Globally termed as shadow banks, NBFCs are entities registered under the Companies Act, 1956 that provide financial and banking services without a bank licence. As of March 2020, NBFCs became the largest net borrowers of funds from the financial systems, their asset growth rate surpassing that of scheduled commercial banks. However, unlike banks, NBFCs did not have a concise governing framework until now. Moreover, the crisis of renowned NBFCs like Diwan Housing Finance Limited, IL&FS brought the spotlight on the swelling need for a consolidated monitoring and governance mechanism for the NBFCs.

Applicable from October 22, 2022, the RBI announced the SBR framework for NBFCs replacing a vastly scattered governance regime. Prior to this framework, the NBFCs were governed by the principle of proportionality and regulated under RBI Act (1934) Companies Act, Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions (2007), Prevention of Money Laundering Act, Know Your Customer Guidelines, and Guidelines on Fair Practices Code. Additionally, SEBI Act (1992), National Housing Bank Act, Chit Funds Act, Insurance Act etc. also apply, subject to the nature of the business carried out by the NBFC.

The new calibrated SBR framework entails capital requirements, governance standards, prudential regulation, etc. It classifies NBFCs based on their asset size, business undertaken, inter-connectedness with the system and perceived risk. Previously, NBFC categorisations were based on the asset size and activities. Thus, NBFCs are now classified into a four tier pyramid where the base layer is subjected to the least regulation and the top layer is subjected to the most stringent regulations.

At the bottom of the pyramid, the base layer (‘NBFC-BL’) comprises all non-deposit taking, peer-to-peer lending platforms, account aggregators, non-operating financial holdings & type-I NBFCs with an asset size within ₹1,000 crore. The middle layer (‘NBFC-ML’) encompasses systemically important non-deposit taking NBFCs, deposit-taking NBFCs, housing financing, infrastructural financing, infrastructure debt fund, core investment, and standalone primary dealer NBFCs with asset size exceeding ₹1,000 crore.

Upper Layer (‘NBFC-UL’) shall consist of systematically significant NBFCs identified based on qualitative parameters like group structure, credit penetration in a particular segment/domain, nature of liabilities and quantitative parameters like risks, asset size, system interconnections. Lastly, the Top layer (‘NBFC-TL’) shall ideally remain vacant unless notified as NBFC-UL with significantly higher risk, thereby warranting higher supervision. Unlike in the earlier regime, a risk management committee is to be constituted in all NBFCs. Enhanced disclosure mechanisms have also been introduced to include types of exposure, related party transactions, loans to directors/senior management and customer complaints.

Further, one director must have a proper relevant experience of working in a bank or NBFC and has been mandated, realising the importance of having an expert professional on board. Another important provision introduced to set in from March 2026 onwards, is the time period of default in the classification of non-performing assets that has been shortened to 90 days as compared to 180 days under the previous regime. More significantly, a ceiling has been set at ₹1 crore on each borrower for subscribing to any initial public offer, applicable from April 1, 2022. This allows NBFC to set enhanced conservative limits as compared to the previous provisions wherein they tend to exit the IPO subsequent to gains from first-day listings while borrowing investment. While the aforementioned provisions will apply to all NBFCs, there are custom provisions for each tier introduced via this framework.

Custom provisions

Firstly, the credit concentration limit applicable on lending and investments in NBFC-ML & NBFC-UL is set to 25 per cent for one individual borrower and 40 per cent for a borrower group. Secondly, they will also have to evaluate whether the capital is sufficient based on the risks via an internal capital adequacy assessment process. The board shall also have to determine and fix the internal limits for sensitive sector exposure of capital markets and commercial real estate to NBFC. Thirdly, such an NBFC with over ten branches shall have a core banking solution system to simplify transaction systems for the customers. Finally, the key managerial persons of these tiers are no longer allowed to hold any other offices except directorships in subsidiaries of the NBFC.

It may be pertinent to mention that NBFCs identified as NBFC-UL have to mandatorily list their equity shares within three months. The board should comprise members with such an educational background and experience profile to efficiently manage the affairs of the NBFC. Furthermore, the need for a chief compliance officer has also been highlighted in this framework. This framework has been projected to set up a systematic structure to ensure liquidity, cash flow and operational flexibility while mitigating risks, strengthening corporate governance and realigning NBFCs to instil trust. While the framework does set a concrete functioning structure, it curtails the organisation’s prerogatives.

(The authors are legal professionals)

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