Scale Based Regulations (SBR): A Revised Regulatory Framework for NBFCs

The contribution of NBFCs towards supporting real economic activity and their role as a supplemental channel of credit intermediation alongside banks is well recognised. Over the years, the sector has undergone considerable evolution in terms of size, complexity, and interconnectedness within the financial sector.

Many entities have grown and become systemically significant and hence there was a need to align the regulatory framework for NBFCs keeping in view their changing risk profile. Thus, the Reserve Bank of India came up with a "Scale Based Regulations" (SBR)in October 2021 for NBFC Sector. A series of SBR Notification and clarifications were issued by Reserve Bank of India.

Further on 19th October 2023, the Reserve Bank of India suspended the existing Non-Banking Financial Company- Non-Systemically Important Non-Deposit taking (Reserve Bank) Directions, 2016 and Non-Banking Financial Company- Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016, and issued a revised Master Direction - Reserve Bank of India (Non-Banking Financial Company - Scale Based Regulation) Directions, 2023 by consolidating various SBR Notifications.

Key Highlights of Scale-Based Regulations(SBR)

A. REVISIONS IN REGULATORY GUIDELINES

Net Owned Fund: (Applicable to BL, ML and UL)

Regulatory minimum Net Owned Fund (NOF) for NBFC-ICC, NBFC-MFI and NBFC-Factor shall be increased to ₹10 Crore for new registrations. The following glid path is provided for the existing NBFCs to achieve the NOF of ₹10 Crore:

However, for NBFC-P2P, NBFC-AA, and NBFCs with no public funds and no customer interface, the NOF shall continue to be ₹2 Crore.

For NBFC-IFC and IDF-NBFC, the NOF shall be ₹300 crore.

NPA Classification: (Applicable to BL, ML and UL)

The extant NPA classification norm stands changed to the overdue period of more than 90 days for all categories of NBFCs. A glide path is provided to NBFCs in Base Layer to adhere to the 90 days NPA norm as under:

The glide path will not be applicable to NBFCs which are already required to follow the 90-day NPA norm.

Experience of the Board: (Applicable to BL, ML and UL)

At least one of the directors shall have relevant experience of having worked in a Bank/NBFC.

Ceiling in IPO Funding: (Applicable to BL, ML and UL)

There shall be ceiling of ₹1 crore per borrower for financing subscription to Initial Public Offer (IPO).

NBFCs can fix more conservative limits.

B. REVISIONS IN CAPITAL GUIDELINES

Internal Capital Adequacy Assessment Process (ICAAP): (Applicable to ML and UL)

• NBFCs are required to make a thorough internal assessment of the need for capital, commensurate with the risk in their business.
• This internal assessment shall be on similar lines as ICAAP prescribed for commercial banks under Pillar 2 (Master Circular- Basel III Capital Regulations dated July 01, 2015)
• The methodology for internal assessment of capital shall be proportionate to the scale and complexity of operations as per their Board approved policy.

Common Equity Tier 1: (Applicable to UL)

NBFC-UL shall maintain, on an on-going basis, Common Equity Tier 1 (CET1) ratio of at least 9%.

Whereas,Common Equity Tier 1 (CET1) ratio = Common Equity Tier 1 Capital/ Total Risk Weighted Assets.

Please refer to SBR for detail calculation.

Leverage: (Applicable to UL)

In addition to the CRAR, NBFC-UL will also be subjected to Leverage requirement. A suitable ceiling for leverage will be prescribed subsequently for these entities as and when necessary.

The leverage ratio of NBFCs (except NBFC-MFIs, NBFCs-MLand above) shall not be more than 7 at any point of time.

Note: Leverage ratio means the total Outside Liabilities divided by Owned Fund.

Differential standard asset provisioning: (Applicable to UL)

NBFC-UL shall be required to hold differential provisioning towards different classes of standard assets.

SBR have a prescribed rate of provision for different category of assets.

C. REVISIONS IN PRUDENTIAL GUIDELINES

Concentration of Credit/ Investment: (Applicable to ML and UL)

The extant credit concentration limits prescribed for NBFCs separately for lending and investments shall be merged into a single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties.

Sensitive Sector Exposure (SSE): (Applicable to ML and UL)

• Exposure to capital market (direct and indirect) and commercial real estate shall be reckoned as sensitive exposure for NBFCs.
• NBFCs shall fix Board-Approved internal limits for SSE separately for capital market and commercial real estate exposures.
• While the Board is free to determine various sub-limits within the overall SSE internal limits, the following are specifically prescribed:
• A sub-limit within the commercial real estate exposure ceiling shall be fixed internally for financing land acquisition.
• Ceiling on IPO Funding as mentioned at Paragraph 34 of SBR.

Regulatory Restrictions on Loans: (Applicable to ML and UL)

1) LOANS AND ADVANCES TO DIRECTORS

Unless sanctioned by the BOD/Committee of Directors, NBFCs shall not grant loans and advances aggregating to ₹ 5 Crores and above to:

• Their directors (including the Chairman/MD) or relatives of director.
• 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.

