Published On - May 09, 2023
Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs
Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs
In October 2021, the Reserve Bank of India (RBI) had prescribed a ‘scale-based regulation’ (SBR) that encompasses different facets of regulation of NBFCs — covering capital requirements, governance standards, prudential regulation, etc. These guidelines are effective from 1 October 2022. However, the amendments regarding ceiling on an IPO funding are effective from 1 April 2022.
On 23 February 2022, guidelines for implementation of core financial services solutions were issued. Further RBI vide circular dated 11 April 2022, issued a framework for Compliance Function and Role of Chief Compliance Officer in NBFC-Upper layer and NBFC-Middle layer.
Thereafter, on 19 April 2022, RBI issued circulars on large exposure framework for NBFCs — Upper layer, capital requirements for NBFCs — Upper layer, regulatory restrictions on loans and advances and disclosures in notes to accounts of the financial statements of NBFCs. On 29 April 2022, RBI issued guidelines on compensation policy of key managerial personnel and members of senior management of all NBFCs under SBR framework, except those categorized under ‘Base Layer’ and government-owned NBFCs, which is effective from 1 April 2023. On 6 June 2022, RBI issued guidelines on provisioning for standard assets, which are applicable for NBFC — Upper layer.
Regulatory structure for NBFCs shall comprise the four layers as defined in the pyramid below:
RBI will come out with separate regulations for NBFCs not availing public funds and not having customer interface in due course. Till such time, the extant regulations will continue to apply. This article provides an overview of changes prescribed in the SBR regulations
Changes under SBR for all the layers in the regulatory structure:
Following is an overview of changes applicable for NBFCs in all the layers in respect of Net Owned Fund (NOF) requirement:
| NBFCs | Current NOF (Rs.) | By 31 March 2025 (Rs.) | By 31 March 2027 (Rs.) |
|---|---|---|---|
| NBFC-ICC | crore | crore | 10crore |
| NBFC-MFI | crore (crore in NE Region) | crore (►crore in NE Region) | 10 crore |
| NBFC-Factors | crore | crore | 10 crore |
| NBFC-P2P, NBFC-AA, and NBFCs with no public funds and no customer interface | crore | crore | 10 crore |
| NBFCs - IDF, IFC, MGCs, HFC, and SPD | No Change | No Change | No Change |
| NBFCs | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL Applicable date | Applicable date | |
|---|---|---|---|---|---|
| NPA Classification | NPA classification norm stands changed to the overdue period of more than 90 days for all categories of NBFCs. Since NBFCs, which will fall in NBFC-UL and NBFC-ML category is already required to follow the overdue period of 90 days for NPA classification, there will be no change in NPA classification norm for them. A glide path is provided to NBFCs in Base Layer to adhere to the 90 days NPA norm as under: | Timeline mentioned in the adjacent column | |||
| NPA Norms | Timeline | ||||
| 150 days overdue | By 31 March 2024 | ||||
| 120 days overdue | By 31 March 2025 | ||||
| 90 days | By 31 March 2026 | ||||
| The above glide path will not be applicable to NBFCs which are already required to follow the 90-day NPA norm. | |||||
| Ceiling on IPO Funding | There shall be a ceiling of ►s. 1 crore per borrower for financing subscription to IPO. NBFCs can fix more conservative limits. | 1 April 2022 | |||
| Extant regulatory guidelines for NBFCs | NBFCs in the base layer (NBFC-BL) shall be subject to regulations as currently applicable to NBFC-ND, except for the changes mentioned in the framework. NBFC-P2P, NBFC-AA, and NOFHC shall be subject to extant regulations governing them. | NBFCs in the middle layer (NBFC-ML) shall continue to follow regulations as currently applicable for NBFC-ND- SIs, NBFC-Ds, CICs, SPDs and HFCs, as the case may be, except for the changes mentioned in the framework. | NBFCs lying in the upper layer (NBFC-UL) shall be subject to regulations applicable to NBFC-ML as well, in addition to the changes mentioned in the framework. | NA | |
NBFCs need to ensure availability of adequate capital so that they comply with the glide path for meeting the minimum NOF requirements.
Presently, non-systemically important, non-deposit taking NBFCs classify advances with an overdue period of more than 180 days as NPA. All other NBFCs have an NPA threshold of advances overdue more than 90 days. The RBI has now harmonized the NPA classification requirement for all NBFCs to 90 days. The new NPA classification norms may result in an increase in the NPA in the books of NBFC-BL (non-systemically important, non-deposit taking NBFCs) and consequently an increase in the provisions.
