The current regulatory approach is based on the size of the NBFC, functions it performs and sectors it operates in. In addition to asset size, the nature of business is also a distinguishing factor for the level of regulation. In comparison to banks, NBFCs are subject to less stringent prudential requirements.

According to RBI, the size of the balance sheet of NBFCs (including Housing Finance Companies (“HFC”)), in the last five years alone, has more than doubled from ₹20.72 lakh crore (2015) to ₹49.22 lakh crore (2020). In the aftermath of the IL&FS and DHFL episodes, financial systems’ vulnerability to systemic risks was evident and this manifested itself in erosion of confidence, rating downgrades and liquidity stress.

Refreshed regulatory approach

RBI’s approach to address the systemic risks posed by the current NBFC regulatory framework is evident from the discussion paper on ‘Revised Regulatory Framework for NBFCs – A Scale-Based Approach’ (“Discussion Paper”) dated January 22, 2021. Recognizing the ‘rule of proportionality’, RBI has proposed to provide for a calibrated and graded regulatory framework by adopting a four-tiered pyramid regulations based structure. The regulatory intervention being commensurate to ‘comprehensive risk perception’, ‘size of operations’ and ‘nature of activities’ of an NBFC, that is, the NBFC at base requiring the least regulatory intervention and the intervention increasing as one moves up the pyramid.

In the Discussion Paper, the RBI proposes to regulate NBFCs by dividing them into: (a) Base Layer -comprising of non-systemically important NBFCs like P2P lending platforms, Account Aggregators, and Type I NBFCs; (b) Middle Layer – comprising of systemically important NBFCs, like deposit taking NBFCs and HFCs etc.; (c) Upper Layer (“NBFC-UL”) – comprising of NBFCs which are identified as systemically significant among NBFCs and have potential to impact financial stability (regulatory framework for NBFC-UL is proposed to be bank-like); and (d) Top Layer – this layer will be empty but can comprise of such NBFC-UL which are seen to pose extreme risks by RBI, which can be put to significantly higher and bespoke regulatory/ supervisory requirements.

The Discussion Paper also proposes an increase in net owned fund requirements for an NBFC from ₹ 2 crores to ₹ 20 crores; increase in monetary threshold for determining systemically important NBFCs from ₹ 500 crores to ₹ 1000 crores and reduction in the threshold for non-performing asset classification from 180 days to 90 days. Given the NPA deluge, it is not surprising that the RBI intends to treat all financial institutions at par when it comes to asset classification. Corporate governance measures are also sought to be enhanced, coupled with the disclosure norms being strengthened. The most significant proposal is to rehash the sectoral exposures for capital markets and real estate.

The Discussion Paper draws a line between keeping the regulatory arbitrage in place, yet allowing for a more stringent framework for NBFCs. While it has been recognised that there can be no ‘one-size-fits-all’ prescription for NBFCs, a graded scale-based approach proportionate to the systemic significance of NBFCs is a step towards evolution of the financial sector as a whole, by ensuring that the economy doesn’t get plagued with issues like rising NPAs, lack of corporate governance, ever greening of assets and the like. While the amendments are awaited, the need for a change in regulatory landscape of the sector continues.

This article was originally published in Economic Times on 03 April 2021 Co-written by: Veena Sivaramakrishnan, Partner; Sumant Prashant, Principal Associate; Jasraj Narul, Associate. Click here for original article

Read Less-