lic funds will be sub­ject­ed to lim­it­ed pru­den­tial reg­u­la­tions but not con­duct of busi­ness reg­u­la­tions if they have no cus­tomer inter­face; where both pub­lic funds are accept­ed and cus­tomer inter­face exist, such com­pa­nies will be sub­ject­ed both to lim­it­ed pru­den­tial reg­u­la­tions and con­duct of busi­ness reg­u­la­tions. How­ev­er, reg­is­tra­tion under Sec­tion 45 IA of the RBI Act will be manda­to­ry and they will be sub­ject­ed to a sim­pli­fied report­ing system.
17.   It is worth­while to note that out of the 12,029 NBFCs reg­is­tered with the Reserve Bank, as many as 11,598 will be reg­u­lat­ed by this sim­pli­fied reg­u­la­to­ry framework.

Thresh­old for Sys­temic Significance

18. The Basel Com­mit­tee on Bank­ing Super­vi­sion and the Finan­cial Sta­bil­i­ty Board, the two inter­na­tion­al stan­dards set­ting bod­ies, have defined what is a sys­tem­i­cal­ly impor­tant finan­cial insti­tu­tion (SIFI). They do not estab­lish mere­ly an asset size thresh­old for defin­ing a Sys­tem­i­cal­ly Impor­tant Finan­cial Insti­tu­tion (SIFI).  They have iden­ti­fied four major para­me­ters for assess­ing whether a finan­cial insti­tu­tion is sys­tem­i­cal­ly impor­tant viz., its size, its com­plex­i­ty, its inter­con­nect­ed­ness, the lack of read­i­ly avail­able sub­sti­tutes for the finan­cial infra­struc­ture it pro­vides. Finan­cial sec­tor reg­u­la­tors in each juris­dic­tion are expect­ed to iden­ti­fy SIFIs with­in their juris­dic­tion and make suit­able laws, reg­u­la­tions and rules that would apply to those enti­ties.  The Finan­cial Sta­bil­i­ty Board also describes G‑SIFIs as finan­cial insti­tu­tions whose dis­tress or dis­or­der­ly fail­ure, because of their size, com­plex­i­ty and sys­temic inter­con­nect­ed­ness, would cause sig­nif­i­cant dis­rup­tion to the wider finan­cial sys­tem and eco­nom­ic activity.
19. The SIFIs iden­ti­fied by the Reserve Bank in the non-bank­ing space have been based on the asset size, although they also meet the oth­er para­me­ters, includ­ing sub­sti­tutabil­i­ty fac­tor.  Nevertheless,‘1 bil­lion in asset size is con­sid­ered too low from both nation­al and inter­na­tion­al standards.
20.   Con­se­quent­ly, the thresh­old for sys­temic sig­nif­i­cance has been relooked at from the per­spec­tive of the over­all growth in the sec­tor and inter­na­tion­al stan­dards and a revised total asset size of‘500 crore has been put in place.  With this rede­f­i­n­i­tion, as men­tioned ear­li­er, there are now only two broad cat­e­gories of NBFCs and reg­u­la­tions accord­ing­ly applied. These are:
21. non — deposit accept­ing NBFCs with asset size of less than‘500 crore (NBFCs-ND) and
22. non — deposit accept­ing NBFCs with assets of‘500 crore and above (NBFCs-ND-SI) and deposit accept­ing NBFCs
23.   There will con­se­quent­ly be as many as 11,598 NBFCs who will be sub­ject­ed to the sim­pli­fied reg­u­la­to­ry frame­work and only 190 NBFC-ND-SIs and 241 NBFC-Ds who will be sub­ject­ed to the enhanced reg­u­la­to­ry framework.
24. Min­i­mal pru­den­tial reg­u­la­tions are pre­scribed for non-deposit accept­ing NBFCs with asset size of less than‘500 crore. For these non-deposit accept­ing com­pa­nies (NBFCs-ND) below the thresh­old of sys­temic sig­nif­i­cance, pru­den­tial reg­u­la­tions, oth­er than cap­i­tal ade­qua­cy and cred­it con­cen­tra­tion norms, are applic­a­ble only where pub­lic funds are accept­ed and con­duct of busi­ness reg­u­la­tions (FPC, KYC) where there is cus­tomer inter­face. A sim­ple lever­age ratio of 7 has been put in place so that their asset growth is in sync with the cap­i­tal they hold.  Fur­ther, report­ing by such NBFCs will be through a sim­pli­fied annu­al return. There have been con­cerns about non-sys­tem­i­cal­ly impor­tant NBFCs not being sub­ject­ed to any super­vi­sion and report­ing require­ments in the past. This is now sought to be addressed by the revised report­ing sys­tem for all NBFC-NDs and the super­vi­so­ry arrange­ments based on risk per­cep­tion and in nor­mal course so that the reg­u­la­tor is in the know on the activ­i­ties of small­er companies.
25. For those non-deposit accept­ing com­pa­nies (NBFCs-ND-SI) above the thresh­old of sys­temic sig­nif­i­cance and for all NBFC‑D, pru­den­tial reg­u­la­tions are applic­a­ble and con­duct of busi­ness reg­u­la­tions wher­ev­er cus­tomer inter­face exists. In line with inter­na­tion­al best prac­tices, core cap­i­tal require­ment has been strength­ened (exist­ing 7.5%; raised to 10% to be phased over 2 years).  The min­i­mum Tier 1 cap­i­tal require­ment for NBFCs pri­mar­i­ly engaged in lend­ing against gold jew­ellery remains unchanged for the present and will be reviewed for har­mo­niza­tion in due course.
26.   Asset Clas­si­fi­ca­tion norms have been aligned with that of banks (from the cur­rent 180 day and 360 day norm for loan and HP/Leased assets respec­tive­ly to a 90 day norm phased in over 3 years). High­er stan­dard asset pro­vi­sion­ing has been put in place (0.4% against the exist­ing 0.25% phased in over 3 years). Fur­ther, cred­it con­cen­tra­tion norms have been har­monised between the var­i­ous cat­e­gories of NBFCs by remov­ing the dis­pen­sa­tion giv­en to AFCs to exceed the defined norms by 5%. (Dis­pen­sa­tion giv­en to IFCs and IDFs has been retained as infra loans are high val­ue loans) and cor­po­rate gov­er­nance stan­dards, viz., fit and prop­er cri­te­ria for direc­tors, dis­clo­sure and trans­paren­cy have been strength­ened so that they are pro­fes­sion­al­ly man­aged and devel­op a sound com­pli­ance culture.
27. Assets of mul­ti­ple NBFCs in a group shall be aggre­gat­ed to deter­mine if such con­sol­i­da­tion falls with­in the asset sizes of the two cat­e­gories men­tioned above. Reg­u­la­tions as applic­a­ble to the two cat­e­gories will be applic­a­ble to each of the NBFC-ND with­in the group.