Revisions in capital guidelines:
As per the extant RBI guidelines, all NBFCs and HFCs are required to maintain a minimum Tier I and Tier II capital ratio, which shall not be less than 15 percent of the aggregate risk-weighted assets. Following is an overview of new capital guidelines prescribed under SBR framework:
| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL Applicable date | Applicable date | ||
|---|---|---|---|---|---|---|
| Introduction of Internal Capital Adequacy Assessment Process (ICAAP) | Not applicable | ICAAP on similar lines as prescribed for commercial banks under Pillar 2. NBFCs-UL and NBFC-ML are required to make a thorough internal assessment of the need of capital, which shall factor in credit risk, market risk, operational risk, and all other residual risks as per methodology to be determined internally. | 1 October 2022 | |||
| Differential standard asset provisioning norms | Not applicable | Not applicable | NBFC-UL shall maintain provisions in respect of ‘standard’ assets at the following rates for the funded amount outstanding: | 1 October 2022 | ||
| Category of Assets | Rate of Provision | |||||
| Individual housing loans and loans to Small and Micro Enterprises (SMEs) | 0.25 percent | |||||
| Housing loans extended at teaser rates | 2.00 per cent, which will decrease to 0.40 per cent after 1 year from the date on which the rates are reset at higher rates (if the accounts remain ‘standard’) | |||||
| Advances to Commercial Real Estate – Residential Housing (CRE - RH) Sector | 0.75 percent | |||||
| Advances to Commercial Real Estate (CRE) Sector (other than CRE-RH) | 1.00 percent | |||||
| Restructured advances | As stipulated in the applicable prudential norms for restructuring of advances | |||||
| Housing finance companies are already following the above provision matrix as per Master Direction – Non-Banking Financial Company – Housing Finance Company (Reserve Bank) Directions, 2021. Hence, there will be no change in provision rates if any NBFC-HFC company is identified as NBFC-UL by RBI. | ||||||
| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL Applicable date | Applicable date |
|---|---|---|---|---|
| NBFCs following Ind AS for the preparation of the financial statements continue to compute impairment allowances as required under Ind AS, subject to norms prescribed in RBI circular on “Implementation of Indian Accounting Standards” dated 13 March 2020. | ||||
| Common Equity Tier 1 capital | Not applicable | Not applicable | NBFC-UL (except CICs) shall maintain on an ongoing basis Common Equity Tier 1 capital of at least 9 percent of risk-weighted assets. RBI will specifically identify the NBFCs to be covered in NBFC-UL. Common equity tier 1 (CET 1) ratio = common equity tier 1 capital/ total risk-weighted assets | 1 October 2022 |
| Leverage | Not applicable | Not applicable | In addition to the CRAR, NBFC-UL will also be subjected to leverage requirement. A suitable ceiling for leverage will be prescribed by RBI subsequently for these entities as and when necessary. | Clarification on this matter is awaited |
The NBFCs will need to consider the following revised capital guidelines:
- NBFCs will need to establish a detailed ICAAP framework and policy to ensure availability of adequate capital to support all risks in business and apply better risk management techniques for monitoring and managing their risks.
- Similar to banks, NBFC-UL will also be required to maintain CET 1 capital. This is likely to enhance the capabilities of NBFCs to absorb losses due to an increase in the quality of regulatory capital.
- NBFCs-UL must monitor further clarifications on leverage requirements from RBI and comply with the leverage ceiling once prescribed.
