The Reserve Bank of India (RBI) intends to implement a four-layered regulatory and supervisory framework for non-banking financial companies (NBFCs) as it moves toward scale-based regulation in the wake of recent market turmoil. The framework suggests that the top 25 to 30 NBFCs in the country be subjected to bank-like regulations.

What is an NBFC?

NBFCs are organizations registered under the Companies Act, 2013 that provide banking and financial services supervised by the Reserve Bank of India (RBI) under the Reserve Bank of India Act, 1934 "Chapter III-B" and the Reserve Bank of India's directions. We shall look at the regulations that regulate NBFCs in India in this blog.

To conduct financial services in India, NBFCs must obtain a license from the RBI. Non-banking financial services perform a variety of functions, including receiving deposits, providing credit at a reasonable interest rate, and directing squandered financial resources toward wealth creation.

Non-banking financial companies are of various types. Non-deposit taking NBFCs are classified:

by the type of liabilities they accept (Deposit and Non-Deposit Accepting NBFCs),
by their size (Systemically Important and Other Non-Deposit Holding Companies (NBFC-NDSI and NBFC-ND).
By the type of activities they engage in (NBFC-NDSI and NBFC-ND).

NBFCs vs. Banks:

Top NBFCs in India provide comparable functions to banks. There are, however, some distinctions between the two. NBFCs, for example, cannot accept demand deposits, unlike banks. NBFCs aren't part of the payment and settlement system, so they can't write checks drawn on themselves. The Deposit Insurance and Credit Guarantee Corporation's deposit insurance provision is not available to NBFC vs bank depositors.

Regulations governing NBFCs in India:

While NBFCs have been providing a variety of financial services to the underserved, flaws in their systems have also been discovered. Currently, all non-banking financial companies (NBFCs) are expected to operate under the Reserve Bank of India's auspices. Following the introduction of the RBI (Amendment) Act, 1997 all NFBCs with net owned funds of Rs. 2 crore or more are required to get statutory authorization from the RBI. The National Housing Bank regulates housing finance enterprises in India.

Read Our Blog: RBI proposes regulatory changes for NBFCs. Here's all you need to know.

RBI said in a discussion paper titled "Revised Regulatory Framework for NBFCs — a Scale-Based Approach" that its proposed framework could be visualized as a pyramid, with NBFCs organized into four layers: Base Layer (BL), Middle Layer (ML), Upper Layer (UL), and a hypothetical Top Layer (TL). In BL, NBFCs will see the least amount of regulatory interference. The regulatory framework will become more stringent as one progresses up the pyramid.

According to the terms of the Companies Act 1956, there are many compliances such as Share Capital, Board of Directors, Meetings, Audits, the publication of books of accounts, management structure, bookkeeping, share capital, and other general conduct that the NBFCs need to comply with.

Along with the aforementioned mandates, they must also comply with the RBI's special requirements, which are communicated through directives and other notifications, as well as changes by the RBI.

Aim of the recent framework:

The proposed framework aims to maintain financial stability while allowing smaller NBFCs to continue to operate in an unrestricted environment.

Proposed NBFC Classification (Four-Tier Structure):

NBFCs' regulatory and supervisory framework should be built on a four-layer structure:

Base Layer:

The lower layer of NBFCs will be referred to as the NBFC-Base Layer (NBFC-BL).
The least amount of regulatory action is required for NBFCs in this layer.

Middle Layer:

The middle layer of NBFCs will be referred to as NBFC-Middle Layer (NBFC-ML).
In comparison to the foundation layer, the regulatory regime for this layer will be more stringent.
For NBFCs at this layer, adverse regulatory arbitrage with banks can be addressed in order to prevent systemic risk spillovers, if necessary.

Upper Layer:

NBFC in the Upper Layer will be referred to as NBFC-Upper Layer (NBFC-UL), and it will be subjected to a new regulatory framework.

This layer will be occupied by NBFCs that have a high potential for systemic risk spillover and can affect financial stability.
As this will be a new layer for regulation, there are currently no parallels for this layer. The regulatory structure for NBFCs at this layer will be similar to that of banks, but with relevant adjustments.
If a recognized NBFC-UL fails to meet the categorization criteria for four years in a row, it will be removed from the enhanced regulatory framework.

Top layer:

This layer should ideally be empty.
It's probable that supervisory judgement will push certain NBFCs out of the systemically significant NBFCs' upper layer, requiring more regulation and supervision.
As a discrete collection, these NBFCs will occupy the top of the upper layer. Unless supervisors take a position on individual NBFCs, this top layer of the pyramid should ideally remain unfilled.
If particular NBFCs in the upper layer are deemed to represent excessive risks by supervisors, they may be subjected to more stringent regulatory and supervisory requirements.

