RBI releases revised draft guidelines for NBFC sector

The Reserve Bank of India (RBI) today issued draft guidelines to address issues and concerns of non-banking finance companies (NBFCs). The new draft guidelines are based on recommendations of the working group headed by former RBI deputy governor Usha Thorat.

The working group, constituted to review the existing regulatory arbitrage and systemic risks of non-banking finance companies (NBFCs), so as to create a strong and resilient non-banking financial sector, submitted its report in August 2011.

The draft revised guidelines relate to entry point norms, principal business criteria, prudential regulations, liquidity requirements for NBFCs and corporate governance.

While accepting some of the suggestions, RBI said in order to ensure that their implementation does not disrupt the sector, ample transition time has been proposed to bring the new regulatory framework into existence.

In order to focus regulatory resources to where the risks lie, it has been decided to classify NBFCs under two categories - exempted NBFCs and registered NBFCs.

However, all registered NBFCs would be under RBI regulation. RBI also reserves the right to bring exempted NBFCs under regulation, should the need arise thereof at a later date.

All deposit taking companies, irrespective of size, would continue to be registered NBFCs with RBI and as such would fall under the purview of RBI regulations. In other words, no deposit taking company is exempt from registration and thereby RBI regulation.

Registered NBFCs are those which have been registered and issued a certificate of registration (CoR) by RBI and are under the purview of RBI regulation.

Exempted NBFCs are those which are exempted from registration by RBI. The following categories of NBFCs are exempted from registration with the RBI:

• NBFCs with asset size below Rs25 crore whether accepting public funds or not;
  
• NBFCs with asset size below Rs500 crore and not accepting public funds, directly or indirectly;

The provisions of Chapter IIIB of the RBI Act 1934, except section 45N, will not apply in respect of the above exempted category of NBFCs. These NBFCs will have the option of surrendering the CoR on a voluntary basis.

The rationale for exemption is that as the above are essentially small non-deposit taking NBFCs and do not contribute to any major systemic risks or major disruptions in the market. Such a measure would not prevent small but potentially dynamic and innovative start-up companies from entering into the financial activity, RBI said.

Existing NBFCs-ND with asset size below the threshold of Rs25 crore but which intend to continue to be registered are required to notify RBI within three months from the date of these directions, with a road map for increasing their asset size to Rs25 crore or above within a period not exceeding 2 years.

Notwithstanding the fact that any such company has obtained a CoR under Section 45IA of the RBI Act 1934, it is required to apply for a fresh CoR within a period of 6 months from the date of achieving the asset size threshold.

Further, NBFCs-ND which de-register would need to approach the RBI afresh for CoR if: individually the asset size exceeds Rs25 crore or the asset size exceeds Rs500 crore, even if such NBFC does not access public funds.

In addition, financial entities will also need to register themselves with the RBI as NBFCs.

No NBFC should commence or carry on the business of NBFI without having net owned funds (NOF) of Rs25 lakh or such other amount not exceeding Rs2 crore as may be specified by RBI.

New companies having NOF not less than Rs2 crore and minimum asset size of Rs25 crore, fulfilling the revised PBC are required to obtain registration.

Foreign owned companies will, however, require the CoR from the RBI before commencing any non-banking financial activity. They will also continue to follow the minimum capitalisation norm as under FEMA.

Principal business criteria

A company is treated as an NBFC if its financial assets are more than 50 per cent of its total assets (net of intangible assets) and income from these financial assets is more than 50 per cent of the gross income. Both these tests are required to be satisfied. This also entails that NBFCs under the current regulation can conduct non-financial activities along with financial activities, as NBFCs registered with the RBI, which could pose risk to its financial activities. There are also operational risks in monitoring such entities as their business modules are not consistent with financial activities, RBI said.

RBI has, therefore, decided that NBFCs should gradually move towards undertaking financial activities, primarily.

Further, there could be systemically important financial entities not fulfilling one of the twin criteria for principal business but holding large financial assets that could have implications for the financial sector.

Consequently, the revised PBC for the purpose of registration as NBFC is redefined as follows:

• A company not accepting deposits, will qualify for registration as NBFC if and when its financial assets aggregate Rs25 crore and constitute 75 per cent and above of its total assets (net of intangible assets) and financial income constitutes 75 per cent or above of its gross income subject to conditions;
  
• Financial entities having asset size of Rs1,000 crore or above, holding financial assets, which constitute 50 per cent of the total assets or generate financial income, which as a proportion of the gross income is at least 50 per cent, will need to be registered and regulated by the RBI.

