RBI introduces Scale-based Regulations for NBFCs

October 24, 2021 I BFSI Research

In January 2021, RBI had issued a discussion paper to introduce a revised scale-based regulatory framework for NBFCs
and has sought comments on the same and has now issued final regulations around the same. These guidelines would
be effective from October 01, 2022, however, instructions relating to ceiling on IPO funding would come into effect
from April 01, 2022.The following short note summarises key points of the same.

Introduction
The NBFC space evolved over the last few years with a complex web of inter-linkages of the sector with banks, capital
market and other financial sector entities. The sector has grown from being around 12% of the balance sheet size of
banks (2010), to around 25% of the size of banks. NBFCs by design have had a lighter and differential regulation as
compared to banks for operational flexibility and extending the access of financial services. The arbitrage between
banks and NBFCs can be broadly categorised as structural arbitrage and prudential arbitrage. However, in view of the
recent stress in the sector, RBI has developed a scale-based approach to regulation from a ‘systemic significance’
vantage point.

Scale-Based Approach to Regulation

Apart from the existing nomenclature, NBFCs would be categorized across four different layers (Base, Middle, Upper,
and Top) based on various parameters including size, interconnectedness with the system, etc. The scale-based
approach can be visualised as a pyramid with the base layer being subjected to the least regulation and the topmost
layer facing the most stringent regulations.

Figure 1: Four layers for classification of NBFCs

Base Layer Middle Layer Upper Layer Top Layer

• NBFC-ND below asset • NBFC-D irrespective • Shall comprise of • The Top Layer will
size of Rs 1,000 crore of asset size those NBFCs which ideally remain
• NBFC-P2P • NBFC-ND with asset are specifically empty.
• NBFC-Account size of Rs. 1,000 crore identified by RBI as • This layer can get
Aggregator and above warranting enhanced populated if RBI is of
• Non-Operative • Standalone Primary regulatory the opinion that
Financial Holding Dealers requirement based there is a substantial
Company (NOFHC) • IDF-NBFCs on a set of increase in the
• NBFCs who do not • CICs parameters and potential systemic
avail public funds and • HFCs scoring methodology risk from specific
do not have any • NBFC-IFCs and guidelines. NBFCs in the Upper
customer interface Layer.

Source: RBI, CARE Ratings

The structural placement shall be as follows

Always Base Layer Always Middle Layer Middle/Upper Layer Any Layer

• NBFC-P2P, NBFC-AA, • SPD and IDF-NBFC • NBFC-D, CIC, IFC and • NBFC-ICC, NBFC-MFI,
NOFHC • Government owned HFC NBFC-Factors, and
• NBFCs who do not NBFCs (#) NBFC-MGC
avail public funds and
do not have any
customer interface

(#) Shall be placed in the Base Layer or Middle Layer. They will not be placed in the Upper Layer till further notice.
Scoring methodology for identification of an NBFC as NBFC-UL shall be based on the set of NBFCs fulfilling the following
criteria:

• Top 50 NBFCs (excluding top ten NBFCs based on asset size, which automatically fall in the Upper Layer) based
on their total exposure including credit equivalent of off-balance sheet exposure.
• NBFCs designated as NBFC-UL in the previous year.
• NBFCs added to the set by supervisors using supervisory judgment.

The computation of scores of all NBFCs in the above set shall be performed annually based on their position as on
March 31st each year.

Figure 2: Scoring Methodology for Identification of NBFC as NBFC-UL

Quantitative Parameters (70%) Qualitative Parameters (30%)

• Size & Leverage: 35% • Nature/type of liabilities: 10%

• Interconnectedness: 25% • Group Structure: 10%
• Complexity: 10% • Segment Penetration: 10%

