RBI's New NBFC Norms To Make Way For Less Arbitrage, More Supervision
The Reserve Bank of India's latest guidelines on scale-based regulation for non-bank finance companies will allow for the larger non-bank lenders to be treated on a par with banks, while also increasing supervision and compliance for smaller lenders.
The guidelines call for creation of four layers — base layer, middle layer, upper layer and top layer. NBFCs will be placed in each of these layers on the basis of their size, business models and interconnectedness with the broader financial system.
The level of supervision and regulatory minimum rises with each layer. While the top layer is expected to remain empty for now, the RBI can identify certain non-bank lenders which can be put there, depending on the risk they pose to the broader financial system.
According to NS Vishwanathan, former RBI deputy governor, regulation in the NBFC sector has always been driven by three principles — depositor protection, systemic protection and consumer or borrower protection.
Now, there is further stratification of the larger NBFCs which enables RBI to focus the more rigorous regulations on fewer NBFCs that need greater attention from a systemic risk perspective.NS Vishwanathan, Former Deputy Governor, RBI
Biggest 50 NBFCs Under A Microscope
The upper layer, and the most tightly regulated one, will include large NBFCs, according to the RBI.
According to the guidelines, the top 10 NBFCs by asset size will automatically qualify to be included in the upper layer, irrespective of any other factor. Apart from these, top 50 NBFCs will be assessed on the following criteria to qualify for the upper layer.
On and off-balance sheet exposures
Interconnectedness with the system
Complexity of the institution
Nature of liabilities
Penetration in respective business segments
While the RBI is yet to release a list of the NBFCs in the upper layer, four analysts who declined to be named, estimate that most listed and large unlisted lenders below could be under consideration for inclusion in the upper layer.
While these lenders will need to hold more regulatory capital and may eventually see caps on leverage, analysts don't see the burden as onerous.
In a report on Monday, analysts at JM Financial said that the exclusion of any additional cash reserve ratio or statutory liquidity ratio requirements for the NBFC sector was a "big relief".
According to Karthik Srinivasan, group head-financial sector ratings at ICRA Ltd, most large NBFCs already follow prudential norms identical to banks. ICRA does not estimate any additional capital requirements for the segment as a consequence of the new regulations.
"We should see the arbitrage between larger NBFCs and banks coming down, since the RBI will be taking a stricter view on supervision for them," he said. "However, some of the specifics on the nature of increased scrutiny for the upper layer of NBFCs need more clarity."
Increased Scrutiny For A Large Number Of Smaller Lenders
While the regulator has proposed stricter supervision for the large NBFCs, it is still not clear what it will do differently for smaller lenders.
The number of NBFCs in the lower two layers will run into thousands. As of May 2021, there were 9,346 NBFCs registered with the RBI. Of this, 9,118 are non-deposit taking, non-systemically important NBFCs. Their contribution to the NBFC sector's Rs 54 lakh crore outstanding exposures will be less than 10%, according to back-of-the-envelope estimates by analysts BloombergQuint spoke to.
Former deputy governor Vishwanathan said that the regulation and supervision of smaller NBFCs will not see any easing. Owing to the size of these companies, any idiosyncratic issues are unlikely to pose a systemic risk, he said.
"The RBI has also introduced the Ombudsman scheme for NBFCs to adequately take care of the customer grievances, which will be the major regulatory concern in this segment,” Vishwanathan said.
To better regulate this segment, RBI will need to grow its supervisory bench strength, said Saurabh Tripathi, managing director and senior partner at Boston Consulting Group.
Presently, the RBI does review financials of smaller NBFCs, but owing to the large numbers, this is not as frequent as in the case of the larger ones. The RBI may need to focus more on data analytics for better supervision of this segment, so it does not become too manpower intensive.Saurabh Tripathi, Senior Partner, BCG
A way to approach this problem would be to have an automated system which throws up any concerning changes in financial strength of the NBFCs. This would be similar to how banks monitor large volumes of transactions each day for any money laundering, Tripathi said.
Raman Agarwal, independent director, Finance Industry Development Council, however, pointed out that the requirement to move to a 90-day bad loan recognition cycle will pinch smaller NBFCs. The guidelines mandate that all NBFCs will adopt a 90-day recognition cycle by March 2026, compared with the 180-day cycle effective now.
"NBFCs are allowed only a 5% tax write-back against provisions and their recovery powers under SARFAESI Act are also constrained," Agarwal said. "While it is not the ambit of the RBI to fix these issues, it is a part of the same government implementing the norms. Changes have to be holistic, otherwise harmonisation of regulation may seem unfair."
Some of these changes will mean that smaller NBFCs may have to face higher compliance cost due to the new guidelines, Srinivasan said.
The RBI's new rules are silent on some issues, while opening up certain windows of arbitrage.
One such issue is the leverage ratio. While the guidelines said that a suitable ceiling for leverage will be prescribed for upper layer NBFCs, it has not specified what this ceiling will be.
If the regulator were to announce a 10x leverage ratio for large NBFCs, it may pose temporary compliance problems for housing finance companies, since they would not have the required common equity Tier-1 capital ratio of 9%, said one of the analysts quoted above, while speaking on condition of anonymity. An even lower leverage ratio would further complicate the matter, he said.
The RBI has also opened a window of arbitrage between government-owned NBFCs and others. The rules specifically state that government-owned NBFCs will be excluded from the upper layer, despite their size.
A person aware of the RBI's thought process said that ideally norms governing any financial sector entity should be ownership neutral. With the exclusion of government-owned NBFCs from the upper layer, there could be some regulatory arbitrage these entities would enjoy.
"It is not clear why the RBI did not include government NBFCs in the upper layer, since they are also sizeable financial sector entities," said Srinivasan.