RBI mandates appointment of an Internal Ombudsman by NBFCs

Updated as on December 29, 2023

– Team Finserv | finserv@vinodkothari.com

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Our Resources on the topic:

  1. RBI mandates appointment of an Internal Ombudsman by NBFCs
  2. RBI’s Ombudsman storm- Tough road ahead for NBFCs
  3. Ombudsman Scheme for PPI issuers
  4. Extension of Ombudsman Scheme to remaining class of notified NBFCs

Year 2023 in retrospect: Regulatory changes for NBFCs

Aanchal Kaur Nagpal | Senior Manager

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Watch our regulatory round series on YouTube here

RBI bars lenders’ investments in AIFs investing in their borrowers

– Team Finserv | finserv@vinodkothari.com

The Reserve Bank of India on 19th December 2023 issued a notification imposing a bar on all regulated entities (REs) with respect to their investments in AIFs. Highlights of the notification are as below –

What has the RBI done?

  • Prohibited all regulated entities (REs), including banks, cooperative banks, NBFCs and All India Financial Institutions from making investments in Alternative Investment funds (AIFs), if the AIF has made any investment into a “debtor company”.
  • Debtor company means a company in which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months
  • The bar applies immediately, that is, effective 19th Dec 2023. No further investments to be made.
  • If investments already exist, the RE shall exit within 30 days, that is, by 18th Jan 2024
  • Further, if an RE has made an investment in an AIF, and the AIF invests in a debtor company, the RE shall make an exit within 30 days.
  • Investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ subject to full deduction from RE’s capital funds.
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Workshop on RBI Circular on Regulatory Measures on Consumer Credit by Banks & NBFCs

– Vinod Kothari | vinod@vinodkothari.com

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Our Resources on the topic:-

  1. RBI raises red flag on increasing personal loan
  2. FAQs on Regulatory measures towards consumer credit and bank credit to NBFCs
  3. Workshop on RBI Circular on Regulatory Measures in Consumer Credit by Banks & NBFCs (YouTube live)

FAQs on Regulatory measures towards consumer credit and bank credit to NBFCs

– Team Finserv | finserv@vinodkothari.com

One may call it insecure about unsecured lending; the central bank has taken what in our view is a bold and timely measure, to rein in unsecured lending. Identifying a notable surge in specific segments of consumer credit, the RBI had recently met senior bankers. The latter had reportedly assured the central bank that things are under control. However, apparently, these assurances have failed to assuage the RBI’s view. Vide its notification dated November 16, 2023, the RBI has taken several mitigating measures.

We have developed a set of FAQs on the Circular, where we intend to answer some of the critical questions relating to the actionables by the REs and the impact of the circular.

Further, our detailed article on this topic can be read here – RBI raises red flag on increasing personal loans

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ARC rights to use SARFAESI for debts assigned by non-SARFAESI entities

– Archana Kejriwal

Asset reconstruction companies, formed under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’/‘the Act’) are an important part of the country’s ecosystem to tackle non-performing loans. ARCs buy and resolve non-performing loans by acquiring them from the financial system.

ARCs were traditionally focusing on acquiring large corporate loan exposures. However, recently, there is increasing participation of the ARCs in retail loans. When ARCs buy retail loans, it is quite likely that the lender or the loan does not qualify for SARFAESI right when the loan was with the lender. This may be either because of the nature of the lender (NBFCs having assets of less than Rs 100 crores) or the size of outstanding (less than Rs 20 lakhs). In such cases, once the ARC acquires the loans, will it have the rights under the SARFAESI Act?

The question becomes important, because in case of corporate loans, the advantage that ARCs had over the original lender was one of aggregation, that is, ARCs acquiring loans given to the same borrower by various lenders, and thus getting significant strength in relation to the borrower. This cannot be the case, obviously, with retail loans. Hence, if the acquiring ARC is no better than the outgoing NBFC, in what way does the transfer of the loans help to accelerate the recovery?

In this article, we discuss this important question.

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Draft framework for Financial Services Outsourcing

Elevating Risk Management and Regulatory Compliance

– Team Finserv | finserv@vinodkothari.com

Introduction

Financial institutions are increasingly turning to outsourcing for cost efficiency and achievement of strategic objectives. The need and economics of outsourcing are quite clear as there is increasing specialisation in several functions in the lending journey , particularly, cloud-sourcing, use of shared technology, software and applications, etc. However, this reliance on third-party providers introduces challenges and risks like data protection, security, operational resilience, service continuity, shifting of risks and compliance responsibilities to unregulated entities, raising concerns about maintaining control, risk management, and regulatory compliance. This  necessitates  regulatory guidelines for regulated institutions, especially when service providers have concentrated functions or engage in regulated activities.

