new regulatory regime for nbfc’s - a c · pdf filethe reserve bank of india (rbi) ,...

New regulatory regime for NBFC’s

CA Mohit Bhuteria

Background

The Reserve Bank of India (RBI) , pursuant to its review of the regulatory framework for Non-Banking Finance Company (NBFC), on Monday, 10 November 2014 made certain amendments to the regulatory framework for NBFCs. Additionally, the RBI revoked with immediate effect its temporary suspension of the issuance of Certificate of Registration (CoR) to companies proposing to conduct NBFC business.

Over the years , the NBFC sector has become

systematically important with rise in assets under

management from around 11% of bank assets to 13% of

bank assets in 2013.

The rising importance of NBFCs and their growing

interconnectedness with banks as well as issues like risk

management framework for the sector, regulatory gaps

and arbitrages ,compliance and governance issues have

led to the RBI making certain regulatory changes.

Need for Regulation

241 465 314

11009

NBFC-D

ND,Asset size>100

ND, Asset size 50-100

ND, Asset Size<50

NBFC’S as on 31st March 2014

“The following major changes have been made through the 10th November,2014 circular’’: Definition of NBFC-ND-SI changed Determination of Asset size for NBFC-ND-SI to include

total assets of NBFC’s in a ‘group’. Prudential Norms applicable based on categories of

asset size Capital requirements increased with 10% Tier 1 capital

for NBFC-ND-SI Change in asset classification for NBFC’s-ND-SI and

NBFCs-D Increased provision for standard assets to 0.40%. Extensive corporate governance controls on NBFCs

Key points in the revised regulatory framework

Requirement of minimum Net Owned Fund

All NBFCs , irrespective of their date of existence are required to attain a minimum NOF of Rs 2 crores.

Existing NBFCs with NOF of less than 2 crores are required to submit a statutory auditor’s certificate certifying compliance to the revised levels at the end of each of the two financial years as given in the adjacent table.

Minimum NOF of Rs 200 lakh to be attained by the end of March 2017, as per the milestones given below:

Rs. 100 lakh by the end of March 2016

Rs. 200 lakh by the end of March 2017 NBFCs failing to achieve the prescribed ceiling within the

stipulated time period shall not be eligible to hold the CoR (Certificate of Registration) as NBFCs.

Requirement of minimum NOF

Presently NBFC-ND with asset size of Rs.100 crore or

more are classified as NBFC-ND-SI. Henceforth , NBFCs which have asset size of more than

Rs. 500 crore and above as per the latest audited Balance Sheet would be classified as NBFC-ND-SI for the purpose of administering prudential norms.

Revised definition of SI

Acceptance of Deposits

Rating and Deposit acceptance for AFCs

NBFC- Asset Finance Company

(AFC)

Existing limits

Revised limits

Unrated AFC Lower of 1.5 limits of NOF or Rs 10 crore, whichever is lower

To get them rated by 31March 2016, failing which they cannot renew or accept fresh deposits

Rated AFC 4 times of NOF 1.5 times of NOF

Unrated AFC – By the time rating is obtained, or rating obtained is of sub-investment grade, the existing deposits can only be renewed on maturity and no fresh deposits can be accepted.

Rated AFC – AFCs holding deposits in excess of the revised limit should not access fresh deposits or renew existing ones till they confirm to the new limits, the existing deposits can run off till maturity.

The total assets of NBFCs in a group ( including deposit taking

NBFCs) to be added to determine the asset size of NBFCs-ND-SI( redefined)

With this revision in the threshold limit, the consolidation will fall within the asset sizes of the two categories viz: NBFC-ND(with asset size of less than Rs 500 crore); and NBFC-ND-SI ( with asset size of Rs 500 crore or more).

Regulations as applicable to the two categories will be applicable to each of NBFC-ND within the group, irrespective of its individual asset size.

For NBFC-D, all applicable regulations would apply.

