The Reserve Bank of India (RBI) on November 10, 2014, has issued the revised regulatory framework for non-banking finance companies (NBFCs). The rising importance of NBFCs and their growing interconnectedness with banks as well as issues like the risk management framework for the sector, regulatory gaps and arbitrage, compliance, and governance issues have driven the RBI to make certain regulatory changes. These changes aim at better addressing the risks in the business, enhance regulatory coverage, standardise regulations and improve governance standards.

The revised regulatory NBFC framework is aimed at addressing foregoing regulatory gaps and arbitrage arising from differential regulations, within the non-banking finance sector as well as in relation to other financial institutions, primarily banks.

The revised norms are to be implemented in a phased manner over the next three financial years, i.e., FY16–FY18. The key changes and their broad impact on NBFCs are as follows:

 

 

Key norms

Impact on NBFC sector

Increase in tier-I capital to 10% from current 7.5% for a deposit-taking NBFCs (NBFC-ND) and non-deposit taking systemically important NBFC (NBFC-ND-SI)

Such increase is in line with the RBI’s intent of improving the NBFCs’ loss absorbing capacities; while this would increase the capital requirement for NBFCs in the long run, it would leave these companies with healthier balance sheets

Revision in threshold limit for defining systemically important NBFC to asset size of INR500 crore from INR100 crore

Relieves smaller NBFCs from regulatory and compliance requirements and facilitates effective supervision by the RBI of larger NBFCs, which are as the name suggests ‘systematically important’ 

NBFCs that are part of the same corporate group or floated by the common set of promoters will not be viewed on a standalone basis

This is an important provision for increasing accountability of corporate groups and operational transparency under a common management; practices adopted by corporate groups to advance their interest by adopting opaque practices would be curbed by this regulation    

NPA recognition norms changed to 90 days overdue from 180 days overdue for loans and 360 days overdue for hire purchase assets

This change impacts the profitability of NBFCs due to higher provisioning requirement with an increase in NPAs and interest reversals in the near future; with a 90-day norm for provisioning, NBFCs have been brought up at par with banks, as far as provisioning is concerned

Provision on standard assets increased from 0.25% to 0.40%

While this change would impact the profitability of NBFCs in the short term, it is in line with the RBI’s objective of strengthening the balance sheet of NBFCs in the long run by increasing delinquency absorption capacity

NBFCs registered prior to April, 1999, to raise their net owned funds (NOF) to INR2 crore by March, 2017

This clause is brought about to ensure that the only entities with an adequate equity base are functional and entry of any unscrupulous players is restricted

Implementation of stricter corporate governance and disclosure norms, including constitution of an audit, nomination and risk committee by NBFCs

Broad initiatives proposed under this category go a long way in improving corporate governance and accountability for NBFCs by bringing in more transparency

Introduction of leverage ratio (total outside liabilities/owned funds) of 7 for NBFC-ND with assets less than INR500 crore

This change aims to restrict the leverage of non-systemically important NBFCs, which are otherwise subjected to lesser scrutiny and regulatory compliances   

 

While the RBI has made a conscious effort to bring parity between NBFCs and banks, as far as regulations are concerned, some of the regulatory advantages available for banks such as access to risk-based capital and liquidity backups have not been made applicable for NBFCs.

While in the short run, these measures may impact profitability, in the long run a better regulatory framework would reduce risks by improved disclosures and strengthened governance standards. Overall, better regulatory environment would facilitate the ease of doing business in India and provide further impetus to investments in India.

 

Deepak Pareek

Deepak Pareek is the Chief Financial Officer of IL&FS Financial Services Ltd. His area of expertise span across finance, accountancy, operations, taxation, technology, Regulatory & statutory compliance and other related areas.


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