The following are the applicable rules that govern NBFCs in India:

Companies interested in becoming a registered NBFC in India must have a minimum net worth fund (NOF) of two crores.
NBFCs should keep a minimum of 15% of their deposits in liquid assets.
Deposits that are repayable on demand are not permitted by NBFCs.
They are not authorized to set interest rates higher than the Reserve Bank of India's ceiling rate.
It is not permitted to provide depositors gifts or additional perks.
The Reserve Bank of India will not guarantee that the NBFC's deposits will be repaid.
They must establish a fund reservoir and transfer at least 20% of their net deposit.
The RBI regulates their operations in areas such as disclosures, loans, prudential standards, investments, and so on.
Depositors of NBFCs are entitled to use the nomination service.
NBFCs, particularly unincorporated ones, are not permitted to receive public deposits.
The company should be able to accept public deposits for a minimum of 12 months and a maximum of 60 months.
A minimum capital adequacy requirement of 8% must be met by NBFCs.
Credit rating firms are required to provide NBFCs a minimum credit rating.
To handle short-term liabilities, NBFCs are required to maintain a specific level of liquidity buffers tied to liquid assets. This will enable them to deal with the liquidity problem with the utmost ease.
According to the RBI Act, 1934, the Reserve Bank of India has the authority to register, issue directions, lay down policy, examine, and scrutinize NBFCs.
The Reserve Bank of India has the right to sanction NBFCs who violate the RBI Act or the RBI's orders issued under the RBI Act.
The RBI may revoke the NBFC's Certificate of Registration as a result of the penalty.
It is illegal to conduct business without the Reserve Bank of India's permission. Failure to comply with this rule could put the involved entities' existence in jeopardy, since RBI can force them to face severe penalties.
According to the last audited balance statement, every NBFC with an asset value of Rs. 50 crore or more is eligible to form an audit committee. At least three members of the BOD must be on the committee.
Companies with a Public Deposit of Rs. 20 Crore or assets of Rs. 100 Crore or more are required to file a half-yearly Asset Liability Management (ALM) return.
On the 31st of March of each year, all NBFCs are required to prepare a balance sheet and a profit and loss statement.
Every NBFC's board of directors, in order to grant call loans, must first establish a policy for doing so.
NBFCs must file Suspicious Transaction Reports (STRs) if they have sufficient cause to believe that a particular transaction is connected to criminal activities, regardless of the amount involved.

Liquidity Coverage Ratio (LCR):

The LCR, or Liquidity Coverage Ratio, is the percentage of liquid assets held by NBFCs to cover short-term liabilities. The Liquidity Coverage Ratio, which took effect in December 2020, has also been set by the RBI for both non-deposit-taking and deposit-taking NBFCs. The following are the conditions:

If the asset size of non-deposit-taking NBFCs falls between the range of Rs 5,000 crore to Rs 10,000 crore, they must keep 30 percent of their liquid assets as LCR.
To overcome the liquidity problem, the RBI requires deposit-taking NBFCs to retain a specific level of liquidity as a buffer asset.

What is the Procedure to incorporate an NBFC?

Incorporating an NBFC is a simple process.

A corporation must first register under the Companies Act, 2013 or be established as a Private Limited or Public Limited Company under the Companies Act, 1956.
The company's net owned funds should be at least Rs. 2 crores.
Finance experience is required for 1/3 of the Board of Directors.
The company's CIBIL records should be spotless.
A five-year business plan is required for the company.
FEMA and capital compliance criteria must be met by the company.
After all of the above requirements have been met, fill out the online application on the RBI website and submit it together with the required documentation.
There will be a CARN Number produced.
A paper copy of the application must also be delivered to the Reserve Bank of India's regional branch.
The License will be awarded to the Company when the application has been thoroughly evaluated.
There will be a CARN Number generated.
A paper copy of the application must also be delivered to the Reserve Bank of India's regional branch.
The License will be awarded to the Company when the application has been thoroughly evaluated.

Conclusion:

To summarize, NBFCs play an important role in developing the country's economic infrastructure. Because NBFCs are required to comply with RBI regulations, they are not permitted to perform services that are beyond the scope of their bylaws. When such restrictions make it impossible for an NBFC to function freely, governing authorities will occasionally change the applicable rules to strike the correct balance between ease of doing business and the risks associated.

As the economy grows, so will the demand for financial lending, and NBFCs have the capacity to propel the Indian economy forward.

Profitability is something that every company enterprise strives for, but this is not the case with NBFCs.

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This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not corpseed, and have not been evaluated by corpseed for accuracy, completeness, or changes in the law.