RBI issued clarification with regard to the revised regulatory framework for NBFCs – Scale Based Regulation

RBI issued clarification with regard to the revised regulatory framework for NBFCs – Scale Based Regulation

Background

In October 2021, the Reserve Bank of India (RBI) had issued the Scale-Based Framework (SBR framework) for Non-Banking Financial Companies (NBFCs), rendering the regulation and supervision of the NBFCs to be a function of their size, activity and perceived riskiness. Various regulatory revisions were prescribed for NBFCs under different layers of the SBR framework (NBFC-Base Layer (BL), NBFC- Middle Layer (ML), NBFC- Upper Layer (UL) and NBFC- Top Layer (TL). However, RBI had mentioned that it would issue clarifications on some of these regulations on subsequent dates.

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New development

On 19 April 2022, RBI issued clarifications on the following topics:

?I. Capital requirements for NBFCs

NBFC-UL shall maintain, on an ongoing basis, Common Equity Tier 1 (CET1) capital of at least 9 percent of Risk-Weighted Assets and provides the formula for the CET 1 ratio. The circular also prescribes the elements of CET I Capital to include heads such as paid-up equity share capital issued by the NBFC, share premium resulting from the issue of equity shares, capital reserves representing surplus arising out of sale proceeds of assets, statutory reserves, revaluation reserves, subject to meeting prescribed conditions, etc.

Applicability – These clarifications are applicable to all NBFCs identified as NBFC-UL, except Core Investment Companies (CICs).

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A.?Disclosures in Financial Statements – Notes to Accounts of NBFCs

NBFCs are required to make disclosures in their financial statements in accordance with existing prudential guidelines, applicable accounting standards, laws, and regulations. RBI has issued certain additional disclosure requirements for NBFCs in line with the SBR framework. Comprehensive disclosures that help in the understanding of financial position and performance of the company have been encouraged. The additional disclosure requirements for NBFCs in accordance with the SBR framework are prescribed as annexure in the RBI circular.

?Applicability – The RBI circular is applicable to all NBFCs. The circular specifies the applicability of specific disclosure requirements to specific NBFC layers as per Scale Based Regulation. The disclosure requirements applicable to lower layers of NBFCs will be applicable to NBFCs in higher layers. These guidelines are effective for annual financial statements for year ending 31 March 2023, and onwards.

B.?Regulatory restrictions with regard to Loans and Advances

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The RBI circular has provided detailed guidelines on regulatory restrictions on lending in respect of NBFCs placed in different layers as per the Scale Based Regulation. These guidelines shall be effective from 1 October 2022.

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Guidelines applicable to NBFC – Middle Layer (ML) and NBFC-Upper Layer (UL) regulatory restrictions on loans and advances

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1.?????Loans and advances to Directors – NBFCs require sanction by the Board of Directors/ Committee of Directors for grant of any loans or advances aggregating INR 5 crore and above to:

???????????????Their directors including the Chairman or relative of directors

???????????????Any firm in which any of their directors or their relatives is interested as a partner, manager, employee or guarantor

???????????????Any company in which any of their directors, or their relatives is interested as a major shareholder, director, manager, employee or guarantor.

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2.?????Loans and advances to senior officers of the NBFC – All loans and advances sanctioned to senior officers are required to be reported to the Board. A senior officer or a committee comprising of a senior officer shall not sanction any credit to a relative of that senior officer. Such a facility shall be sanctioned by the next higher sanctioning authority under the delegation of powers.

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3.?????Loans and advances to real estate sector – The borrowers from this sector are required to obtain prior permission from government/ local government/ other statutory authorities for the project. The disbursements shall be made only after the borrower has obtained requisite clearances from the government/other statutory authorities.

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4.?????Guidelines for NBFC Base Layer (BL) – A Board approved policy shall be in place for grant of loans to directors, senior officers and relatives of directors and to entities where directors or their relatives have major shareholding. The policy should prescribe a threshold beyond which loans to abovementioned persons shall be reported to the Board. A disclosure is required in the annual financial statements stating the aggregate amount of such sanctioned loans and advances.

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C.?Large Exposure Framework for NBFC (UL)

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RBI has introduced Larger Exposures Framework (LEF) for NBFC-UL which sets out the prudential guidelines on exposure norms aimed at addressing credit risk concentration in NBFC-UL. These instructions set out to identify large exposures, refine the criteria for grouping of connected counterparties and put in place norms for large exposures. These instructions will be applicable from 1 October 2022.

?(Source: RBI circular no RBI/2022-23/26, RBI/2022-23/29, RBI/2022-23/30 and RBI/2022-23/32 dated 19 April 2022)

Compliance function and role of chief compliance officer under the Scale Based Regulation framework

As per the revised regulatory framework for NBFCs (SBR framework) issued by RBI in October 2021, the Non-Banking Financial Companies in the Upper Layer (NBFC-UL) and Middle Layer (NBFC- ML) would be required to have an independent Compliance Function and a Chief Compliance Officer (CCO).

?Compliance function has a critical part in the overall corporate governance structure. RBI, on 11 April 2022, issued a circular with the aim of introducing certain principles, standards and procedures for Compliance Function in NBFC-UL and NBFC-ML, keeping in view the principles of proportionality. NBFC (UL) and (ML) shall put in place a Board approved policy and a Compliance Function, including the appointment of a Chief Compliance Officer (CCO), based on the framework provided in the circular, latest by 1 April 2023 and 1 October 2023, respectively.

? (Source: RBI circular no RBI/2022-23/24 dated 11 April 2022)