Revisions in Prudential Guidelines:
RBI has prescribed certain prudential guidelines in the SBR framework to manage the risk exposure of NBFCs. Following is an overview of prudential guidelines prescribed under the SBR framework:
| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL | Applicable date | ||
|---|---|---|---|---|---|---|
| Differential standard asset provisioning norms | Not applicable | NBFC-UL shall follow large exposure framework limits issued by RBI circular dated 19 April 2022, as mentioned below: (as % of eligible capital base*) | ||||
| Exposure to /by NBFC-UL (Other than IFC**) | NBFC-UL (Other than IFC**) | NBFC-UL (IFC) | ||||
| Single Counterparty |
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| Group of connected Counterparties |
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| *Eligible capital base means Tier 1 Capital ** Infrastructure finance company NBFC-ML shall follow the merged lending and investment exposure limits as prescribed in SBR regulation as mentioned below: |
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| Revised Limit (as a percentage of Tier 1 Capital) | ||||||
| Single group of borrowers/parties | 25% | |||||
| Single group of borrowers/parties | 40% | |||||
| Sensitive Sector Exposure (SSE) | Not applicable | Board approved internal limits to be fixed for SSE, separately for capital market and commercial real estate exposures. No change in norms for HFCs, they will continue to follow current regulations. RBI will specifically identify the NBFCs to be covered in NBFC-UL. | 1 October 2022 | |||
| Internal exposure limits | Not applicable | Not applicable | Board approved internal exposure limits to be set for important sectors (other than sensitive sectors) to which credit is extended. RBI will specifically identify the NBFCs to be covered in NBFC-UL. | 1 October 2022 | ||
| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL Applicable date | Applicable date |
|---|---|---|---|---|
| Regulatory restrictions on loans | NBFCs in Base layer shall have a Board approved policy on grant of loans to directors, senior officers, and relatives of directors and to entities where directors or their relatives have major shareholding. The Board approved policy shall include a threshold beyond which loans to above mentioned persons shall be reported to the Board. Further, NBFCs shall disclose in their Annual Financial Statement, aggregate amount of such sanctioned loans and advances as per template provided in the circular. | Unless sanctioned by the Board of Directors/ Committee of Directors, NBFCs shall not grant loans and advances aggregating Rs. 5 crores and above to:
The proposals for credit facilities of an amount less than Rs. 5 crore to above borrowers may be sanctioned by the appropriate authority in the NBFC under powers vested in such authority, but the matter should be reported to the Board. Loans and advances to Senior Officers of the NBFC shall be reported to the Board. Loans and advances to real estate sector shall be disbursed after ensuring that borrower has obtained prior permission from government/ local government/ other statutory authorities for the project |
1 October 2022 | |
| Disclosures in financial statements | All NBFCs shall disclose in their annual financial statement, agg loans and advances as per below format:
Loans to Directors, Senior Officers, and relatives of Directors |
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| Current year | Previous year | |||
| Directors and their relatives | xx | xx | ||
| Entities associated with directors and their relatives | xx | xx | ||
| Senior officers and their relatives | xx | xx | ||
NBFCs need to identify and monitor their existing exposures to the capital market sector, commercial real estate sector and other important sectors as identified by the Board of Directors which will help in addressing credit risk concentration. Further, NBFCs will need to put in place reporting processes for timely and accurate reporting of large exposures to RBI, as per the format prescribed by RBI.
Further, the requirements relating to restrictions on loans to directors and their relatives and senior officers and disclosures thereof will bring in transparency around such loans and advances provided.
Revisions in Governance Guidelines:
To strengthen the governance framework of NBFCs, RBI has prescribed various governance guidelines under SBR framework. Below is an overview of governance guidelines prescribed under SBR framework:
| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL Applicable date | Applicable date |
|---|---|---|---|---|
| Key Managerial Personnel (as defined in Section 2 (51) of Companies Act, 2013) | Not applicable | Except for directorship in a subsidiary, Key Managerial Person shall not hold any office (including directorships) in any other NBFC ML or NBFC UL. A timeline of two years is provided with effect from 01 October 2022, to ensure compliance with these norms. It is further clarified that they can assume directorship in NBFC-BLs. | 1 October 2022 | |
| Compensation of Key Managerial (KMP) And Senior Management in NBFCs | Not applicable | NBFCs are required to put in place a Board approved compensation
policy. The policy shall at the minimum include:
The RBI has provided guidelines which intends only to provide broad guidance to NBFCs and their NRCs in formulating their compensation policy. While formulating the compensation policy, it must be ensured that all statutory mandates and the rules and directions issued under them are fully complied with. |
1 October 2022 | |
| Compliance function and Chief compliance officer (CCO) | Not applicable | NBFCs in the middle and upper layer are required to have an independent compliance function and appoint a Chief Compliance Officer (CCO). NBFC-UL and NBFC-ML shall put in place a Board approved policy by 1 April 2023 and establish compliance function, including appointment of CCO by 1 October 2023. | 1 April 2023 and 1 October 2023 | |
