Microfinance and NBFC-MFIs in Economic Survey 2026

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Simrat Singh | finserv@vinodkothari.com

The Economic Survey 2026 takes an honest view of India’s microfinance sector. Rather than celebrating credit growth alone, it frames microfinance as a household balance-sheet business, where the real test of success is whether borrowing improves stability and resilience at the last mile or not. NBFC-MFIs, as the primary delivery channel, sit at the heart of this assessment. In this short note, we explore major observations of the Survey w.r.t infrastructure financing and microfinance.

Microfinance remains central to financial inclusion

The Survey reiterates the importance of microfinance in extending formal credit to underserved households. Women account for the vast majority of borrowers and most lending continues to be rural. Over the past decade, the sector has expanded rapidly in both outreach and scale, with NBFC-MFIs accounting for the largest share of lending, followed by banks and small finance banks.

This expansion has made microfinance one of the most effective channels for last-mile credit delivery but it has also exposed the sector to sharper credit cycles.

Recent stress reflects excess lending, not weak demand

The slowdown seen in FY25 is presented as a supply-side correction rather than a failure of the model. The Survey attributes the stress primarily to over-lending and borrower over-indebtedness in certain regions, driven by multiple lenders targeting the same customer base after the pandemic. The key takeaway being that access to credit was not the constraint credit discipline was.

NBFC-MFIs: essential but cycle-prone

NBFC-MFIs remain indispensable to microfinance, but the Survey recognises their structural vulnerability during rapid growth phases. Unsecured lending and limited visibility into borrowers’ total debt make the model sensitive to concentration risks. Regulatory responses have therefore focused on restoring balance rather than tightening credit indiscriminately. The RBI’s decision to lower the minimum qualifying asset requirement has given NBFC-MFIs room to diversify, while self-regulatory measures have reinforced borrower-level safeguards. The Survey notes early signs of stabilisation in asset quality and disbursement trends.

The core challenge: understanding the borrower better

A recurring concern in the Survey is the lack of reliable tools to assess household income and repayment capacity. Many borrowers carry obligations beyond microfinance such as gold loans or agricultural credit that are not always visible at the point of lending. The Survey sees digital public infrastructure as a gradual solution. Wider use of digital payments, data sharing frameworks and account aggregators is expected to improve cash-flow assessment and reduce reliance on informal income proxies. Using all this information about its borrowers, the MFIs are expected to improve their credit assessment.

Rethinking what “impact” really means

One of the Survey’s most important observations is its critique of how success in microfinance is measured. While private capital has helped scale the sector, growth-centric metrics can unintentionally encourage repeated lending without sufficient regard for borrower outcomes. The Survey argues for a shift towards welfare-oriented indicators such as income stability, reduction in distress borrowing and sustainable debt levels rather than portfolio size alone. In doing so, it challenges the assumption that more credit automatically translates into better outcomes.

What the Survey ultimately says

The Survey neither dismisses microfinance nor romanticises it. It acknowledges its critical role in inclusion, while warning that unchecked expansion can weaken household balance sheets. Long-term sustainability, it suggests, depends less on how fast credit grows and more on how responsibly it is delivered. The Economic Survey’s message is simple: the future of microfinance lies in lending better, not lending more. For NBFC-MFIs, this means aligning growth with borrower capacity, using data more intelligently and treating household stability, not loan volumes, as the true measure of success.

Read our other resources

Climate Finance: domestic resources insufficient to bridge funding gaps

Microfinance: State of the Industry and Way Forward

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This episode of Mahattva – Voices that Matter, brings together the heads of two prominent MFIs. Microfinance has been attracting attention of the entire financial system, with concerns as well as with significant optimist curiosity. Clearly, this is one segment of the financial system where financial inclusion is at its very core. We intend to have a range of questions of what are the causes of the current state of things, opportunities, way forward, induction of capital and debt, and regulatory advocacy.