Concept of Multiple NBFCs

The definition of the word ‘group’ will be the same as

Accounting Standards. “Companies in the Group” shall mean an arrangement

arrangement involving two or more entities relayed to each other through any of the following relationships:

Subsidiary-parent (defined in terms of AS 21) Joint venture (defined in terms of As 27) Associate (defined in terms of As 23) Promoter-promotee [as provided in the SEBI (Acquisition

of Shares and Takeover) Regulations,1997], For Listed companies, related party (defined in terms of

AS 18),common brand name, and investment in equity shares of 20% and above.

However, for determining the asset size, clubbing of assets of non-financial companies should be excluded.

‘group’ defined

Prudential Regulations

The following categories are being created: No public funds and no customer interface: No prudential

norms or conduct of business regulations (i.e. KYC,fair practices code (FPC) etc).

No public funds but having customer interface: Conduct of business regulations (i.e. KYC,fair practices code (FPC) etc) and no business regulations.

Public funds but not having customer interface: No conduct of business regulations and limited prudential regulations.

Both public funds and having customer interface: Conduct of business regulations (i.e. KYC,fair practices code (FPC) etc) and limited prudential regulations.

NBFC-ND with asset size less than 500 crore


They have also been exempted from:

Requirement of maintaining CRAR: Complying with Credit Concentration Norms Leverage Ratio of 7 times is being introduced to

link their asset growth with the capital they hold.


For this purpose: ‘Public Funds’ to include funds raised directly or indirectly

through: Public deposits, commercial papers, debentures, inter-

corporate deposits and bank finance. But excludes funds raised by issue of instruments

compulsorily convertible into equity shares within a period not exceeding 5 years from the date of issue of issue.

Leverage Ratio is defined as Total Outside Liabilities/Owned funds

NBFC-ND-SI with asset size more than 500 crore

1. Tier I Capital: Current requirement of CRAR of 15% remains unchanged.

The revised requirement of Tier I: Capital is as under:

The minimum Tier I capital requirement for NBFCs primarily engaged in lending against gold jewellery shall be reviewed by the RBI for harmonisation in due course.

NBFC Existing

requirement

Revised requirement

By end of March 2016


NBFC-D and NBFC-ND-SI 7.5% 8.5% 10%

Infrastructure Finance Company

10% 10% 10%

NBFC engaged in financing of gold and jewellery

12%

12%

12%


2. Asset Classification : Asset classification norms for NBFCs-ND-SI and NBFCs-D

are being changed, in line with that of banks: At present, an asset is classified as NPA when it has

remained overdue for 6 months or more for loans; and overdue for 12 months or more in case of lease rental and hire purchase instalments.

Asset classification is being implemented in a phased manner over a period of 3 years beginning 31st March, 2016.

The following categories of asset classification has been

provided: Determination of NPA for Lease Rental and Hire

Purchase Assets Determination of NPA for other than Lease Rental and

Hire-Purchase Assets Determination of sub-standard asset for all loan and

hire-purchase and lease assets Determination of doubtful asset for all loan and hire-

purchase and lease assets.

For the existing loans, a one-time adjustment of the repayment schedule, which shall not amount to restructuring will, however, be permitted.


Revised NPA recognition policy

Period ended Lease Rental and Hire Purchase

Other Asset Classes

March 2016 NPA if overdue for 9 months (12 months presently)

NPA if overdue for 5 months (6 months presently)

March 2017 NPA if overdue for 6 months

NPA if overdue for 4 months

March 2018 NPA if overdue for 3 months

NPA if overdue for 3 months


3. Provisioning for Standard Assets: For NBFCs-ND-SI and for all NBFCs-D, provisioning of

standard assets has been revised as under:

Particulars

Existing requiremen

t

Revised requirement




and thereafter

Provision for Standard Assets

0.25% 0.30% 0.35% 0.40%


4. Credit/Investment Concentration Norms for AFCs

The credit concentration norms for AFCs are now being brought in line with other NBFCs.

For all new loans excluding those already sanctioned –Applicable with immediate effect.

All existing excess exposures would be allowed to run off till maturity.

