The non-banking financial sector in India is regulated by the Reserve Bank of India (RBI). The RBI had set up a working group under the chairmanship of Usha Thorat, to review the regulatory framework for non-banking financial companies (NBFCs). The working group submitted its report in August 2011, suggesting certain amendments to the regulatory framework governing NBFCs. The RBI released the new draft guidelines for NBFCs based on the Usha Thorat Committee report on 12 December 2012 and has sought public comments on them.
The draft guidelines seek to completely revamp the existing regulatory environment for NBFCs.
KEY HIGHLIGHTS OF THE DRAFT GUIDELINES
Guidelines on entry point norms, the principal business criteria, and multiple and captive NBFCs
Approach to regulation and nomenclature for various NBFCs
The RBI has proposed new classifications for NBFCs:
- Exempted NBFCs (ie exempted from registration with the RBI).
- Registered NBFCs (ie registered with the RBI and thereby regulated by it).
Exempted NBFCs
The following categories of NBFCs are proposed to be exempt from registration with the RBI:
- NBFCs with an asset size below INR 25 crore (250m) whether accepting public funds or not.
- Non-deposit taking NBFCs with an asset size below INR 500 crore (5bn) not accepting public funds (directly or indirectly).
The exempted NBFCs can surrender their certificate of registration on a voluntary basis and, other than the RBI’s powers of inspection, no other provisions of the Reserve Bank of India Act 1934 will apply to such exempted NBFCs.
However, at one point in the draft, the RBI has indicated that all NBFCs accepting deposits will continue to be registered with and regulated by the RBI.
Therefore, it remains to be seen whether in the final guidelines, deposit-accepting NBFCs with an asset size of less than INR 25 crore (250m) will be exempted from registration.
Principal business criteria
The RBI has expressed its concern over an NBFC undertaking significant non-financial activities, and stated that NBFCs should gradually move towards primarily undertaking financial activities. With this mandate, the RBI has prescribed the following revised principal business criteria for NBFCs:
- a company not accepting deposits will qualify for registration as an NBFC if and when its financial assets aggregate INR 25 crore (250m) and at least 75% and above of its total assets (net of tangible assets) are financial assets and the financial income constitutes at least 75% or above of its gross income subject to fulfilment of the entry point norms given below (financial assets will include all assets that are financial in nature except cash, bank deposits, advance payment of taxes and deferred tax payments); and
- a financial entity that has an asset size of at least INR 1000 crore (10bn) or above, holding financial assets that constitute 50% of the total assets or generate at least 50% of the gross income will require registration.
The draft guidelines do not indicate the principal business test for deposit-taking NBFCs with an asset size below INR 1000 crore (10bn) but it seems that such NBFCs will also need to meet the test in (1) above.
Entry point norms for new NBFCs
As is the case with existing NBFCs, new companies seeking to register with RBI as an NBFC will be required to have net owned funds of not less than INR 2 crore (20m) and an asset size of INR 25 crores (250m). Such companies must also fulfil the principal business criteria discussed above.
However, foreign-owned companies must be registered with the RBI before commencing any non-banking financial activity. They must also comply with existing minimum capitalisation norms prescribed under the Foreign Exchange Management Act 1999.
Multiple and captive NBFCs
The draft guidelines provide that multiple non-deposit taking NBFCs floated by the same group of companies with a common set of promoters will be regulated on a consolidated basis.
The draft guidelines also seek to regulate ‘captive NBFCs’, ie an NBFC floated by a particular industrial group which is captive to the requirements of such group (that is, facilitates the sale of the group’s products and services). The RBI has prescribed higher Tier I capital thresholds for captive NBFCs.
Guidelines for prudential regulations
Higher Tier 1 capital requirements and risk weights
The draft guidelines require NBFCs (including IFCs) to maintain Tier I capital at 10% as against the current requirement of 7.5%. The Tier I capital requirement for captive NBFCs and for NBFCs which are lending into or investing in sensitive sectors such as capital markets, commodities and real estate has been raised to 12% (to the extent of 75% or more of their total assets, net of intangible assets). The draft guidelines have prescribed higher risk weights for capital market exposures and commercial real exposures. NBFCs that form part of a bank group are now required to maintain the same risk weights as a bank for capital market exposures and commercial real exposures.
Asset classification and provisioning norms, and credit rating for NBFCs
One of the highly debated changes that has been proposed by the draft guidelines relates to asset classification and provisioning norms. The draft guidelines propose to make asset classification and provisioning norms on a par for banks and NBFCs (in a phased manner). Consequently, the period for classifying a loan as a non-performing asset (NPA) for an NBFC, will be reduced from the existing 180/360 day period to 120 days from 1 April 2014- 31 March 2015, and ultimately be reduced to 90 days, which is the standard for banks.
Further it is proposed that the provisioning for standard assets will be raised from 0.25% to 0.4% of the outstanding amount with effect from 31 March 2014 for all NBFCs.
Guidelines on corporate governance and disclosures for NBFCs
The draft guidelines propose to improve corporate governance controls and enhance disclosure standards applicable to NBFCs. All NBFCs will be required to institute a policy for setting out ‘fit and proper’ criteria for the appointment of directors in accordance with standards prescribed by the draft guidelines. More stringent standards for disclosures in financial statements have been prescribed.
Prior approval of the RBI in cases of change in control or transfer of shareholding of an NBFC
Other than acquisitions in the ordinary course of business by an underwriter, stockbroker etc, the draft guidelines now propose that all registered NBFCs will require prior approval of the RBI to effect a change in control and/or increase in shareholding to the extent of, or exceeding, 25% of its the paid-up equity capital.
Prior approval of the RBI for appointment of CEO and other matters
The draft guidelines require any NBFC with an asset size of INR 1000 crore (10bn) and above to seek prior approval from the RBI for the appointment of its CEO and also to comply with clause 49 of the Listing Agreement (irrespective of whether such NBFC is listed or not).
COMMENT
An important theme of the guidelines is to minimise the regulatory arbitrage that currently exists between banks and NBFCs. The enhanced corporate governance standards are a welcome step, given the growth of NBFCs and the importance they have assumed in the financial sector in India.
The key concerns for NBFCs raised by the draft guidelines primarily relate to:
- increased Tier I capital requirements;
- increased risk weights on certain types of exposures; and
- the progressively stringent criteria for asset classification and provisioning norms.
The capital adequacy ratio for NBFCs has been increased by almost 50% over the last four years (from 10% in 2009 to 15% by March 2013). The recommendation for the enhancement of Tier I capital requirements for NBFCs is largely perceived by the industry as an onerous condition that will trigger greater equity infusion requirements. Several NBFCs may be forced to shrink their business size in order to comply with the increased Tier I capital requirements.
The proposal to make asset classification standards for NBFCs on a par with those for banks has been met with severe criticism. Several NBFCs in India service the unorganised and informal sectors. Shortening the period for the classification of loan accounts as NPAs may place undue pressure on debtors from such sectors and lead to the classification of loans accounts as NPAs even when there is no genuine apprehension of default. Further, unlike banks, NBFCs do not have the benefit of taking recourse to the provisions of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, which empowers banks to expedite the recovery of their NPAs without the intervention of courts.