Revok­ing of Tem­po­rary Sus­pen­sion of CoR

26. The reg­u­la­to­ry frame­work for NBFCs was based on the pro­vi­sions of the RBI Act 1934, as amend­ed in 1997. Since then, sev­er­al impor­tant devel­op­ments war­rant­ed a major shift in the reg­u­la­to­ry par­a­digm for the NBFC sec­tor. In the cir­cum­stances, a deci­sion to revamp the basic frame­work was tak­en. It was thought appro­pri­ate that no new NBFCs may be reg­is­tered when the reg­u­la­to­ry frame­work is being over­hauled and the grant of issue of CoR was sus­pend­ed on April 1, 2014. With the revised guide­lines in place, the sus­pen­sion on new appli­ca­tions has been revoked simultaneously.

Relax­ation in the Fac­tor­ing Guidelines

27. Fac­tor­ing com­pa­nies were fac­ing dif­fi­cul­ties in meet­ing the Prin­ci­pal Busi­ness Cri­te­ria (PBC) set down for them for the pur­pose of reg­is­tra­tion. Fac­tors need­ed to ensure that their finan­cial assets in fac­tor­ing busi­ness con­sti­tutes at least 75 per cent of its total assets and income derived from fac­tor­ing busi­ness is not less than 75 per cent of  gross income.  The PBC was placed high to align with that of all spe­cial­ized NBFCs, such as IFCs, MFIs, etc.  A num­ber of rep­re­sen­ta­tions were received from the indus­try request­ing for low­er­ing the PBC espe­cial­ly in the ini­tial teething phase.  Con­se­quent­ly, and to pro­vide impe­tus to fac­tor­ing, it was decid­ed to make it eas­i­er for Fac­tors to apply for reg­is­tra­tion by low­er­ing the PBC. Exist­ing com­pa­nies can now seek reg­is­tra­tion if their finan­cial assets in the fac­tor­ing busi­ness con­sti­tute at least 50 per cent of its total assets and income derived from fac­tor­ing busi­ness is not less than 50 per cent of its gross income. Sev­er­al statu­to­ry amend­ments are required to the Fac­tor­ing Act, 2011 which the Reserve Bank is sep­a­rate­ly tak­ing up with the Gov­ern­ment of India.

Feed­back on the Framework

28. The revised reg­u­la­to­ry frame­work has been gen­er­al­ly received pos­i­tive­ly by the mar­ket.  As some­body put it, giv­en the con­text of high anx­i­ety lev­els, these guide­lines came as ‘polite reg­u­la­to­ry action’. There could be short term impact on the prof­itabil­i­ty due to increased pro­vi­sion­ing and on account of the revised asset clas­si­fi­ca­tion norms, but the phased intro­duc­tion of these norms is like­ly to cush­ion any adverse impact on the NBFCs.  Besides, the strength­en­ing of gov­er­nance stan­dards and dis­clo­sures will enhance share­hold­er and investor con­fi­dence. NBFCs already hold a high Tier 1 cap­i­tal, and hence there is like­ly to be no mate­r­i­al impact on them.
29. There have been some appre­hen­sions expressed in the media per­tain­ing specif­i­cal­ly to the asset clas­si­fi­ca­tion norms being aligned with that of banks, a high­er stan­dard asset pro­vi­sion­ing require­ment and the reduc­tion in the quan­tum of deposits that can be accept­ed by NBFCs.  Media reports have stat­ed that NBFCs cater­ing to small bor­row­ers are like­ly to see a jump in gross NPAs and pro­vi­sion­ing as they migrate to the 90 days norm by 2018, while restric­tion on access­ing pub­lic deposits will nar­row mar­gins and will adverse­ly impact the prof­itabil­i­ty of the NBFCs.