Corporate Governance and Disclosure Norms

Board Committees All NBFC-D and NBFCs-ND-SI are now mandatorily

required to constitute: Audit Comittee Nomination Comittee Risk Comittee

Under the Companies Act,2013, constitution of Audit Committee and NRC is mandatory for only: Listed Companies Public Companies with:

Paid up capital of Rs.10 crore or more Turnover of Rs 100 crore or more or Aggregate outstanding loans or borrowings or

debenture or deposits exceeding 50 crore or more. However, all NBFC-D and NBFC-ND-SI, irrespective of

whether they are public or private, are required to constitute these committees.

Audit Comitteee

Constitution of this Committee was earlier mandatory by the RBI regulations for NBFC-D with deposit size of 20 crore and NBFC having asset size of 50 crore and above and consisting not more than 3 members of the Board.

In addition , all the NBFCs-ND-SI (revised) will now form this Committee as per Companies Act,2013:

Audit Committee shall be constituted by the BOD of Listed Company and other prescribed classes of companies.

Audit Committee shall consist of minimum of three directors with independent directors forming a majority.

The Audit Committee must ensure that an Information Systems Audit of the internal systems and processes is conducted at least once in two years to assess operational risks faced by the company.

Nomination Committee

Constitution of this Committee was earlier recommendatory

by the RBI for NBFC-D with deposit size of Rs 50 crore and above and NBFC-ND-SI with asset size of Rs 50 crore or more.

Its constitution shall, in the absence of any provision laid under the RBI Circular, will be as per the Act,2013 and/or Listing Agreement, which is, minimum 3 NEDs with half as IDs

Under the Act,2013 the Nomenclature of the Committee shall be ‘Nomination and Remuneration Committee’, which shall perform dual responsibilities of a Nomination Committee as also a Remuneration Committee.

The Committee shall ensure ‘fit and proper’ status of proposed/existing Directors in addition to the responsibilities laid down under the Act,2013 and Listing Agreement.

Risk Management Committee Constitution of this Committee was earlier recommendatory

by the RBI for NBFC-D with deposit size of Rs 20 crore and above and NBFC-ND-SI of Rs 100 crore and more.

The Act 2013 does not lay down its mandatory constitution. However, the Listing Agreement requires constitution of a

Risk Management Committee only for the top 100 listed companies by market capitalisation.

Would be responsible to manage the integrated risk. For Listed NBFCs , composition to be as per Listing

Agreement, in the absence RBI provisions As per Listing Agreement- composition shall be as decided

by the Board with Board members forming a majority. The Chairman of the committee shall be a Board Member.

Mandatory rotation of Audit Partner

All NBFC-D and NBFC-ND-SI are now mandatorily required to rotate the audit partners of their statutory audit firm every 3 years so that same partner does not conduct audit of the company continuously for a period of more than 3 years.

This is different from the rotation of auditors, as applicable to certain classes of companies under the Act,2013

The audit partner so rotated will be eligible for conducting the audit of the NBFC after an interval of 3 years, if the NBFC, so decides

Presently this was a recommendation provision for NBFCs with public deposits/deposits of Rs 50 crore and above.

‘fit and proper criteria’

All NBFCs-ND-SI and NBFC-D with effect from March

31,2015 are required to put in place a policy for ascertaining the fit and proper criteria for its directors.

Under the Act,2013 and the Listing Agreement, the NRC is required to frame criteria for identifying persons who are qualified to become directors and who may be appointed in senior management.

The ‘fit and proper’ criteria is to be ascertained both at the time of appointment of Directors and also on a continuing basis.

Fit and proper person criteria replicates much of the current guidelines applicable to banks.

Policy Guidelines

Due Diligence

To ascertain that the person being appointed/re-appointed as a director is suitable based on a qualification, expertise ,track record, integrity and other ‘fit and proper’ criteria.

Declaration by a Director Every director being appointed and as also every

existing director shall, at the time of appointment or annually on 31st March, respectively, declare to the NBFC, requisite details regarding his qualification, list of relatives, relationships with other entities in which he is interested, proceedings against him etc.

In case of any change in the declaration, intimation to be given forthwith.

This declaration is in addition to the declarations to be given by the director under Section 184 and 164 of the Act,2013 regarding their interest in other entities, contracts and arrangements and their disqualifications.

Policy Guidelines Deed of Covenant

It is an agreement to be signed both by the director and the company.

