RBI proposes changes to NBFC-UL identification

• Anita Baid, finserv@vinodktohari.com 

Revised Criteria for Classification

RBI has vide its Press Releases – Reserve Bank of India proposed to review methodology for identification of NBFCs in Upper Layer. The key changes are as follows:

1. Annual Classification: RBI shall conduct an annual identification process for classification of NBFCs in the Upper Layer.

It may be noted that NBFCs belonging to the banking group are also required to comply with the compliance requirements applicable to Upper Layer NBFCs (except the listing requirement). Our article on compliances to be followed by such NBFCs in the banking group can be seen here. 

2. Criteria for classification: The current two-step approach (top ten by asset size and parametric scoring) will be replaced by a simple, absolute asset size criterion. The proposed asset size threshold for an NBFC to be classified as UL is ₹1,00,000 crore and above, as per the latest audited balance sheet (this limit is subject to review every 5 years).

A crucial question that arises here is whether the consolidation criteria (multiple NBFCs in the group) be applicable in this case as well to determine the asset size? Though as per prudence, it should apply, to avoid surpassing the regulatory intent, however, the same is specifically not applicable as per the SBR Directions (refer para 21) .

3. Inclusion of Government-owned NBFCs: Eligible Government-owned NBFCs will now also be considered for inclusion in Upper Layer, based on the revised asset size criteria. Previously, these were placed only in the Base or Middle Layer.

It may be noted that the category of NBFC is not a pre-condition, hence, the list of UL NBFCs would include not just NBFC-ICCs but also HFCs, CICs, deposit taking NBFCs, and not even Govt. NBFCs

4. Provision for Credit Risk Transfer: All NBFC-UL will be allowed to use State Government guarantees as a credit risk transfer instrument without any specific limit, provided they meet the prescribed conditions.

Implications of NBFC-UL Classification

Once the proposed criteria are implemented and the new list of Upper Layer NBFCs is notified by the RBI, entities classified as NBFC-UL will face certain immediate implications, in addition to specific corporate governance norms. The central point of discussion is how these requirements might impact the growth plans of large NBFCs.

1. CET 1 requirement: NBFC-UL are required to maintain Common Equity Tier 1 capital of at least 9% of Risk Weighted Assets.

While CET 1 is currently manageable for most existing UL entities, aggressive growth plans could potentially make this a constraining factor for larger NBFCs newly classified as UL.

2. Leverage Restriction: In addition to CRAR, NBFC-UL shall also be subject to leverage requirements to ensure that their growth is supported by adequate capital, among other factors. Also, NBFC-UL shall be required to hold differential provisioning towards different classes of standard assets.

Leverage ratio would have been an issue if the entity was engaged in derivatives transactions. However, most of the NBFCs in India are not very active in this space. 

3. Exposure Framework: NBFC-ULs are required to adhere to the Large Exposures Framework. Furthermore, their Board must determine internal exposure limits for important sectors, including exposure to the NBFC sector, in addition to limits on internal exposures to Sensitive Sector Entities (SSEs).

The applicability of the large exposure framework may be a real concern. Large exposure framework looks at economic interdependence as the basis of classification into group risk. There is an absolute limit that the single party exposure cannot be more than 20% of Tier 1 capital (including quarterly audited profits) and 25% in case of a group of counterparties.

4. Listing Requirement:  NBFC-ULs must be mandatorily listed within three years of being identified and notified as such. Unlisted NBFC-ULs shall be required to make the necessary arrangements for listing within this three-year period.

5. CICs not accessing public funds: Under the CIC Directions, those CICs that don’t have access to public funds, irrespective of the asset size, are eligible to be classified as an unregistered CIC. Accordingly, such CICs should not be classified in the upper layer even if they breach the asset size criteria.