30. Sev­er­al rep­re­sen­ta­tions that we have received are with regard to the issue of align­ing the asset clas­si­fi­ca­tion norms with banks; if you all will recall, this has been the focus of the Reserve Bank for sev­er­al years and has also been the rec­om­men­da­tion of sev­er­al Com­mit­tees. Cer­tain unin­formed cam­paign has been spread­ing a fear that this reg­u­la­tion will lead to increase in the bor­row­ing cost for bor­row­ers of NBFCs and it will lead to recall of loans, repos­ses­sion of the assets, etc. These fears are all base­less. What are we telling the NBFCs? We are say­ing that you be truth­ful, when you pre­pare your bal­ance sheets. If a loan is non-per­form­ing i.e. if an instal­ment or inter­est pay­ment is not received even after a rea­son­able peri­od after the due date, you can­not recog­nise income out of that loan. Thus, what we are bring­ing is an account­ing dis­ci­pline, so that all stake­hold­ers know the real finan­cial posi­tion of an NBFC. Be it the depos­i­tor who keeps a deposit with an NBFC or be it an investor or prospec­tive investor of the NBFC when it rais­es funds from the mar­ket, or be it a bank which finances an NBFC, all of them need to know the real finan­cial posi­tion of the NBFC’s assets. These IRAC norms i.e. the Income Recog­ni­tion and Asset Clas­si­fi­ca­tion norms are thus an account­ing require­ment; these in no way cur­tail the NBFCs’ right to extend further/adequate time to the bor­row­ers who are viable. These norms do not require that these loans/assets clas­si­fied as NPAs should be recalled or repos­sessed. That is a call the NBFCs will take, based on their assess­ment about the pos­si­bil­i­ty of repay­ment, and the prob­a­bil­i­ty of default, not on the mere fact that these are clas­si­fied as NPAs.
31.   I under­stand that sev­er­al mem­bers of the indus­try have already fac­tored these changes and suit­ably, that too vol­un­tar­i­ly, moved towards a 150 days or a 120 days asset clas­si­fi­ca­tion norm. Also it may be borne in mind that the revised rules have been made applic­a­ble to only sys­tem­i­cal­ly impor­tant NBFCs, that too as per the new def­i­n­i­tion and for deposit accept­ing NBFCs in line with the Bank’s man­date of finan­cial sta­bil­i­ty and depos­i­tor pro­tec­tion. Besides, ample time of 3 years has been giv­en for com­pli­ance, which is like­ly to cush­ion impact on prof­itabil­i­ty.  As on date, as I said ear­li­er, out of the total 12,029 reg­is­tered NBFCs, only 190 NBFCs which are sys­tem­i­cal­ly impor­tant, non-deposit tak­ing NBFCS and only 241 deposit tak­ing NBFCs will be required to com­ply with these requirements.
32.   On reduc­tion in deposit accep­tance, I would like to clar­i­fy that these have not been reduced but mere­ly aligned to the indus­try prac­tice.  Reg­u­la­tions are framed tak­ing into account the prac­tices in indus­try as a whole, not by the prac­tices of out­liers. Most NBFCs have migrat­ed to oth­er forms of resource mobil­i­sa­tion.  As per data avail­able with us, only 5 deposit tak­ing NBFCs may have to bring down their deposit lev­el. All oth­er 236 deposit accept­ing NBFCs are already with­in the revised deposit accep­tance threshold.