In short, the covenant will expose independent directors to substantial risks

Every director and the company to execute the deed which includes declarations to be provided by the director, information to be provided by the company to the director, the roles and responsibilities of the director and the like.

Age of independent director Independent Directors should be between 35-70 years of

age . No such restrictions under the Act,2013. Listing Agreement

provides that ID should not be less than 21 years of age. Huge increase in the age limit from 21 years to 35 years to

qualify as ID. Further ineligibility has been provided if the ID exceeds the

age of 70 years.

Declaration by NBFC Declaration statement to be furnished by NBFC to the RBI on

change of Directors certified by the auditors and a certificate from the Managing Director that fit and proper criteria in selection of directors have been followed.

Disclosure in financial statements-Notes to Account

All NBFCs-ND-SI (redefined) as also all NBFCs-D shall

additionally disclose the following in their Annual Financial Statements ,with effect from March 31,2015 : Registration /license/authorisation obtained from other

financial sector regulators Ratings assigned by credit rating agencies and migration of

ratings during the year. Penalties, if any, levied by any regulator. Information viz, area ,country of operation and joint venture

partners with regard to Joint Ventures and Overseas Subsidiaries.

Asset liability profile, extent of financing of parent company products, NPAs and movement of NPAs, details of all off-Balance Sheet exposure, structured products issued by them as also securitisation/asssignment transactions

Exceptions

The provisions of the Circular will also be applicable to NBFC-MFIs and CICs

Tier I capital for NBFCs primarily engaged in lending against gold jewellery remains unchanged.

In the circular dated March 21,2014 on Early Recognition of Financial Distress, Prompt Steps for resolution and Fair recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy, ‘Notified NBFCs’ shall be defined as (a) NBFCs with assets of Rs. 100 crore and above, (b) NBFCs-D, and © all NBFC-Factors.

Impact Assessment The revised regulatory framework has been generally

recieved by the market. The guidelines propose, among other things, tightening of the NPA recognition and provisioning norms for NBFCs so as to bring them on a par with those applicable for banks. However the issues arising out of the changes in framework are:

Retail NBFCs covering 63% of total managed advances classify NPAs on the basis of the existing 180-day norm, while NBFCs with 20% advances are already on the 90-day norm. Thus the change in norm is likely to lead to a rise in the reported Gross NPA percentage from 4.5% as on June 30, 2014 to 6-8% once the norms are fully implemented, thereby increasing incremental credit provisioning.

Access to SARFAESI Act:. RBI wants NBFCs to recognise NPAs 90 days past due, RBI has not included provisions granting NBFC access to SARFAESI Act, which has been used effectively by banks to expedite recovery and has also served to improve credit behaviour.

When an asset is classified as non-performing, banks and NBFCs have to provide for the same. However, banks get

Impact Assessment

The risk-weights for the same assets should be aligned for banks and NBFCs. increasing the Tier-I capital for NBFCs while not aligning (reducing) the risk weights with what is allowed to banks would reduce the NBFCs’ leveraging capacity vis-à-vis banks.

NBFCs remain at a disadvantage vis-à-vis banks with respect to capital requirement on a part of their retail lending books (loans for commercial vehicles, construction equipment, home, gold, etc). For instance, for commercial vehicle or construction equipment loans, banks are permitted to apply 75% risk weight, while NBFCs have to apply a risk weight of 100%. Thus, the capital requirement for banks would ~6% under Basel III, while NBFCs would have to maintain Tier I capital of 10%. proposed norms. Similarly, for home loans the amount of capital provided by banks would be 4% to 10% and in the case of gold loans up to 1.65%, while NBFCs will need to keep a Tier I of 10% on these exposures.

Impact Assessment

The revised regulatory framework for NBFCs will gradually reduce profitability of these companies by around 40 basis points over the next four years till 31 March 2018,

The impact on RoA in FY 2016 therefore is estimated to be in the range of 10-80 bps (average of ~20 bp, which translates to a 1.1% to 1.3% dip in ROEs) depending upon the extent of increase in NPAs and the provisioning coverage

NBFCs will re-calibrate their business models and intensify collection efforts in the early-delinquency buckets to reduce NPA

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