PCA Framework for NBFCs brings further parity with banks in terms of regulations: Ind-Ra

The Reserve Bank of India’s prompt corrective action (PCA) framework for non-banking financial companies (NBFCs) brings further parity in terms of the regulations between banks and non-banks, due to the increased size and scale of NBFCs and interconnectedness with banks, along with the scale-based regulation implemented in October 2021 and the alignment of asset quality classifications implemented in November 2021, says a report of India Ratings (Ind-Ra).

The move also establishes a regulatory course of action in an event of a breach of certain parameters, thus acting as an early warning signal. In case of any breach, the NBFC’s performance will be measured over four consecutive quarters on risk threshold parameters to declassify the NBFC placed under PCA, it added.

Any NBFC breaching any of the risk threshold has the time to course correct till March 2022 as the guidelines will be based on year-end numbers. NBFCs with net non-performing assets of 6 per cent and higher may have to make higher provisions or sell assets to asset reconstruction companies during H2FY22 to bring-in the ratio outside the threshold, in line with the guidance. This may impact profitability and capital buffers.

While the PCA framework is a progression towards increasing the alignment of regulations between banks and NBFCs, the PCA norms bring-in a risk threshold monitoring for non-banks based on the total capital, tier 1 capital and net non-performing assets.

Restrictions

Companies falling under these categories post October 1, 2022 will have restrictions on dividend pay-outs, require a capital infusion or a reduction in leverage, and face restrictions on branch expansion and capital expenditure depending on the defined risk threshold category.

The framework is applicable to NBFC-D (excluding government companies) and NBFC-ND (middle, upper and top layer). However, it excludes housing finance companies.

As of now, most of the large NBFCs are comfortably poised to comply with the regulations. Many NBFCs have raised capital before and during pandemic, leading to an improvement in their capital buffers, and carried excess expected credit loss provisions to navigate the pandemic impact on asset quality.

However, any increase in the asset quality challenges in form of slippage from the restructured book and book benefitted through Emergency Credit Linked Guarantee Schemes will led to NBFCs turning cautious in terms of increasing provisions to maintain the risk threshold within the permitted limits on the asset quality side.

The rating agency believes that the PCA framework will bring greater clarity in terms of the regulator’s approach on NBFCs breaching threshold limits on capital buffers or facing heightened credit risk.