RBI’s New and Stricter Approach to Regulate NBFCs
Regulating Non-Banking Financial Sector (NBFC) has always been at the top in the Reserve Bank of India’s (RBI) checklist as this sector has evolved manifold times in the recent years. As per RBI, NBFC’s are now more than a quarter of the size of banks and therefore, they act as a spare tyre to the Indian economy. However, weak regulatory framework can turn this sector into a catastrophe for the economy, and thus, RBI in its latest discussion paper dated 22.01.2021 titled Revised regulatory framework for nbfc’s- A scale-based approach”[1]https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DP220121630D1F9A2A51415B98D92B8CF4A54185.PDF has come out with a strong and tougher regulatory framework to govern theses institution. In its discussion paper, RBI has proposed a four-tier pyramid structure having progressive level of regulation based on the principle of proportionality. The principle as mentioned explicates that the degree of regulation of a financial entity should be proportionate with the perception of risk the entity poses to the financial system and the scale of its operation.
This concept of proportionality-based regulation will ensure that those entities which are generating higher systemic risk will be governed by stricter regulations as compared to those entities which are not a potent threat. The important factors that will decide the tier for an entity are firstly, comprehensive risk perception which will consist of different parameters like size, leverage, interconnectedness, complexity, etc. and once the entity crosses such threshold, it will be subject to proportionately higher regulation. Secondly, the size of operation of an institution will be an essential factor wherein an entity whose balance sheet crosses a particular mark, such entity would be regulated at a higher pedestal. The third and one of the critical factors in analysing the proportionality is the nature of activity that an institution performs. It means that those entities whose business model involves a certain level of systemic risk, they would fall under a category where regulations would be tighter.
As per the discussion paper, RBI has proposed pyramid like structure with four different layers according to scale-based framework. The four layers are as follows-
- Base Layer (NBFC-BL)
This layer is at the bottom of the pyramid indicating those institutions which require least regulatory intervention. As per RBI’s discussion paper, this layer can consist of those NBFCs which are currently classified as Non-systemically Important Non-deposit Taking NBFCs (NBFC-ND), NBFC Peer-to-Peer lending platforms (NBFC P2P), NBFC Account Aggregator (NBFC-AA), Non-Operative Financial Holding Company (NOFHC) and Type I NBFCs. Approximately 9209 NBFCs of an asset size upto Rs. 1000 Crore will be placed in this layer.
- Middle Layer (NBFC-ML)
This layer is just above the Base layer and accordingly the NBFCs in this layer will have stricter regulatory regime compared to the base layer. This layer consists of those NBFCs which are currently classified as Systemically Important Non-Deposit taking Company NBFCs (NBFC-ND-SI), Deposit Taking NBFCs (NBFC-D), Housing Finance Companies (NBFC-HFC), Infrastructure Finance Companies (NBFC-IFC), Infrastructure Debt-Fund (NBFC-IDF), Standalone Primary Dealers (SPD) and Core Investment Companies (CIC). Mostly, the regulatory structure will be broadly similar to the framework which is currently applicable to NBFC-ND-SI and NBFC-D.
- Upper Layer (NBFC-UL)
The third layer of NBFCs will be governed more or less like banks with suitable modifications in the regulations. In this layer, those NBFCs will be placed which are identified as systemically significant among all NBFCs. It certainly means that those NBFCs which have large potential of systemic spill-over of risks and have the ability to impact financial stability as compared to other NBFCs will occupy Upper Layer. A range of parameters including substitutability, complexity, nature of activity, etc. will be used in identifying those small set of NBFCs which possess systemic risk of spill-over and are in need of tighter regulations. It is expected that not more than 25-30 NBFCs will be placed in this layer.
- Top Layer
This top layer is scheduled to be kept empty unless a view is taken that some NBFCs out of the upper layer consisting of the systemically significant NBFCs require higher regulation and supervision than others present in this layer. Therefore, only those NBFCs will be positioned in this layer which as per the discretion of the supervisor poses extreme risks and requires significantly higher level of regulations.
Through the proposed regulatory framework, RBI is of the view that such sectoral classifications of NBFCs can result in minimizing the systemic risk keeping in mind the flexibility these institutions enjoy as compared to the banks. The problem of arbitrage induced due to less rigorous regulation would be solved as the proposed framework identifies the NBFC on different parameters and then proposes the kind of regulation that a particular NBFC is required to be governed with, thereby making the room available for threat elimination and maintaining financial stability.