A must-watch for everyone interested in microfinance. To watch it live, join our WA Channel on VKC NBFC Updates here- https://www.whatsapp.com/channel/0029Vb5epkr65yDCj3YJHg44

Read our resources on MFI lending here

  1. Micro Credit in India: Overview of regulatory scenario
  2. A Face-off with micro finance – world over
  3. Leveling the playing field for all Microfinance Lenders
  4. RBI takes measures to boost MFI lending and regulate PPI issuers
  5. The Great Consolidation: RBI’s subtle shifts; big impacts on NBFCs

India FSAP 2025: Key Takeaways and Policy Recommendations

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– Chirag Agarwal, Assistant Manager | chirag@vinodkothari.com

A joint World Bank-IMF team visited India in 2024 to update the findings of the Financial Sector Assessment Program (FSAP), which took place in 2017. World Bank on October 30, 2025 released the report1 which summarises the main findings of the mission, identifies key financial development issues, and provides policy recommendations.

We were in touch with the FSA team for our recommendations on certain aspects. The FSA recommendation on leasing (discussed below) is based on our feedback.

This article discusses in brief the key takeaways from the FSA Report.

Key Takeaways:

  1. Stronger and More Diversified Financial System: As per the report, India’s financial system has become more resilient, inclusive, and diversified since the previous 2017 assessment. Non-bank financial institutions (NBFIs) and market financing (other than from banks) now account for 44% of total financial assets—up from 35% in 2017—reflecting deeper financial intermediation beyond banks.
  2. Reforms Critical for India’s 2047 Growth Vision: The report suggests that to achieve the target of a USD 30 trillion economy by 2047, India must modernize its financial architecture to channel both domestic and foreign savings into productive investment, deepen capital markets, and attract long-term infrastructure and green financing2.
  3. Macroprudential Tools: The assessment highlights rising systemic risks due to financial diversification and interlinkages. It recommends expanding data collection and deploying macroprudential tools—including introducing Debt Service to Income (DSTI) limits across banks and NBFCs and building counter-cyclical capital buffers (CCyBs) for banks to manage liquidity, intersectoral contagion, household credit risks, and climate-related financial risks
  4. Regulatory and Supervisory Enhancements: While India’s regulatory oversight framework for banks, insurers, and markets is broadly sound, lingering issues include state influence on regulators, limited powers over governance of state-owned entities, and gaps in conglomerate and climate-risk supervision. The report suggests that efforts should be made to ensure better coordination between regulators and extending the scope of the regulatory and supervisory frameworks.
  5. Banking and NBFC Reforms: The report stresses adoption of IFRS 9, enforcing Pillar 2 capital add-ons, and elimination of prudential exemptions for state-owned NBFCs. It also suggests considering additional liquidity requirements tailored to different business models.
  6. Tax  treatment of leasing: The report suggests that to diversify MSME finance the tax treatment of leasing should be reviewed to ensure an equal treatment between lease and debt transactions. At present, interest on loans is exempted under the GST laws and hence, there is no GST levied on the loan repayments, however, the entire rentals are subject to GST in case of financial leases.
  7. Transfer of oversight function of NHB to RBI: While regulation of HFCs moved to RBI in 2019, supervision still rests with NHB, which follows a limited, compliance-based approach. Shifting supervision to RBI would strengthen oversight and remove the conflict of interest since NHB also acts as promoter and refinancer for HFCs.
  8. MSME Finance: The report recommends integrating TReDs with the e-invoicing portal for automatic invoice uploads. It also suggests incentivizing large buyers and mandating state-owned enterprises to upload invoices to improve cash flow for MSMEs. Further, the report also mentions that SIDBI’s funding support to NBFCs, including NBFC factors, should be increased, along with developing credit enhancement and guarantee facilities for NBFC bonds and MSME loan securitizations.
  1. https://documents1.worldbank.org/curated/en/099103025110514063/pdf/BOSIB-606133f7-2e00-4696-9b41-57f3737d140d.pdf
    ↩︎
  2. See our resources on sustainable financing: https://vinodkothari.com/resources-on-sustainability-finance/  ↩︎

