ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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A Cautionary Approach

Bank-like Regulations for Non-banking Financial Companies

The purpose of this article is to address some of the lacunae in the scale-based framework proposed by the Reserve Bank of India in a discussion paper on non-banking financial companies that have turned a blind eye to the growth aspect and recognising only the stability by minimising the possibility of systemic risk. In this context, the introduction of pyramid-based structure of NBFCs is found to be lacking a common parameter for classification of companies in different layers. Further, the revision of threshold asset size limit for identifying systemically important non-deposit taking NBFCs from `500 crore to `1,000 crore is found be undervalued, which will result into making the smaller asset sized NBFCs subject to stricter prudential norms.

 

The Reserve Bank of India (RBI), on 22 January 2021, published a discussion paper on revised regulatory framework for non-banking fin­an­cial companies (NBFCs) in which the central bank has proposed to replace the extant regulatory framework with a new set of regulations. The existing set of regulations impart sizeable operational flexibility to the NBFC sector as they are laxing in nature and provide enough space to NBFCs to augment their business. The inc­reasing business activities of the NBFC sector are evident from the loans and advances disbursed by them, which has exhibited a rise from `11,86,400 crore at end-March 2015 to `23,60,504 crore at end-March 2020. This has simultaneously raised the interconnectedness of the NBFCs with the rest of the financial sector as is reflected from the spike in bank borrowings from `3,10,600 crore at end-March 2015 to `7,08,035 crore at end-March 2020. This, to some extent, has triggered the systemic risk in the financial sector of the country, which got revealed with the failure of the Infrastructure Leasing and Financial Services (IL&FS) in September 2018. Keeping in view this fact, the RBI has proposed a scale-based approach for regulating the NBFCs in its discussion paper. As per scale-based approach of the regulatory framework, NBFCs will be subject to stricter prudential norms, which will grow proportionately as their scale of operations, interconnectedness with the financial system and risk perception experiences rise.

For this purpose, the RBI has proposed a four-layered pyramid structure for the NBFC sector which will be composed of base layer, middle layer (ML), upper layer and top layer, in which the base layer will be subject to lighter regulations and as one moves up the pyramid, the prudential norms get stringent. However, there are certain issues that must be addressed. The segmentation of pyramid structure proposed by the RBI in its discussion paper lacks common criteria. For the base layer the RBI has put up `1,000 crore as threshold and a few categories of NBFCs named type I NBFCs, peer to peer lending platform (P2P), non-­operative financial holding company (NOFHC) and account aggregator will be included in this layer irrespective of their asset size. For the middle layer, it is proposed that all systemically important non-deposit taking NBFCs (NBFC–ND–SI), deposit taking NBFCs (NBFC–D), core investment companies (CICs), infrastructure finance companies (IFCs), stand­alone primary dealers (SPDs), infrastructure debt funds (IDFs) and housing finance companies (HFCs) will populate this layer. Hence for the base layer, there is a threshold asset size limit and activity-based segmentation while for the middle layer the RBI has proposed an activity-based segmentation. For the upper layer, a filtration process on the basis of size and scale of significance is proposed to identify the systemically significant NBFCs. The top layer will be empty for the time being and will include those NBFCs from the upper layer, which will be expected to experience a heightened systemic risk and its possible spillover in the financial system. For each layer there are different criteria for the inclusion of companies. Hence, there is an absence of a common parameter on which the pyramid can be segmented and can impart uniformity on the basis of classification of different layers.

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Updated On : 16th Feb, 2022
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