The proposals for credit facilities of an amount less than ₹ 5 Crores to these borrowers may be sanctionedby the appropriate authority in the NBFC under powers vested in such authority, but the matter should be reported to the Board.

2. LOANS AND ADVANCES TO SENIOR OFFICERS OF THE NBFC

NBFCs shall abide by the following when granting loans and advances to their senior officers:

• Loans and advances sanctioned to senior officers of the NBFC shall be reported to the Board.
• No senior officer or any Committee comprising, inter alia, a senior officer as member, shall while exercising powers of sanction of any credit facilities, sanction any credit facility to a relative of that senior officer. Such a facility be sanctioned by the next higher sanctioning authority under the delegation of powers.

3. LOANS AND ADVANCES TO REAL ESTATE SECTOR

• While appraising loan proposals involving real estate, NBFCs shall ensure that the borrowers have obtained prior permission from government/local government/ other statutory authorities for the project, wherever required.
• Ensure that the disbursement shall be made only after the borrowers has obtained requisite clearances from the government/ other statutory authorities.

4. IN RESPECT OF GRANT OF LOANS MENTIONED IN POINT 1 AND 2 ABOVE

• NBFCs shall obtain a declaration from the borrower giving details of the relationship of the borrower to their directors/ senior officers for loans and advances aggregating₹5 Crores and above.
• NBFCs shall recall the loan if it comes to their knowledge that the borrower has given a false declaration.
• These guidelines shall be duly brought to the notice of all directors and placed before the NBFC’s Board of Directors.
• NBFCs shall disclose in their Annual Financial Statement, aggregate amount of such sanctioned loans and advances as per template provided in the Appendix.

Large Exposure Framework: (Applicable to UL)

SBR set out to identify large exposures, refine the criteria for grouping of connected counterparties and put in place reporting norms for large exposures.

NBFC-UL shall report its Large Exposures to the Reserve Bank (Department of Supervision, Central Office) as per the reporting template given in Appendix 1. The LEF reporting shall cover the following:

• All exposures, meeting the definition of large exposure.
• All other exposures, measured as specified in paragraph 6 of this framework without offsetting exposure value with credit risk transfer instruments, where values stand equal to or above 10% of the NBFC-UL’s eligible capital base.
• All the exempted exposures with value equal to or above 10% of the NBFC-UL’s eligible capital base.
• 10 largest exposures included in the scope of application, irrespective of the values of these exposures relative to the NBFC-UL’s eligible capital base.

Internal Exposure Limits: (Applicable to UL)

In addition to the internal limits on SSE in respect of capital market and commercial real estate, Board of NBFC-UL shall also determine internal exposure limits on other important sectors to which credit is extended.

Further, NBFC-UL shall put in place an internal Board approved limit for exposure to the NBFC sector.

D. REVISIONS IN GOVERNANCE GUIDELINES

Risk Management Committee:(Applicable to BL, ML and UL)

• NBFCs shall constitute a Risk Management Committee RMC). For BL- either at the Board or executive level, ML and UL- Board level.
• The RMC shall be responsible for evaluating the overall risks faced by the NBFC including liquidity risk and shall report to the Board.

Disclosures: (Applicable to BL, ML and UL)

With effect from 31st March 2023, NBFCs are required to make the following additional disclosures in their Financial Statements:

Exposure to Real Estate Sector:

(A) Direct Exposure:

1. Residential Mortgages
2. Commercial Real Estate
3. Investments in Mortgage-Backed Securities (MBS) and other securitized exposures.

(B) Indirect Exposure:

• Exposure to Capital Market
• Sectoral Exposures
• Intra-Group Exposures
• Unhedged Foreign Currency Exposure
• Related Party Disclosures
• Disclosures of Complaints
• Corporate Governance
• Breach of Covenant
• Divergence in Assets Classification and Provisioning

Loans to directors, senior officers, and relatives of director: (Applicable to BL, ML and UL)

• NBFCs 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 abovementioned persons shall be reported to the Board.
• Further, NBFCs shall disclose in their Annual Financial Statement, aggregate amount of such sanctioned loans and advances.

Key Managerial Personnel: (Applicable to ML and UL)

• Except for directorship in a subsidiary, Key Managerial Personnelshall not hold any office (including directorships) in any other NBFC-ML or NBFC-UL.
• It is clarified that they can assume directorship in NBFC-BL.
• A timeline of two years is provided with effect from October 01, 2022 to ensure compliance with these norms.

Independent Director:(Applicable to ML and UL)

• Within the permissible limits in terms of Companies Act, 2013, an independent director shall not be on the Board of more than three NBFCs (NBFCs-ML or NBFCs-UL) at thesame time.
• There shall be no restriction to directorship on the Boards of NBFCs- BL, subject to provisions of Companies Act, 2013.
• A timeline of two years is provided with effect from October 01, 2022 to ensure compliance with these norms.