Way Ahead

33. The above revised reg­u­la­to­ry frame­work is the first step towards a vibrant pro­fes­sion­al­ly man­aged and healthy NBFC sec­tor. Much needs to be done and there is work already in progress.  These include migra­tion to an activ­i­ty based rather than enti­ty based reg­u­la­tion, com­pre­hen­sive review of reg­u­la­tions placed on the NBFC-MFIs in the light of the sig­nif­i­cant progress made by them post the AP cri­sis, a for­mal insti­tu­tion­al frame­work for griev­ance redress for the cus­tomers of the NBFCs and bring­ing the Gov­ern­ment owned NBFCs with­in the reg­u­la­to­ry juris­dic­tion of the Bank. There are also sev­er­al amend­ments to the RBI Act, 1934, that need to be tak­en up with the Gov­ern­ment in right earnest.
34. Anoth­er issue that need to be tack­led is resource rais­ing by NBFCs.  Today deben­tures and bank finance are the two main sources of funds for report­ing NBFCs. The Bank had in the past observed an unhealthy and sud­den spurt in deben­ture issuances under the pri­vate place­ment route.  On-site inspec­tions of the com­pa­nies also showed that the deben­tures were accept­ed on tap, the sub­scrip­tion amounts as low as in dou­ble dig­its, pass­books and inter­nal cir­cu­lars of com­pa­nies using the nomen­cla­ture of deposits, loans being extend­ed against the amounts received, deben­tures being issued to walk-in cus­tomers, besides oth­er fea­tures reflect­ing that the deben­tures were in effect sur­ro­gate deposits.  As NBFCs are to be accept­ing only whole­sale funds, the Bank took action to pre­vent retail par­tic­i­pa­tion by stip­u­lat­ing the min­i­mum sub­scrip­tion amounts, the max­i­mum num­ber of sub­scribers per issue, and pre­vent­ing NBFCs from lend­ing against the secu­ri­ty of their own deben­tures.  This while curb­ing the unde­sir­able prac­tices, has con­strained the resource rais­ing abil­i­ty of NBFCs. With the revi­sions in the Com­pa­nies Act on pri­vate place­ments, the Bank is in the process of align­ing large­ly the Bank’s deben­ture reg­u­la­tions with that of the Com­pa­nies Act 2013.