Existing NBFCs will be given a period of 2 years with the following milestones for achieving the minimum threshold of Rs25 crore of financial assets:

• March 2014 – 65 per cent
  
• March 2015 – 75 per cent

NBFCs-ND unable to comply with the threshold within the two-year period, will be deregistered by the RBI through a public notification and will no longer be eligible to carry out such activity and must exit the business within a given time frame.

Existing NBFC-D failing to achieve the 75 per cent threshold in financial assets and income by March 2015 will not be allowed to accept fresh deposits or renew deposits thereafter. They will be required to repay deposits within a given timeframe as decided by the Bank and be deregistered thereafter.

Principal business for AFCs has been redefined in alignment with that of the revised principal business criteria for NBFCs. Accordingly, a minimum of 75 per cent of the assets of AFCs (as against 60 per cent at present) should be in asset financing activities and at least 75 per cent of total income (as against 60 per cent at present), should be from these asset financing activities. Existing AFCs would be allowed to conform to the revised principal business criteria within a period of two years from the date of this Directions, in two stages as per the milestones.

Multiple NBFCs

Multiple non-deposit taking NBFCs floated for different reasons, and are part of a corporate group or are floated by a common set of promoters, will not be viewed on a standalone basis and instead their total assets will be aggregated to determine if such consolidation leads to the cut-off limit prescribed for a systemically important NBFC, ie, Rs100 crore of assets. For this purpose, the definition of the word ''group'' will be the same as per accounting sandards.

For the purpose of regulation, the total assets of all NBFCs in a group will be taken together to determine the cut-ff limit of Rs100 crore for application of prudential norms. All provisions of the NBFC Prudential Norms, 2007 will be applicable to each NBFC in the group. For this purpose, statutory auditors would be required to certify the asset size of all the NBFCs if the group has more than one NBFC.

In case there is a deposit accepting NBFC within the group, it would be supervised on a solo basis and all regulations prescribed for registered NBFCs would apply.

Captive NBFCs

Captive NBFCs floated by corporates, which hold receivables generated on account of their parents' activities at least to the extent of 90 per cent of its total assets, net of intangible assets, are inextricably linked to the parent's fortunes. As a result, credit underwriting standards could be weaker in such entities and the recall, if any, of parental assets could further stress the captive NBFC. Consequently, risks in the captives are much higher and warrant a higher Tier I capital, if not a different start-up NOF requirement.

It has, therefore, been decided that captive NBFCs should maintain Tier I capital at 12 per cent, as against 7.5 per cent at present. Existing captive NBFCs that do not fulfill the requirement would be given a period of three years from the date of this notification to comply, upon which they should produce a statutory auditor's certificate of compliance.

Financial assets will include all assets that are financial in nature except cash, bank deposits, advance payment of taxes and deferred tax payments.

As NBFCs are involved in maturity transformation, liquidity risks are endemic to them, with assets being mostly illiquid and of longer tenure than liabilities. Most NBFCs are seen to be dependent on money market instruments such as CPs and short-term bank borrowings but have little flexibility in shedding their long-term assets under situation of stress.

 As per the extant regulatory framework, the RBI has stipulated the maintenance of a statutory liquidity ratio of 15 per cent of aggregate deposit for deposit accepting NBFCs, besides, making applicable ALM guidelines to those holding deposit of Rs20 crore and above.  But the ALM guidelines on short term mismatches running up to 30 days do not adequately address liquidity risks faced by the NBFCs.

Accordingly, it has been decided that, henceforth, all registered NBFCs - deposit taking and non-deposit taking - should maintain high quality liquid assets in cash, bank deposits available within 30 days, money market instruments maturing within 30 days, investment in actively traded debt securities (valued at 90 per cent of the quoted price) and carrying a rating not lower than AA or equivalent, equal to the gap between total net cash inflows and outflows over the 1 to 30 day time bucket as a liquidity coverage requirement.  In other words, there should not be any liquidity gap in the 1-30 day bucket.

For deposit taking NBFCs, the extant requirement of SLR will continue.