Karnataka Micro Loan, and Small Loan Ordinance, 2025 

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An attempt to regulate the unorganised microfinance market 

– Team Finserv –  Aditya Iyer | Manager  (finserv@vinodkothari.com) 

Background 

As has been evident from numerous reports, the microfinance sector in India is facing mounting pressure. Rising borrower distress and overindebtedness have led to criticism of microlenders for their aggressive loan sanctions without adequate checks on the borrower’s ability to pay and harsh recovery practices.   Concerns broadly pertain to: Vulnerability of borrowers, cross-selling and opacity of terms, unjustified/usurious rates of interest, multiple loan facilities and coercive methods of recovery etc.

While RBI registered entities are subjected to various regulations such as sector-specific RBI directions on microfinance, MFIN guardrails, NBFC Directions etc. there is not much to regulate the unorganised sector. In an attempt to address these concerns, and curb the challenges faced by local borrowers, the Karnataka Government promulgated ‘The Karnataka Micro Loan And Small Loan (Prevention Of Coercive Actions) Ordinance, 2025’, hereafter referred to as “Ordinance”.  Other states too have attempted to regulate microfinance lending in the past. For instance, the aftermath of the 2010 Andhra Pradesh microfinance crisis, resulted in the Andhra Pradesh Microfinance Institutions (Regulations of Money Lending) Act (2011). Similarly, Assam has also promulgated the Assam Microfinance Institutions (Regulations of Money Lending) Act (2021). The Karnataka ordinance emerges particularly in light of the spate of reported borrower suicides in the region, and reports of usurious recovery practices by lenders. 

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Union Budget 2025: Key Highlights and Reforms focusing on Financial Sector Entities

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Bond Issuance by HFCs: RBI aligns norms with those for NBFCs

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Harshita Malik (finserv@vinodkothari.com)

Introduction:

While all issuance of debentures are governed by general laws under Companies Act, 2013 and SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 (for listed debentures), debt issuance (with maturity of more than one year) on a private placement basis,  by financial entities are also subject to additional regulatory requirements issued by RBI and NHB for NBFCs and HFCs respectively. Notable, the guidelines for HFCs were stricter and more detailed than those for NBFCs imposing a higher level of regulatory oversight and compliance requirements for HFCs. 

The RBI vide its  circular dated the 29th of January, 2025, has made a significant modification to the HFC Master Directions stating that the guidelines applicable to NBFCs for issuance of  NCDs (with a maturity of more than one year) shall mutatis mutandis apply to debenture issuances by HFCs. Accordingly, additional requirements applicable to HFCs stand deleted. Such change reflects a deliberate effort of the regulator to streamline and simplify the regulatory framework, while simultaneously easing the compliance burden for HFCs in issuing NCDs. This is in line with the overall objective of reducing the compliance burden for debt issuances through private placements, which are primarily targeted at institutional and informed investors.

In any case, NCD issuances will still be governed by other regulatory provisions. Where the existing NCDs are listed, the SEBI principle w.r.t. ‘once listed to be always listed’[1] shall continue to apply, thereby requiring listed HFCs to list every subsequent NCDs and comply with governance norms under SEBI Regulations.

It shall be noted that these guidelines are only applicable to NCDs with a maturity period of more than one year, while short-term NCDs with maturity of less than one year, shall be governed by the Master Direction – Reserve Bank of India (Commercial Paper and Non-Convertible Debentures of Original or Initial Maturity Up to One Year) Directions, 2024.

Applicability:

This circular shall be applicable to all fresh private placements of NCDs (with maturity more than one year) by HFCs from the date of this circular, that is January 29, 2025.

Analysis of Changes:

It appears that the RBI has effectively removed such provisions from the HFC Master Directions that were not explicitly mirrored in the SBR Master Directions. The newly inserted Para 56A, drawn verbatim from Para 58 of the SBR Master Directions, retains only such provisions that are common for both .

