Discussion Paper on Revised Regulatory Framework for NBFCs: A Scale Based Approach

The Non-Banking Finance Company space has attracted the Reserve Bank of India's (RBI) gaze, again, of late with the regulator releasing a statement and a discussion paper at different times in the space of the last 60 days.

On December 4 2020, the RBI in a statement1 on developmental and regulatory policies, set out the need for regulation and supervision over NBFC (Non-Banking Financial Companies).

A Discussion Paper2 on the same was published on January 22, 2021 inviting responses and suggestions by February 22, 2021.

NBFCs are regulated in India on the principle of proportionality: calibrated regulatory measures that are commensurate with the scale of its operation and with the perception of risk that the entity poses to the financial system. This calibrated approach is aimed at allowing NBFCs adequate operational flexibility.

This approach will lead to judicious use of regulatory and supervisory resources as entities posing systemic risks would be regulated and supervised more closely as compared to others.

Over the years, the NBFC sector has undergone a significant evolution. The higher risk appetite of NBFCs has contributed to their size, complexity and interconnectedness making some of the entities systemically significant, posing potential threat to financial stability. Hence, under the current circumstances, the regulatory framework of NBFC needs to be reoriented to be updated with the current financial realities.

Hence the RBI's recent concern to review its regulations.

The Discussion Paper of 21 January proposes splitting up of NBFCs in 4 (four) categories as follows:

  1. The bottom of the pyramid, where least regulatory intervention is warranted, can consist of NBFCs, currently classified as non-systemically important NBFCs (Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company) NBFCP2P (Non-Banking Financial Company – Peer to Peer Lending Platform), NBFCAA (Non-Banking Financial Company – Account Aggregator), NOFHC (Non-Operative Financial Holding Company) and Type I NBFCs.
  2. The next layer proposed shall consist of NBFCs currently classified as systemically important NBFCs (Non-Banking Financial Company – Systematically Important Non-Deposit taking Company (NBFC-ND-SI), deposit taking NBFCs (NBFC-D), HFCs (Housing Finance Company), IFCs (Infrastructure Finance Company), IDFs (Infrastructure Debt Fund), SPDs (Standalone Primary Dealer) and CICs (Core Investment Company). The regulatory regime for this layer shall be stricter compared to the base layer.
  3. The next layer is proposed to consist of NBFCs which are identified as systemically significant among NBFCs (The parametric matrix for identifying such NBFCs will be based on Quantitative parameters & Qualitative Parameters as discussed in the table below). The regulatory framework for this category of NBFCs shall be similar to those of banks, with suitable modifications.
  4. The top layer of the pyramid will remain empty unless supervisors take a view on specific NBFCs. In other words, if certain NBFCs lying in the upper layer are seen to pose extreme risks as per supervisory judgement, they can be put to significantly higher and bespoke regulatory/ supervisory requirements.

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