Source: RBI, CARE Ratings

Summary of Select Regulatory changes for NBFCs – Scale Based Approach

Figure 3: Table of Select Changes
NBFC – Base Layer NBFC – Middle Layer NBFC – Upper Layer
Parameters
(NBFC-BL) (NBFC-ML) (NBFC-UL)
CET 1 9% of RWA
Leverage To be stipulated
Standard Asset Differential Provisioning
provisioning towards different classes
of standard assets
NPA Classification Harmonisation from 180 No impact since NBFCs with asset size of more than Rs
days to 90 days overdue 500 crores are already required to follow the 90-day NPA
norm
ICAAP Board approved policy considering all risks. This internal
assessment shall be on similar lines as ICAAP prescribed
for commercial banks under Pillar 2
Credit Concentration Extant instructions on Merger of lending and investment limits into a single
Norms concentration norms exposure limit. As a percentage of Tier 1 capital: Single
borrower/ party (25%) and Single group of borrowers/
parties (40%)
Large Exposure NBFC-UL to follow above
Framework (LEF) Credit Concentration
Norms till Large Exposure
Framework is
operationalised
Compensation Not stipulated (i) Constitution of a Remuneration Committee
Guidelines – Constitute (ii) Principles for fixed/ variable pay structures
Nomination and (ii) Malus/ claw back requirements
Remuneration
Committee
Governance Norms • The Board shall delineate the role of various
committees (Audit Committee, Nomination and
Remuneration Committee, or any other Committee)
and lay down a calendar of reviews.
• NBFCs shall formulate a whistle blower mechanism
for directors and employees to report genuine
concerns.
• The Board shall ensure good corporate governance
practices in the subsidiaries of the NBFC.
Key Managerial As per Companies Act, (i) No KMP of an NBFC shall hold office in any other NBFC-
Personnel (KMP) - 2013 ML or NBFC-UL except for directorships in subsidiaries
whole time employee (ii) An Independent Director cannot be director in more
in the nature of CEO, than three NBFCs (NBFC-ML and NBFC-UL) at the same
CFO, CS and WTD time
Timeline of two years is provided with effect from
October 01, 2022, to ensure compliance
Appointment of Chief Not stipulated Mandatory Mandatory
Compliance Officer
Listing Not Mandatory Not Mandatory Shall be mandatorily listed
within 3 years of
identification as NBFC-UL.
Disclosure requirements
shall be put in place on the
same lines as applicable to
a listed company even
before the actual listing, as
per Board approved policy
of the NBFC.
Expertise for Board (i) Adequate experience & educational qualification
members (ii) At least one of the directors should have experience in retail lending in a bank/NBFC
(iii) The composition of the Board should ensure mix of educational qualification and
experience within the Board. Specific expertise of Board members will be a prerequisite
depending on the type of business pursued by the NBFC.
Removal of Not stipulated Not stipulated Required to report to the
Independent Directors supervisors in case any
with Supervisory Independent Director is
approval removed/ resigns before
completion of normal
tenure.
Risk Management Could be Board or Board-level RMC Board-level RMC
Committee Executive level as decided applicable applicable
by the Board
Disclosures Expanded to include types Beginning March 2023, additional disclosures include:
of exposure, related party • Corporate Governance report containing
transactions, loans to composition and category of directors, shareholding
Directors/ Senior Officers of non-executive directors, etc.
and customer complaints. • Disclosure on modified opinion, if any, expressed by
auditors, its impact on various financial items and
views of management on audit qualifications.
• Items of income and expenditure of exceptional
nature.
• Breaches in terms of covenants in respect of loans
availed by the NBFC or debt securities issued by the
NBFC including incidence/s of default.
• Divergence in asset classification and provisioning
above a certain threshold to be decided by the
Reserve Bank.
Loans to directors, Have a Board approved
senior officers and policy
relatives of directors
Sensitive Sector Not stipulated (i) Board approved internal (i) Board approved internal
Exposure (SSE) limits separately for capital limits separately for
market exposure and capital market exposure
commercial real estate and commercial real
sector, supplemented by estate sector,
adequate disclosures supplemented by
ii) Internal sub-limit within adequate disclosures
the CRE ceiling for ii) Internal sub-limit within
financing land acquisition the CRE ceiling for
(iii) Dynamic vulnerability financing land acquisition
assessment by NBFCs (iii) Dynamic vulnerability
(iv) Supervisory review assessment by NBFCs
(iv) Supervisory review
 (v) Board approved
internal exposure limits on
other important sectors of
the economy
(vi) Internal Board
approved limit on
exposure to NBFC sector
Regulatory Restrictions Not stipulated Restrictions on grant of loans and advances for/to the
on lending following:
(a) Directors and relatives of directors
(b) Officers and relatives of Senior Officers
(c) Real Estate – disbursals only after the borrower has
obtained requisite clearances from the government
authorities.
IPO Financing with Ceiling of Rs.1 crore per individual. NBFCs can prescribe more conservative criteria
effect from April 01,
2022
Core Banking Solution Not mandatory Mandatory for NBFCs with Mandatory for NBFCs with
for NBFCs more than 10 branches more than 10 branches
with a glide path of 3 years with a glide path of 3 years
with effect from October with effect from October
01, 2022 01, 2022
RBI would release detailed circulars due course wherever required in the above parameters
Source: RBI, CARE Ratings

Changes in Regulatory minimum Net Owned Fund (NOF)