An analysis of the impact on the applicable provisions of the HFC Master Directions is provided in the table below:

Para No.ParticularsApplicabilityImpact of the change
EarlierNow
57.1Use of NCD proceeds for balance sheet funding only✅✅No change in the purpose of issue
57.2Prohibition on issuing NCDs for group or parent company use✅✅
58.1Minimum maturity period of 12 months for NCDs✅XRemoval of restrictions on exercise date, roll-over and tenor of the NCDs. However, as discussed, these guidelines will only be applicable for NCDs with a tenure of more than one year and short-term debentures will be governed by separate guidelines.   Further, where the Company has obtained credit rating, quite naturally, the tenor would not exceed the validity period.
58.2Option exercise date must exceed one year from issue date✅X
58.3Roll-over of NCDs- not allowed✅X
58.4Tenor of NCDs limited to Credit Rating validity period✅X
59.1Requirement of Credit Rating from approved agencies for issuing NCDs✅XNo requirement to obtain credit rating for issuance of NCDs
59.2Minimum credit rating requirement for timely servicing of obligations✅XSince no requirement to mandatorily obtain credit rating, this provision would no longer be relevant
59.3Ensure current and valid credit rating at NCD issuance✅XNo need to ensure current and valid Credit Rating for NCD issuance
60.1Subscriber limit and security requirement for NCDs with maximum subscription of less than ₹1 crore✅✅No change in maximum number of investors and minimum amount of subscription per investor  
60.2No subscriber limit or requirement for security creation for NCDs with maximum subscription of ₹1 crore and above✅✅
60.3Minimum subscription of ₹20,000 per investor✅✅
60.4Two categories for private placement of NCDs based on subscription amount✅✅
61.1Limit on on amount of NCD issuance based on Board approval or credit rating agency guidelines✅XSince credit rating is not mandatory, the requirement does not seem relevant. However, if the HFC obtains credit rating, naturally, the amount of issuance under such rating will be limited to the amount stated in the letter.
61.2Completion of NCD issuance within 30 days of opening✅XNo time limit for completion of the issue. However, the time lines under Companies Act, 2013 and SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 will apply.
62.1Board-approved policy for resource planning and NCD issuance✅✅No change in the requirement of a Board approved policy
62.2Offer document for private placement of NCDs to be issued within 6 Months of Board resolution✅XNo timeline is there within which offer document has to be issued from the date of passing of board resolution.
63.1Disclosure requirements in offer document for private placement of NCDs✅XThe requirement for disclosure in offer documents as per the HFC Directions has been removed. However, the HFCs shall continue to comply with the disclosure requirements as per Section 42 of the Companies Act, 2013 read with  Rule 14(1) of Companies (Prospectus and Allotment of Securities) Rules, 2014 and Regulation 28 of the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 in case of issuance of listed NCDs
63.2Auditor’s certification requirement✅XNo requirement for obtaining  auditor’s certificate
63.3Compliance with Companies Act, SEBI Regulations, and other applicable laws✅✅While the said provision has not been retained, in any case, any debt issuance will be subjected to provisions of Companies Act, 2013 and Rules framed thereunder shall be applicable, wherever not contradictory, along with other applicable laws.
63.4Issuance of Debenture Certificate in accordance with legal timeframe✅XThis paragraph becomes redundant, as SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 and Rule 9A and Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014, stipulate that securities,  must be issued in dematerialized form only.
64.1Appointment of Debenture Trustee for each issue✅XNo need to appoint a Debenture Trustee
64.2Eligibility criteria for Debenture Trustee✅X
64.3Submission of information by HFCs, based on information provided by theDebenture Trustee,  as required by NHB✅X
65.1Requirement for fully  secured NCDs✅XThis would be relevant only where the debentures are secured in nature. This requirement has been deleted, however, applicable provisions under Companies Act and SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021/SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 will be applicable in case of security creation for secured debentures.
65.2Escrow arrangement for insufficient security cover✅X
65.3Exemption for hybrid or subordinated debt✅X
65.4Exemption for NCDs with  a maturity of more than one year and having the minimum subscription per investor at ₹1 crore and above✅X
66Preference for issuance of NCDs in dematerialized form✅XDirections no longer prescribe a preferred mode of issuance, however, SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 and Rule 9A and Rule 9B of the Companies (Prospectus and Allotment of Securities) Rules, 2014, stipulate that securities,  must be issued in dematerialized form only.
67Prohibition on loans against own debentures✅✅Restrictions on extension of loans against security of HFCs’ own debentures continues
68.1Disclosure in the Board’s report requirements on unclaimed or unpaid NCDs✅XNo requirement of disclosures in the Board’s report. However, disclosure requirements as per applicable laws will continue to apply
68.2Disclosure in the Board’s report requirements on the remaining unclaimed or unpaid NCDs✅X
68AExemption for tax-exempt bonds issued by HFCs✅✅Exemption from applicability of these Directions given to tax exempt bonds continues

