NBFC Regulations

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Evergreen Bonds – Release new bond to pay for old Bond.

Ex: January 2021 Company release Bond of 100 Cr for 2 years’ maturity period, Person A buy Bond & give 100 Cr. After 2 years January 2023 Company release new bond to get 100 Cr, Person B buy the bond & give 100 Cr. Company Money get from person B is Given to Person A. The process continues…

Reason for Regulation: Failure of ILFS Company, Franklin Templeton Mutual Fund Company & DHFL Company.

  • Recently, the Reserve Bank of India (RBI) has proposed discussion paper or suggestion for a tighter regulatory framework for Non-Banking Financial Companies (NBFCs) by creating a four-tier structure with a progressive increase in intensity of regulation.
  • It has also proposed classification of Non-Performing Assets (NPAs) of base layer NBFCs from 180 days to 90 days overdue.
  • Earlier in 2020 the RBI announced a host of measures to provide liquidity support to NBFCs.
  • The proposed framework is aimed at protecting financial stability while ensuring that smaller NBFCs continue to enjoy light regulations and grow with ease.
  • Proposed Classification of NBFC (The Four-Tier Structure): The regulatory and supervisory framework of NBFCs should be based on a four-layered structure:
Base Layer
(Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman
Ex: Person A having Money & Person B need Money, P2P company act as a market place (Middle Man) for Person A & Person B)
  • NBFCs in the lower layer will be known as NBFC-Base Layer (NBFC-BL).
  • For NBFCs in this layer least regulatory intervention is warranted.
Middle Layer
  • NBFCs in the middle layer will be known as NBFC-Middle Layer (NBFC-ML)
  • The regulatory regime for this layer will be stricter compared to the base layer.
  • Adverse regulatory arbitrage vis-à-vis banks can be addressed for NBFCs falling in this layer in order to reduce systemic risk spill-overs, where required. CAR – 15%; Tier 1 is 10%
Upper Layer
  • BFC in the Upper Layer will be known as NBFC-Upper Layer (NBFC-UL) and will invite a new regulatory superstructure.
  • This layer will be populated by NBFCs which have large potential of systemic spill-over of risks and have the ability to impact financial stability.
  • There is no parallel for this layer at present, as this will be a new layer for regulation. The regulatory framework for NBFCs falling in this layer will be bank-like, albeit with suitable and appropriate modifications.
  • If an identified NBFC-UL does not meet the criteria for classification for four consecutive years, it will move out of the enhanced regulatory framework.
Top Layer
  • Ideally this layer is supposed to be empty.
  • It is possible that supervisory judgment might push some NBFCs out of the upper layer of the systemically significant NBFCs for higher regulation/supervision.
  • These NBFCs will occupy the top of the upper layer as a distinct set. Ideally, this top layer of the pyramid will remain empty unless supervisors take a view on specific NBFCs.
  • If certain NBFCs lying in the upper layer are seen to pose extreme risks as per supervisory judgement, they can be put to higher and bespoke regulatory/supervisory requirements.

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