Context: The Reserve Bank of India (RBI) has released the list of Non-Banking Finance Companies categorised under the upper layer segment (NBFC-UL) for the year 2024-25.
Relevance of the Topic: Prelims: Scale based Regulation of NBFCs.
Need for Effective Regulation of NBFCs?
- Growth of the Sector: Size of balance sheet of NBFCs (including HFCs) has more than doubled from Rs 20.72 lakh crore (2015) to Rs 49.22 lakh crore (2020).
- Increased lending by NBFCs: The share of credit given by NBFCs increased from 8.5 % (2012-13) to 11.5 % (2019-20). However, bank credit as a proportion of GDP declined from 52% to 50% during the same period.
- Interconnectedness: NBFCs mobilise more than 50% of funds by borrowing from Banks. This interconnectedness between Banks and NBFCs has systemic implications. Failure of large NBFCs such as IL&FS could have adverse implications on the financial health of the Banks.
- Recent failure of large NBFCs such as IL&FS, Dewan Housing Finance etc. has also highlighted the need for strengthening supervisory tools for NBFCs.
What is Scale Based Regulation of NBFCs?
- The scale-based regulation is based on the principle of proportionality and narrows the regulatory arbitrage between banks and large NBFCs while allowing for operational flexibility.
- Under this regulation, NBFCs are segregated into four layers based on their size, activity, and perceived level of riskiness: (i) Base Layer (NBFC-BL), (ii) Middle Layer (NBFC-ML), (iii) Upper Layer (NBFC-UL), and (iv) Top Layer (NBFC-TL).
Regulatory Changes under the SBR Framework
- Applicability: Any regulatory stipulation applicable to a lower layer under the new NBFC categorisation will automatically apply to a higher layer, unless otherwise notified by the RBI.
- Increase in Net owned Fund (NOF) requirement: The RBI has increased the minimum net owned fund (NOF) requirement for NBFC-ICC from Rs 2 crores to Rs 10 crores. For NBFC-MFI and NBFC-Factor, the NOF requirement has been increased from Rs 5 crores to Rs 10 crores.
- Changes to NPA classification norms: Presently, all NBFCs other than NBFC-MFIs classify loans as NPA if it is due for more than 180 days. The RBI has prescribed a uniform overdue period of more than 90 days for classification of loans as NPA for all categories of NBFCs. Hence, going forward, the NPA classification requirements for banks and NBFCs would be aligned.
- Extension of PCA Framework: The Prompt Corrective Action (PCA) framework, applicable to banks, has been extended to NBFCs in the middle and upper layers. Under the PCA framework, NBFCs need to undertake timely remedial measures if they breach the prescribed risk thresholds.