[1] https://www.sebi.gov.in/media/press-releases/jun-2023/sebi-board-meeting_73278.html
Our article on the same can be read here-

Mandatory listing for further bond issues

Reserve Bank of India (Commercial Paper and Non-Convertible Debentures of
original or initial maturity upto one year) Directions, 2024

The Clean up call: RBI Action against Lending practices

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Virtual Webinar | 28th October 2024 | 6:15 PM.

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Recent Updates to HFC Directions: What you need to know

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-Chirag Agarwal | chirag@vinodkothari.com

On October 10, 2024, RBI updated the Master Direction – Non-Banking Financial Company – Housing Finance (‘HFC Directions’) applicable to HFCs. The HFC Directions were updated to consolidate various circulars that have been issued since its last update on March 21, 2024. A significant change in this edition is the introduction of a new format for the Most Important Terms and Conditions (MITC) following the rollout of the Key Facts Statement (KFS) vide circular no DOR.STR.REC.13/13.03.00/2024-25 dated April 15, 2024. 

In this article, we will be discussing the changes introduced by the October 10th update to the HFC Directions.

Clarification regarding MITC and KFS

Previously, Para 85.8 of the HFC Directions mandated that to facilitate a quick, and better understanding of the terms and conditions of the housing loan,  a document containing the ‘Most Important Terms and Conditions’ (MITC) must be furnished to the borrower. However, when the KFS circular was first introduced, there was some ambiguity regarding whether both the MITC and KFS would apply to HFCs. This confusion arose because both disclosures contained overlapping information. However, with the recent updates to the HFC Directions on October 10, 2024, clarity has been provided on this matter. The revised regulations clearly state that “the HFCs shall additionally obtain a document containing the other most important terms and conditions (MITC) of such loan (i.e., other than the details included in KFS)”. 

Notably, the MITC has now been renamed as Other Most Important Terms and Conditions (‘OMITC’). The OMITC will no longer include disclosures that are already covered in the KFS. The revised format no longer includes an obligation to disclose details of the loan amount, interest rate, type of interest, details of moratorium, date of reset of interest, installment type, loan tenure, the purpose of the loan, fees and other charges, as well as the details of the grievance redressal mechanisms now exclusively appear in the KFS. Further, other substantive aspects have been retained, i.e., details of the security/collateral for the loan, details of the insurance, conditions for disbursement of the loan, repayment of the loans and interest,  procedure to be followed for recovery, the date on which annual outstanding balance sheet will be issued, and details of the customer services.

This updated approach simplifies the compliance process for HFCs by clearly defining where specific information should be disclosed. It reduces redundancy and ensures that borrowers can find critical information in a consolidated format without surfing through repetitive disclosures. 