• For NBFC-ICC, NBFC-MFI and NBFC-Factors has been increased from Rs 2/5 crores to Rs. 10 crores. These
institutions must achieve the same by March 31, 2027.
• For NBFC-P2P, NBFC-AA, and NBFCs with no public funds and no customer interface, the NOF continues to be
Rs. 2 crores.
• no change in the existing regulatory minimum NOF for NBFCs - IDF, IFC, MGCs, HFC, and SPD. Minimum NOF
for different categories: IDF and IFC – Rs 300 crore, MGC- Rs 100 crore, HFCs- Rs 20 crore, SPDs which
undertake only the core activities – Rs 150 crore, SPDs which also undertake non-core activities – Rs 250 crore
NBFCs falling in the Top Layer of the regulatory structure would be subject to a higher capital charge. Such higher
requirements would be specifically communicated to the NBFC at the time of its classification in the Top Layer. There
will be enhanced and intensive supervisory engagement with these NBFCs by RBI.

Currently most of the NBFCs are likely have an adequate level of Tier I capital as required under these guidelines; some
entities may have to raise capital for boosting their CET I levels. Regulations on leverage of NBFC-UL in addition to
CRAR, would reduce the regulatory arbitrage (especially of HFCs). This would strengthen their balance sheets thereby
minimizing the chances of systemic risk arising from such large HFCs. Introduction of internal capital assessment on
similar lines as ICAAP prescribed for commercial banks under Pillar 2 is also expected to significantly enhance standards
of overall risk assessment of NBFCs from present level.

As per initial assessment, the top 10 companies that could form part of the Upper layer are already listed. The second
list of NBFCs in the Upper Layer would consist of a set of NBFCs that may have to go public. Further the disclosure
requirements for the Middle Layer NBFCs especially at the lower end of the threshold might see a significant increase
(NBFCs at the higher end are already subject to listing requirements as quite a few of them have listed debt securities
that already impose more or less similar requirements).
Conclusion
In absolute terms, the asset size of NBFC sector (including HFCs), as on March 31, 2021, was over Rs.54 lakh crore with
over 9,600 NBFCs registered across 12 categories and the sector has grown at a CAGR of close to 18% over the last five
years. Out of this size of the sector, the following figure quite deftly indicate the top-heavy nature of the sector.

Figure 4: Share of the sector’s assets

Set of NBFCs ~% Share of the asset size
Select seven Govt. controlled NBFCs ~30%
Select five HFCs ~20%
Select 20 NBFCs (excl. HFCs and govt. controlled NBFCs) ~20%

The level of regulation / compliance requirement increases with each layer. Over 90% of the NBFCs which have an asset
size of less than Rs 1,000 crores, would be in the Base Layer, where no meaningful changes have been suggested. A
 significant portion of the listed NBFCs would form part of the Middle/Upper layer and would need to comply with the
new regulations related to capitalization, disclosure norms, and governance.

These scale-based regulations tighten and consolidates regulations across categories along with reducing regulatory
arbitrage with banks especially for the Upper Layer NBFCs. These changes are expected to increase the resiliency of the
sector going forward. However, RBI at the same time has acknowledged that NBFCs have contributed significantly to
the under-banked segment. This scale-based approach is more pragmatic to following the one size fits all model.
Smaller NBFCs which typically cater to the bottom of the pyramid of the population would be negatively impacted if
tighter regulations are imposed on the same and which would defeat the raison d’etre of such NBFCs i.e., the goal of
financial inclusion.

Given the current market highs and IPO issuances, IPO financing could witness some impact as the individual exposure
has been capped at Rs 1 crore per NBFC from no limits beginning from April 01, 2022. However, there is no stated cap
on number of lenders, consequently an investor could still use leverage by utilising multiple NBFCs. But such regulatory
restrictions on lending could hamper some businesses of NBFCs. Given the implementation deadline, no impact would
be witnessed in the current financial year, however, beginning the next fiscal, IPO oversubscription could see some
moderation from current peak levels estimated to be over one trillion rupees.

The sensitive Sector Exposure (SSE) norms could shift this business to smaller NBFCs which may reduce the availability
of funds for such businesses. Additionally, implementation of a core banking solutions and the changes in corporate
governance including risk management systems may limit the flexibility of entities as a NBFC platform.

Further as expected, at least for the time being, government entities have been kept out of these proposed regulations.
Hence it would be business as usual for these entities.

Contact:
Sanjay Agarwal Senior Director [email protected] +91-22-6754 3582/+91-810-800-7676
Saurabh Bhalerao Associate Director – BFSI Research [email protected] +91-22-6754 3519/+91-900-495-2514
Mradul Mishra Media Relations [email protected] +91-22- 6837 4424

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