| Independent director (ID) | Not applicable | IDs are restricted from being on the Board of more than three NBFCs (NBFC-ML or NBFC-UL) at the same time. Further, the Board of the NBFC shall ensure that there is no conflict arising out of their independent directors being on the Board of another NBFC at the same time. A timeline of two years is provided with effect from 1 October 2022, to ensure compliance with these norms. There shall be no restriction to directorship on the Boards of NBFC-BLs, subject to applicable provisions of Companies Act, 2013. | 1 October 2024 | |
| Removal of independent directors | Not applicable | Not applicable | NBFCs in the upper layer are required to report to the RBI in case any ID is removed/ resigns before the completion of his/her normal tenure. Earlier NBFCs were not required to report removal/resignation by an ID. | 1 October 2022 |
| Additional governance matters | Not applicable | Additional governance matters to be complied with include:
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Detailed circular is awaited from RBI | |
| Qualification of Board members | Not applicable | Not applicable | NBFCs in the upper layer pose higher systemic risk and need to maintain highest corporate governance standards, they need to ensure that composition of Board of directors has relevant educational qualification and experience. Specific expertise of board members would be a prerequisite for appointment of directors depending on the type of business pursued by the NBFC-UL. | 1 October 2022 |
| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL | Applicable date |
|---|---|---|---|---|
| Risk Management Committee (RMC) | Could be at board or executive level | Board level RMC | Board level RMC | 1 October 2022 |
| Listing and disclosures | Not applicable | Not applicable |
Once an NBFC is identified for inclusion as NBFC-UL, it must get listed within three years of identification as NBFC-UL. The RBI vide press release dated 30 September 2022 announced the list of NBFCs in the upper layer under SBR. To access the press release, click here Further, within three months of being advised by the RBI regarding its inclusion as NBFC-UL, they should put in place a Board approved policy for adoption of the enhanced regulatory framework and develop a detailed implementation plan for complying with the new regulations The Board of Directors shall ensure that the stipulations prescribed for the NBFC-UL are adhered to within a maximum time- period of 24 months from the date of advice regarding classification as a NBFC-UL from the Reserve Bank. The period of 3 months provided to develop an implementation plan shall be subsumed within 24 months. Once an NBFC is categorized as NBFC-UL, it shall be subject to enhanced regulatory requirement, at least for a period of 5 years from its classification in the layer, even in case it does not meet the parametric criteria in the subsequent year/s. In other words, it will be eligible to move out of the enhanced regulatory framework only if it does not meet the criteria for classification for 5 consecutive years. |
Board approved policy - within 3 months from date of advice Enhanced regulatory requirements - Within 24 months from date of advice Listing within three years from date of identification as NBFC-UL |
| Disclosures in financial statements | List of existing disclosures with amendments:
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31 March 2023 | ||
List of new disclosure requirements.
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List of new disclosure requirements:
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| Particulars | NBFC – Base Layer NBFC – BL | NBFC – Middle Layer BFC – ML | NBFC – Upper Layer NBFC – UL Applicable date | Applicable date |
|---|---|---|---|---|
| Core Financial Services Solution | NBFC – BL may voluntarily consider implementation of a Core Financial Services Solution for their own benefit. | NBFCs ML and NBFCs UL with 10 and more ’Fixed point service delivery units’ as on 1 October 2022 have to implement ‘Core Financial Services Solution (CFSS)’, akin to the Core Banking Solution (CBS) adopted by banks, by 30 September 2025. However, NBFC-UL shall ensure that the CFSS is implemented at least in 70 percent of ‘Fixed point service delivery units’ on or before 30 September 2024. | 30 September 2025 (70% units of NBFC-UL by 30 September 2024) | |
| Experience of board of Directors | At least one of the directors in the board should have relevant experience of having worked in a bank/ NBFC. This is a new requirement for all NBFCs. | 1 October 2022 | ||
How we look at it
- NBFCs need to ensure that appropriate steps are taken as per the SBR to strengthen the governance framework and necessary policies and governance functions are aligned with new SBR requirements.
- urther, NBFCs in each layer will also need to comply with the Companies Act, 2013 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 as applicable while complying with the above mentioned SBR requirements.
- NBFCs should gear up for significant additional disclosures to be provided in the financial statements. This may require NBFCs to enhance/modify the financial reporting process so that such additional disclosures can be provided.
- In addition to the above key changes, there are various other changes prescribed under the SBR framework and subsequent circulars issued by RBI, which are effective from various dates as prescribed in those circulars. Further, clarification on certain matters under the regulations is awaited and NBFCs need to monitor the same.
- The SBR has been introduced keeping in mind the changing risk profiles of NBFCs considering that the sector has witnessed exponential growth and considerable evolution in terms of size, complexity, and interconnectedness within the financial sector. Considering the significant changes in regulatory framework, it is imperative for the NBFCs within each layer to put in place a detailed plan of action, robust policies, and processes, and gear up for the implementation of changes as soon as possible to ensure compliance with the various requirements of the SBR framework.