Consolidation of Circulars

The following circulars and notifications have been consolidated under the HFC Directions pursuant to the update:

Details of circulars consolidatedOur resources on the topic
Key Facts Statement (KFS) for Loans & AdvancesThe Key to Loan Transparency: RBI frames KFS norms for all retail and MSME loans
Master Directions on Fraud Risk Management in Non-Banking Financial Companies (NBFCs) (including Housing Finance Companies)Revamped Fraud Risk Management Directions: Governance structure, natural justice, early warning system as key requirements
Guidance Note on Operational Risk Management and Operational ResilienceRisk Management Function of NBFCs – A Need to Integrate Operational Risk Management & Resilience
Review of Risk Weights for Housing Finance Companies (HFCs)HFCs: risk weights for undisbursed home loans rationalised
Investments in Alternative Investment Funds (AIFs)Some relief in RBI stance on lenders’ round tripping investments in AIFs
Frequency of reporting of credit information by Credit Institutions to Credit Information Companies–

Conclusion 

To summarise, the recent updates to the HFC Directions not only consolidate past circulars but also clarify the relationship between the MITC and KFS. HFCs can now navigate their disclosure requirements more effectively, enhancing transparency and making it easier for consumers to understand the terms of their loan.

Our other resources on the topic are:-

  1. Aligning Regulations: Harmonizing the Frameworks for HFCs and NBFCs
  2. Housing finance companies regulatory framework: RBI proposes sectoral harmonisation
  3. HFCs: risk weights for undisbursed home loans rationalised

RBI proposes major regulatory restrictions on bank NBFCs and HFCs

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– Vinod Kothari, finserv@vinodkothari.com

Banking regulation is slated to get into a group-wide regulatory framework, embroiling group entities of banks. According to a draft of the proposed regulation circulated on 4th October, 2024,[1] (“Draft Proposal”) NBFCs in the bank group, engaged in lending or housing finance shall be treated as Upper Layer entities, and additionally, shall be subject to the restrictions on lending as applicable to banks. The proposed regulations also provide that there shall be no overlap between the business carried by the bank[2], and that by bank group entities, which, literally, would mean that lending and asset finance business cannot be done by banking group companies, and if the bank has a housing finance subsidiary, housing finance can be done only by the housing finance entity.

Once the draft circular, expected to force banks to do a major group rejig, is finalised, banks will have 2 years time to comply with it. The restrictions are proposed to be put by way of amendments to the 2016 Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016[3] (‘Master Directions’).

The following are some of the major proposals:

  1. Certain activities can be carried only by subsidiaries, and not by banks departmentally

These include activities listed under paragraphs 13, 14(a), 14(b), 15, 16, 17 and 22 in Chapter – III of the Master Directions viz. mutual fund business, insurance business, pension fund management, investment advisory services, portfolio management services and broking services or other such risk-sharing activities that require ring-fencing. While out of the list aforesaid, mutual fund business and Insurance business with risk participation, pension fund management investment advisory services, portfolio management service, broking services for commodity derivatives segment were there in the 2016 Directions as well, the new inclusion seems to be “risk sharing activities that require ring-fencing”. This expression will obviously require explanation. Formation of a limited liability entity is sometimes recommended for the reason of ring-fencing, that is, ensuring that the business liabilities do not go beyond the investment made by the shareholder. Hence, if the activity carried by the bank is something that is in the nature of risk absorption or risk participation, the same can be done only through separate entities.

  1. No overlap in permitted businesses

The most challenging requirement would be to ensure that in case of multiple regulated entities in the same banking group, only one entity within the group shall be allowed to engage in a specific type of permissible business. There should not be any overlap between loan products extended by the bank and its group entities. Hence, in case the group has an HFC extending housing loans, the same shall not be extended by the banking entity.

  1. Bank lending restrictions apply to group entities as well

There are numerous restrictions on lending by banks[4], including lending to connected entities, directors’ interested entities, senior officers, etc. To the extent these are not currently applicable to NBFCs and HFCs, these restrictions will now apply to such entities in the banking group.

Further, the Draft Proposal also provides that group entities shall not be deployed for regulatory arbitrage – they cannot do what is not permitted for the bank.

