Regulating NBFCs : RBI Recommendations – UPSC GS3

Reserve Bank of India (RBI) has proposed a tighter regulatory framework for non-banking financial companies (NBFCs) by creating a four-tier structure. The intensity of regulations will be greatest at the top layer and lowest at the base layer.
Objective: It is to keep the big NBFCs in good financial health. It has become
important after the failure of extremely large NBFC like IL&FS.
Four Tier Structure:
  • Base layer: 
    • This layer will include the large number of small NBFCs in the country and will subject to the least regulation.
    • It is because they have a limited impact on systemic stability.
    • The proposals for this set of NBFCs include:
      • Entry-level net owned funds required to be raised to Rs 20 crore from Rs 2 crore.
      • NPA classification norm of 180 days will be harmonized to 90 days.
      • Disclosure requirements will be widened by including disclosures on types of exposure, related party transactions, customer complaints.
  • Middle Layer: 
    • It will consist of NBFCs that currently fall in the ‘systemically important’ category along with deposit-taking non-bank lenders.
    • Housing Finance Companies, Infrastructure Finance Companies, Infrastructure Debt Funds, Core Investment Companies.
    • The proposals for this set of NBFCs include:
      • It will be subjected to tighter corporate governance norms.
      • No changes proposed in the capital-to-risk-assets ratio (CRAR) of 15% with a minimum Tier-I ratio of 10%.
      • These NBFCs cannot provide loans to companies for buy-back of securities.
      • NBFCs with 10 or more branches will be required to adopt core banking solutions.
  • Upper Layer: 
    • It will include about 25-30 NBFCs and will be subjected to bank-like regulation.
    • It will have to implement differential standard asset provisioning and also the large exposure framework as applicable to banks.
    • The concept of Core Equity Tier-1 will be introduced for this category and is proposed to be set at 9%.
    • They will also be subject to a mandatory listing requirement.
  • Top Layer: This layer will be empty for now and will be populated with NBFCs, where the RBI may see an elevated systemic risk.
What was the need for a change in the regulatory framework?
  • The size of NBFC has increased from just about 12% of banks in 2010, to a quarter of the banking sector.
  • The growth has been facilitated by the lighter regulations on sourcing funds from home loans to micro-finance and large infrastructure projects.
  • However, These lighter regulations revealed a systematic risk. For instance, IL&FS’s payment defaults resulted in a large scale economic crisis in 2018.
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