The NBFC sector plays an important role in supplementing credit creation along with the Banks. Over the years, the NBFC sector has undergone considerable evolution in terms of size, complexity, and interconnectedness within the financial sector. Recent crisis such as IL&FS and DHL have highlighted the need to strengthen the regulatory framework for NBFCs.
In this regard, the RBI has recently unveiled Scale based Regulation (SBR) for the NBFCs.
| Difference between Banks and NBFCs | ||
| Characteristics | Bank | NBFCs |
| Deposits | Accepts all types of deposits | Cannot accept demand deposits |
| Deposit insurance of DICGC | Applicable (up to Rs.5 lakh) | Non-Applicable |
| Payment and Settlement system of the RBI | Supports RTGS, NEFT etc., | Not supported. Cannot issue their own cheque books. |
| Foreign investment | Up to 74% | Up to 100% |
| Cash Reserve Requirement | Applicable | Not Applicable |
| Capital Adequacy Norms | Applicable | Applicable only to Deposit-taking NBFCs and Systematically Important NBFCs (CRAR - 15%) |
| SLR | Applicable | Applicable only to Deposit-taking NBFCs (SLR - 15%) |
| Incorporated under | Banking Regulation Act, 1949 | Incorporated under Companies Act and regulated by various bodies depending on category. |
Types
- Based on Asset-Liability Structures: Deposit-taking NBFCs (NBFCs-D) and non-deposit taking NBFCs (NBFCs-ND).
- Based on Systemic Importance: Among non-deposit taking NBFCs, those with asset size of Rs 500 crore or more are classified as non-deposit taking systemically important NBFCs (NBFCs-ND-SI).
On the basis of activities
- NBFCs regulated by RBI
- Investment and Credit Company (ICC): Lending and Investment.
- NBFC-Infrastructure Finance Company (NBFC-IFC): Provision of infrastructure loans.
- NBFC-Systemically Important Core Investment Company (CIC-ND-SI): Investment in equity shares, preference shares, debt or loans in group companies.
- NBFC-Infrastructure Debt Fund (NBFC-IDF): Facilitation of flow of long-term debt into infrastructure projects.
- NBFC-Micro Finance Institution (NBFC-MFI): Credit to economically disadvantaged groups.
- NBFC-Factor: extending loans against the security interest of the receivables at a discount
- NBFC-Non-Operative Financial Holding Company (NBFC-NOFHC): Facilitation of promoters/ promoter groups in setting up new banks.
- Mortgage Guarantee Company (MGC): Undertaking of mortgage guarantee business.
- NBFC-Account Aggregator (NBFC-AA): Collecting and providing information about a customer’s financial assets in a consolidated, organized and retrievable manner to the customer.
- NBFC–Peer to Peer Lending Platform (NBFC-P2P): online platform to bring lenders and borrowers together to help mobilize funds.
- Housing Finance Companies (HFC): Financing for housing (Earlier, the Housing Finance Companies (HFCs) were regulated by NHB)
- Note: In 2018-19, three categories of NBFCs namely, asset finance companies (AFCs), loan companies (LCs) and investment companies (ICs) were merged into a new category called investment and credit companies (ICCs).
Other categories of NBFCs
- Venture Capital Fund/Merchant Banking companies/ Stock broking companies are registered with SEBI.
- The Insurance Companies are regulated by IRDA
- Chit Fund Companies are regulated by the respective State Governments
- Nidhi Companies are regulated by Ministry of Corporate Affairs, Government of India
- Scale based Regulation (SBR) of NBFCs
Scale Based Regulation (SBR) of NBFCs
Need for effective regulation of NBFCs
- 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 mobilize 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.
Regulatory structure for NBFCs shall comprise of four layers based on their size, activity, and perceived riskiness. NBFCs in the lowest layer shall be known as NBFC - Base Layer (NBFC-BL).
NBFCs in middle layer and upper layer shall be known as NBFC - Middle Layer (NBFC-ML) and NBFC - Upper Layer (NBFC-UL) respectively. The Top Layer is ideally expected to be empty and will be known as NBFC - 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.
PCA framework for NBFCs
- Applicability
- All Deposit Taking NBFCs
- All Non-Deposit Taking NBFCs in Middle, Upper and Top Layers
- Note: The Government companies, NBFCs below Rs 1,000 crore in size, and Housing Finance Companies (HFCs) will not be brought under ambit of PCA.
- Indicators used
- Capital to Risk weighted Asset Ratio (CRAR)
- Tier-1 Capital Ratio
- Net Non-Performing Assets (NPA)
- When does it get triggered: When the above 3 Indicators breach the threshold target. (Example: If Net NPA Is greater than or equal to 6%)
What happens if a NBFC is placed under PCA framework?
- RBI can take certain mandatory and discretionary actions which can include
- Halting branch expansion
- Stopping dividend payment
- Undertake special audit, restructuring operations and activation of recovery plan.
- NBFCs' promoters can be asked to bring in new management.
- RBI can also supersede the NBFC's board.
Core Financial Services Solution (CFSS)
- According to RBI’s guidelines, NBFCs in the Upper layer and Middle Layer are required to mandatorily required to implement ‘Core Financial Services Solution (CFSS)’. The CFSS is akin to the Core Banking Solution (CBS) adopted by banks.
- The CFSS shall provide for seamless customer interface in digital offerings and transactions relating to products and services offered by NBFCs.