  1. Bar on investment in Category III AIFs

Banks shall not invest in Cat III AIFs. In case of a bank’s group entities, if the entity is a sponsor of an AIF, it can only hold the minimum investment required as a sponsor [Rs. 1 crore]. Note that earlier in December 2023, the RBI has given a shocker, to curb round tripping of money, prohibiting banks and NBFCs to make investment in such AIFs, which in turn have an investment in borrowers of banks/NBFCs[5]. Further, prior approval from RBI’s Department of Regulations shall be required before investing 20% or more in the equity capital of any financial services company/ Category I or II AIF either individually or collectively by the bank group

  1. The statutory cap of 30% of investee’s capital to include investments by group companies

It is an important provision of the Banking Regulation Act [Section 19(2)] that restricts a bank from holding more than 30% of the equity capital of an investee. This cap shall now include shares held by group companies as well. In existing practice, NBFCs/lending entities in the group are deployed for holding shares or pledges of more than 30%. In fact, one of the proposed changes speaks about shares held indirectly through “trustee companies” as well, raising a question whether shares held by mutual funds and AIFs will also be aggregated. The answer should be negative, as MF and AIF investments cannot be said to be investments held indirectly by the bank, unless the AIF is majority controlled by the bank.

  1. Capital management to be group-wide

The banking group shall have a group-wide capital management policy, enumerating risks and providing economic capital. Understandably, ICAAP will also have to be monitored on a group-wide basis.

Our comments

Veteran bankers are not surprised by the RBI’s move, though, with expected losses, changes in LCR requirements and lot more in the offing, this seems too much over too short a time. In fact, when the non-operating financial holding company (NOFHC) model was recommended in 2013 by the Parliamentary Standing Committee on Finance, it was laid there that “(T)he general principle is that no financial services entity held by the NOFHC would be allowed to engage in any activity that a bank is permitted to undertake departmentally”. The idea of ring fencing of diverse activities was inspired by the need for controlling contagion, alleviation of regulatory arbitrage, etc. The RBI’s Internal Committee named P K Mohanty Working Group also made similar recommendations.

The proposed changes are clearly aimed at curbing any possibility of regulatory arbitrage. Currently, most foreign banks in India have non-banking finance companies; several Indian banks also have NBFCs which are quite large in size and do things which the bank does. In some cases, such as lending against shares, given the NBFC lending norms being more liberal, NBFCs are used for loans against shares, particularly for funding equity investments by group holding companies. Further, NBFCs are not subject to the statutory limit of 30% of the investee company’s capital, by way of ownership, pledge or mortgage. This liberty will no longer be available.

As regards housing finance entities forming part of banking groups, unless the RBI provides a carve out, there will be need to do major corporate restructuring. There are large home loan portfolios both within banks, as also in bank group HFCs. The bank will either need to spin off the housing finance business, or to consider stake sale in HFCs to bring them out of the “group company” definition.

In short, once the proposed changes are finally coded, the banking sector in the country is headed for some very far reaching restructuring changes.

[1] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/DRAFTCIRCULAR0410202419AC7BEE698D41F4BF221D39468A9E59.PDF

[2] There is a list of permissible activities that can be undertaken by the bank, laid down in Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016 (Updated as on August 10, 2021)

[3] 25MD2605164EDAA7B1E214468EBE2D7CC406CA6648.PDF (rbi.org.in)

[4] Prescribed under Master Circular- Loans and Advances – Statutory and Other Restrictions 95MND246C0F34D0041F6831205AB5D695422.PDF (rbi.org.in)

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12572&Mode=0

Other related resources:

  1. RBI bars lenders’ investments in AIFs investing in their borrowers

Aligning Regulations: Harmonizing the Frameworks for HFCs and NBFCs

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Team Finserv (finserv@vinodkothari.com)