Disclosures in Annual Financial Statements: (Applicable to ML and UL)

NBFCs shall in addition to the existing regulatory disclosures, disclose the following in their Annual Financial Statements with effect from 31st March 2023:

• Corporate Governance report containing composition and category of directors, shareholding of non-executive directors, etc.
• Disclosure on modified opinion, if any, expressed by auditors, its impact on various financial items and views of management on audit qualifications.
• Items of income and expenditure of exceptional natures.
• Breaches in terms of covenants or defaults.
• Divergence in asset classification and provisioning.

Chief Compliance Officer:(Applicable to ML and UL)

• Setup an Independent Compliance Function and a strong compliance risk management framework in NBFCs.
• Appoint a Chief Compliance Officer.
• NBFCs shall put in place a Board approved policy laying down the role and responsibilities of the CCO.

Compensation Guidelines:(Applicable to ML and UL)

In order to address issues arising out of excessive risk taking caused by misaligned compensation packages, it has been decided that NBFCs shall put in place a Board approved compensation policy.

The guidelines shall at the minimum includes:

• Constitution of Remuneration Committee,
• Principals for fixed/variable pay structures
• Malus/ claw back provisions.

Other Governance Matters:(Applicable to ML and UL)

NBFCs shall comply with the following:

• The Board shall delineate the role of various committees (Audit Committee, Nomination and Remuneration Committee, Risk Management Committee, or any other Committee) and lay down a calendar of reviews.
• NBFCs shall formulate a whistle blower mechanism for directors and employees to report genuine concerns.
• The Board shall ensure good governance practices in the subsidiaries of the NBFC.

Core Banking Solutions:(Applicable to ML and UL)

• NBFCs with 10 and more branches are mandated to adopt Core Banking Solution. A glide path of 3 years with effect from 01st October 2022 is being provided.
• The timeframe for implementation of the requirement shall be on or before 30th September, 2025

Qualification of Board Members: (Applicable to UL)

• Board members shall be competent to manage the affairs of the NBFC.
• The composition of the Board should ensure mix of educational qualification and experience within the Board.
• Specific expertise of Board members will be a prerequisite depending on the type of business pursued by the NBFC.

Listing and Disclosures: (Applicable to UL)

• NBFC shall be mandatorily listed within three years of identification as NBFC-UL.
• Disclosure requirements shall be put in place on the same lines as applicable to a listedcompany even before the actual listing, as per Board approved policy of the NBFC.

Removal of Independent Directors: (Applicable to UL)

• NBFC-UL Shall be mandatorily listed within 3 years of identification as NBFC-UL.
• Disclosure requirements shall be put in place on the same lines as applicable to a listed company even before the actual listing, as per Board approved policy of the NBFC.

E. TRANSITION PATH

Transition Plan:(Applicable toUL)

Once a NBFC is identified for inclusion as NBFC-UL, the NBFC shall be advised aboutits classification by the Department of Regulation, the Reserve Bank and it will be placed under regulation applicable to the Upper Layer. For this purpose, the following timelinesshall be adhered to:

• Within 3 months of being advised by the Reserve Bank regarding its inclusionin the NBFC-UL, the NBFC shall put in place a Board approved policy for adoption of the enhanced regulatory framework and chart out an implementation plan for adhering to thenew set of regulations.
• The Board shall ensure that the stipulations prescribed for the NBFC-UL areadhered to within a maximum time-period of 24 months from the date of advice regarding classification as a NBFC-UL from the Reserve Bank. Theperiod of 3 months provided for charting out the plan for implementation shall be subsumed within the 24-months’ time-period referred to above.
• The roadmap as approved by the Board towards implementation of the enhanced regulatory requirement shall be submitted to the Reserve Bank and shall be subject to supervisory review.

Transition of NBFCs to the Upper Layer: (Applicable to UL)

• Once an NBFC is categorised as NBFC-UL, it shall be subject to enhanced regulatory requirement, at least for a period of five 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 five consecutive years.
• NBFC-UL may however move out of the enhanced regulatory framework before the period of five years if the movement is on account of voluntary strategic move to readjust operations as per a Board approved policy.
• NBFCs which are close to meeting the parameters and benchmarks that would render them eligible for classification as NBFC-UL shall be intimated about the same to enable them to readjust their operations, in case they intend to continue to function asNBFC-ML on a long-term basis and do not want to graduate to NBFC-UL.

Review of Assessment Methodology: (Applicable to UL)

The methodology for assessing the NBFC-UL shall be reviewed periodically.

We Integrius Advisors are a boutique firm offering integrated solutions in regulatory compliance, governance, and legal functions. We are one-step service provider to obtain any type of NBFC Registration in India.

Apart from NBFC Registration we also provide other integrated services including but not limited to:

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The author can also be reached at neha@integriusadvisors.com