Context: Recently, the Reserve Bank of India (RBI) has proposed a four-layered structure for regulating non-banking finance companies (NBFCs). 

  • It is aimed at tighter capital, lending and governance norms.
  • The new norms aim to prevent defaults such as those at Infrastructure Leasing & Financial Services (IL&FS) and Dewan Housing Finance Corp. Ltd (DHFL). 
  • The regulatory framework for NBFCs is formulated on a scale-based approach.
  • The regulator has sought feedback on the proposals before finalising norms.

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances etc.

What is the difference between banks & NBFCs?

NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:

i. NBFC cannot accept demand deposits;

ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;

iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

About the proposed framework: The regulatory and supervisory framework of NBFCs will be based on a four-layered structure:

  • NBFC-BL: NBFCs in the lower layer will be known as NBFC-Base Layer (NBFC-BL). 
    • Least regulatory intervention is warranted, can consist of NBFCs currently classified as non-systemically important NBFCs.
  • NBFC-ML: NBFCs in the middle layer will be known as NBFC-Middle Layer (NBFC-ML). It may comprise NBFCs currently classified as systemically important NBFCs (NBFC-ND-SI), deposit-taking NBFCs (NBFC-D), HFCs, IFCs, IDFs, SPDs and CICs.
  • NBFC-UL: NBFC in the Upper Layer will be known as NBFC-Upper Layer (NBFC-UL) and will invite a new regulatory superstructure. 
    • NBFCs in this Layer will be subject to higher capital charge, including Capital Conservation Buffers.
    • Not more than 25-30 large non-bank lenders will be constituents of the upper levels of the pyramid.
    • Those in the upper tier could include Housing Development Finance Corp. (HDFC), Bajaj Finance, Shriram Capital, Tata Capital and Mahindra & Mahindra Financial Services.
  • NBFC in Top Layer which is ideally supposed to be empty. 
    • This layer will be populated by NBFCs having a large potential of systemic spill-over of risks and the ability to impact financial stability.

Other proposed changes:

  • The threshold for systemic importance, is proposed to be revised to ₹1,000 crore from ₹500 crore now.
    • Currently, NBFCs whose asset size is of ₹ 500 cr or more as per last audited balance sheet are considered as systemically important NBFCs
    • The rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability of the overall economy.
  • The NPA classification norm of 180 days will be reduced to 90 days. 
  • NBFC entry norms are proposed to be tightened with the minimum net owned funds requirement to increase 10-fold from Rs 2 crore to Rs 20 crore. 
  • Importantly, the regulator has also proposed mandatory listing requirements for NBFCs in the upper layer on the lines of private banks. 
  • The regulatory framework for NBFCs needs to be reoriented to keep pace with changing realities in the financial sector.