Chal­lenges for the Regulator

35. The chal­lenges faced by the reg­u­la­tor are many.  First, there is a need to stream­line the sec­tor, to bring with­in its fold enti­ties that should have, but have not, sought reg­is­tra­tion from the Bank. These have been iden­ti­fied and suit­able cor­rec­tive action is under­way. Sec­ond, it has come to the notice of the Bank that there are finan­cial com­pa­nies that have been accept­ing deposits from the pub­lic with­out autho­ri­sa­tion from the Bank. These again have been iden­ti­fied and the respec­tive State Gov­ern­ments are in the process of tak­ing suit­able action under the State Pro­tec­tion of Inter­est of Depos­i­tors Acts. Third, the men­ace of unin­cor­po­rat­ed enti­ties and fly by night oper­a­tors accept­ing deposits need to be addressed in full earnest. The Bank is strength­en­ing its Mar­ket Intel­li­gence efforts and the inter-reg­u­la­to­ry coor­di­na­tion. The State lev­el Coor­di­na­tion Com­mit­tees (SLCCs), an inter-reg­u­la­to­ry forum, has been strength­ened, with the Chief Sec­re­taries pre­sid­ing over the SLCCs, and the fre­quen­cy of such meet­ings has also been increased. The Bank is also exam­in­ing the need for a Resid­ual Reg­u­la­tor which can address issues and prod­ucts that are hybrid in nature and do not strict­ly fall under any finan­cial sec­tor reg­u­la­tor. Some State Gov­ern­ments have expressed the desire to act as Resid­ual Reg­u­la­tor for the finan­cial sec­tor. This again, is work in progress.
36. In keep­ing with the work done on Shad­ow Bank­ing by G‑20 and Finan­cial Sta­bil­i­ty Board, the Reserve Bank has been tasked with iden­ti­fi­ca­tion of shad­ow bank­ing enti­ties and activ­i­ties in the coun­try, putting in place a data gath­er­ing mech­a­nism to ascer­tain the inter­con­nect­ed­ness and the risks trans­mit­ted to the for­mal finan­cial sec­tor from shad­ow banks. This is a humon­gous task, as today there is lit­tle data avail­able on say Chit Funds, both in the for­mal and infor­mal sec­tor, mon­ey lenders, and the like.  An inter-reg­u­la­to­ry group con­sist­ing of finan­cial sec­tor reg­u­la­tors, enforce­ment agen­cies and the con­cerned Gov­ern­ment Min­istries are engaged in this task.

Con­clu­sion

37. In con­clu­sion, may I empha­size that fram­ing reg­u­la­tions is a pub­lic pol­i­cy func­tion and it retains a long term per­spec­tive; though there may be some short term set­backs, the revised pru­den­tial reg­u­la­tions as detailed so far, includ­ing the strength­en­ing of core cap­i­tal, gov­er­nance stan­dards and dis­clo­sures, will strength­en the NBFC sec­tor, make it more resilient to eco­nom­ic down­turns, low­er sys­temic risks and enhance stake­hold­er con­fi­dence. Over­all the Reserve Bank is con­fi­dent that the recent reg­u­la­to­ry changes will have a salu­tary effect on finan­cial sta­bil­i­ty in the long run.  It is hoped that these and oth­er forth­com­ing changes in the pipeline, will fur­ther strength­en the robust­ness of sig­nif­i­cant­ly impor­tant NBFCs and allow them and oth­er NBFCs to oper­ate in an enabling reg­u­la­to­ry environment.