Vide notification dated August 12, 2024, RBI has amended certain regulations applicable to Housing Finance Companies, and NBFCs to enure harmonization between HFC Master Directions and SBR Master Directions. These amendments shall be effective from January 01, 2025. The following table contains a snapshot of the changes from all HFCs and NBFCs1:

Sr.Particulars Erstwhile provisionAmended / Harmonised provision
Changes in HFC Master Directions for all HFCs
1Participation in exchange-traded currency derivativesHFCs were allowed to participate in currency futures and options however no regulatory guidelines were prescribed for the same.All HFCs can now participate in currency futures exchanges and Non-deposit HFCs with asset size of ₹1000 crore and above can participate in currency option exchanges, subject to the guidelines issued in the matter by the Foreign Exchange Department of the Reserve Bank and necessary disclosures in the balance sheet in accordance with guidelines issued by SEBI.
3Participation in Interest Rate FuturesHFCs were allowed to participate in interest rate futures however no regulatory guidelines were prescribed for the same.All HFCs can now participate in interest rate futures exchanges as clients and Non-deposit HFCs with asset size of ₹1000 crore and above are permitted to participate in interest rate futures market as trading members, subject to adherence to instructions contained in Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019 dated June 26, 2019, as amended from time to time.
4Credit Default Swaps (CDS)HFCs were allowed to participate in the CDS market however no regulatory guidelines were prescribed for the same.HFCs will now be permitted to participate in the CDS market as users only and they may buy credit protection only to hedge their credit risk on corporate bonds they hold. 

HFCs cannot enter into short positions in CDS contracts.

HFCs shall be required to comply with Annex XIV of SBR Directions while participating in CDS market as users.
5Issue of co-branded credit cardsHFCs were not allowed to issue co-branded cards under the erstwhile directions.HFCs are now allowed to issue co-branded credit cards, subject to the instructions prescribed in Master Direction – Credit Card and Debit Card – Issuance and Conduct Directions, 2022, as amended from time to time.
6Accounting YearEvery HFC shall prepare its financial statements for the year ending on the 31st day of March.HFCs must finalize their balance sheets within 3 months from the relevant date. If an HFC wishes to extend this period under the Companies Act, it must first obtain approval from NHB before seeking an extension from the RoC. In cases where NHB and RoC grants extension of time, the HFC shall furnish to NHB a proforma balance sheet(unaudited) as on March 31 of the year and the returns due on the said date.
7Periodicity of IS AuditThe Audit Committee must ensure that an Information System Audit of the critical and significant internal systems and processes is conducted at least once in two years to assess operational risks faced by the HFC. HFCs can now decide the periodicity of IS Audit as per its policy in accordance with IT Governance Directions. However, a continuous auditing approach for critical systems shall be undertaken.
8Investment through Alternative Investment Funds for calculation of NOFNo regulatory guidelines were prescribedTo determine the Net Owned Funds (NOF) of a Housing Finance Company (HFC), investments or loans to subsidiaries, group companies, and other HFCs exceeding 10% of owned funds are deducted from the owned funds. Investments made by an HFC in group entities, either directly or indirectly through an AIF (if 50% or more of the AIF’s funds come from the HFC) or an AIF trust (if the HFC is the beneficial owner and 50% of the trust’s funds come from the HFC), shall be treated similarly.
9Technical Specifications for all participants of Account Aggregator ecosystemRegulatory provisions did not existHFCs acting either as ‘Financial Information Provider’ or ‘Financial Information User’ are expected to adopt the technical specifications published by ReBIT, as updated from time to time.
Changes in SBR Directions for all NBFCs
7Periodicity of IS AuditThe Audit Committee must ensure that an Information System Audit of the critical and significant internal systems and processes is conducted at least once in two years to assess operational risks faced by the NBFCs. NBFCs can now decide the periodicity of IS Audit as per its policy in accordance with IT Governance Directions. Further, a continuous auditing approach for critical systems shall be undertaken.
  1.  The changes specifically for deposit taking HFCs and NBFCs have note been covered ↩︎