References
| ↑1 | https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DP220121630D1F9A2A51415B98D92B8CF4A54185.PDF |
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He holds a Bachelor’s and Master’s Degree in Corporate Secretaryship and a Degree in Law. He is a Fellow member of the Institute of Company Secretaries of India and an Associate Member of the Corporate Governance Institute, UK and Ireland. He has also completed a program from ISB on ‘Value Creation through Mergers and Acquisitions.
Mr P Muthusamy is an Indian Revenue Service (IRS) officer with an outstanding career of 30+ years of experience and expertise in all niche areas of Indirect Taxes covering a wide spectrum including GST, Customs, GATT Valuation, Central Excise and Foreign Trade.
During his judicial role, he heard and decided a large number of cases, including some of the most sensitive, complicated, and high-stake matters on insolvency and bankruptcy, including many cases on resolution plans, shareholder disputes and Schemes of Amalgamation, De-mergers, restructuring etc.,
Ms. Sarah Abraham has been enrolled with the Bar Council of Tamil Nadu since 1998. Her areas of practice include Shareholder Disputes, Corporate Compliances, Mergers and Acquisitions, Private Equity/ Venture Capital Agreements and allied disputes, Information Technology Contracts, Intellectual Property, General Commercial Agreements, Litigation, Arbitration and Mediation.
A K Mylsamy is the Founder, Managing Partner and the anchor of the firm. He holds a Degree in law and a Degree in Literature. He is enrolled with the Bar Council of Tamil Nadu.
M Subathra holds a Degree in law and a Master’s Degree in International Business Law from the University of Manchester, United Kingdom. She is enrolled with the Bar Council of Tamil Nadu.
Mr. K Rajendran is a former Indian Revenue Service (IRS) officer with a distinguished service of 35 years in the Indirect Taxation Department with rich experience and expertise in the fields of Customs, Central Excise, Service Tax and GST. He possesses Master’s Degree in English literature. Prior to joining the Department, he served for the All India Radio, Coimbatore for a period of about 4 years.
An MBA from the Indian Institute of Management, Calcutta, and an M.Sc. in Tourism Management from the Scottish Hotel School, UK, Ashok Anantram was one fo the earliest IIM graduates to enter the Indian hospitality industry. He joined India Tourism Development Corporation (ITDC) in 1970 and after a brief stint proceeded to the UK on a scholarship. On his return to India, he joined ITC Hotels Limited in 1975. Over the 30 years in this Organisation, he held senior leadership positions in Sales & Marketing and was its Vice President – Sales & Marketing. He was closely involved in decision making at the corporate level and saw the chain grow from a single hotel in 1975 to a very large multi-brand professional hospitality group.
Mani holds a Bachelor Degree in Science and P.G. Diploma in Journalism and Public Relations. He has a rich and varied experience of over 4 decades in Banking, Finance, Hospitality and freelance Journalism. He began his career with Andhra Bank and had the benefit of several training programs in Banking.
Mr. Kailash Chandra Kala joined the Department of Revenue, Ministry of Finance as ‘Customs Appraiser’ at Mumbai in the year 1993.
S Ramanujam, is a Chartered Accountant with over 40 years of experience and specialization in areas of Corporate Tax, Mergers or Demergers, Restructuring and Acquisitions. He worked as the Executive Vice-President, Group Taxation of the UB Group, Bangalore.
K K Balu holds a degree in B.A and B.L and is a Corporate Lawyer having over 50 years of Legal, Teaching and Judicial experience.
Justice M. Jaichandren hails from an illustrious family of lawyers, academics and politicians. Justice Jaichandren majored in criminology and then qualified as a lawyer by securing a gold medal. He successfully practiced in the Madras High Court and appeared in several civil, criminal, consumer, labour, administrative and debt recovery tribunals. He held office as an Advocate for the Government (Writs Side) in Chennai and was on the panel of several government organizations as senior counsel. His true passion lay in practicing Constitutional laws with focus on writs in the Madras High Court. He was appointed Judge, High Court of Madras in December 2005 and retired in February 2017.
S Balasubramanian is a Commerce and Law Graduate. He is a member of the Delhi Bar Council, an associate Member of the Institute of Chartered Accountants of India, the Institute of Company Secretaries of India and Management Accountants of India.