The concerns about outsourcing by financial entities have been a part of regulatory attention for years. In 2005, the Basel Committee framed General Principles on Outsourcing, and it was indicated in 2023 that these principles will be superseded by new outsourcing principles. The European Banking Authority also has comprehensive guidelines on outsourcing IOSCO also has set principles on outsourcing by entities coming within its regulatory domain. 

Currently, RBI has different guidelines for outsourcing by different financial institutions.  In this article, the author examines the RBI’s recently released Draft Master Direction on Managing Risks and Code of Conduct in Outsourcing of Financial Services (“Proposed Master Direction”/”Draft Master Directions”), intended to repeal the existing guidelines and cover all financial institutions under its gamut, particularly focusing on the major changes, that these Proposed Directions bring with them..  .

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Consolidated NBFC Regulations for all Scales and Functions

– Anita Baid, Vice President | anita@vinodkothari.com

Updated as on 09.11.2023

The Reserve Bank of India (RBI) has issued a notification outlining a new regulatory framework for Non-Banking Financial Companies (NBFCs) on October 19, 2023 (‘SBR Framework’). The RBI has played a crucial role in regulating the NBFC sector over the years. With the sector’s evolution and changing dynamics, the regulator has been proactive in amending regulations. Previously, NBFCs were classified into two categories: systemically important and non-systemically important. However, starting from October 2022, the RBI introduced a new classification system based on layers: base, middle, upper, and top.

The reclassification introduced some progressive changes but also created certain ambiguities in the applicability of regulatory rules. Specifically, the terms “base layer” and “middle layer” were related with non-systemically important (non-SI) and systemically important (SI) NBFCs. When classifying NBFCs based on asset size, those with assets under Rs. 500 crores were considered non-SIs, while those with assets over Rs. 500 crores were classified as SIs.

However, the SBR Framework introduced a different set of criteria. According to this framework, NBFCs with assets less than Rs. 1000 crores are categorized as Base Layer entities, while those with assets exceeding Rs. 1000 crores are classified as Middle Layer entities. This creates a gray area for NBFCs with assets falling between Rs. 500 crores and Rs. 1000 crores.

To address this issue and provide a more streamlined regulatory framework, the RBI has issued the Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 (‘SBR Master Directions’).

The SBR Master Direction, effective immediately, intends to consolidate the various regulations for NBFCs of different scales and functions in one place. The consolidation has streamlined various regulations issued under the SBR Framework governing the different layers of NBFCs. It brings clarity to compliance requirements and ensures that all NBFCs operate within a framework that is consistent and transparent. The SBR Master Directions is divided into sections for different categories of NBFCs, based on size as well as function:

  1. Regulations for Base Layer;
  2. Regulations for Middle Layer (this would be in addition to the regulations for BL);
  3. Regulations for Upper Layer (this would be in addition to the regulations for BL and ML);
  4. Regulations for Top Layer (to be specifically communicated upon classification in TL);
  5. Specific Directions for MFIs this is in addition to the regulations based on layers);
  6. Specific Directions for Factors and NBFCs registered under Factoring Act (this is in addition to the regulations based on layers);
  7. Specific Directions for IDFs (this is in addition to the regulations based on layers).

Further, the specific regulations issued by the RBI would still be relevant and continue to be applicable for Housing Finance Companies, Core Investment Companies, NBFC-P2P, NBFC-Account Aggegator, deposit taking NBFCs, Residuary Non-Banking Companies, Mortgage Guarantee Companies and  Asset Reconstruction Companies. Additionally, based on the classification under the SBR Framework (BL or ML), the relevant provisions of the SBR Master Directions shall be applicable. 

Previously, under the SBR notification dated October 22, 2021, the RBI clarified that all references to NBFC-ND (non-systemically important non-deposit taking NBFC) would now be referred to as NBFC-BL, and all references to NBFC-D (deposit-taking NBFC) and NBFC-ND-SI (systemically important non-deposit taking NBFC) would be known as NBFC-ML or NBFC-UL, depending on the case.

Furthermore, it specified that existing NBFC-ND-SI with asset sizes of ₹ 500 crore and above but below ₹1000 crore (except those necessarily categorized as Middle Layer) would be reclassified as NBFC-BL.

However, upon an initial review of the SBR Master Directions, it appears that certain guidelines that were typically applicable to NBFC-SI and should logically apply to NBFC-ML are explicitly retained for NBFCs with asset sizes exceeding ₹ 500 crores. Here is a list of such guidelines:

  1. Prudential Framework for Resolution of Stressed Assets dated June 07, 2019, as amended from time to time would be applicable on all NBFCs-D and non-deposit taking NBFCs of asset size of ₹500 crore and above. It may be noted that there are specific norms for restructuring of advances by non-deposit taking NBFCs with asset size less than ₹500 crore
  2. Non-Cooperative Borrowers identification shall be done by all NBFC-Factors, NBFCs-D and non-deposit taking NBFCs of asset s.ize of ₹500 crore and above.
  3. Refinancing of Project Loans to any existing infrastructure and other project loans by non-deposit taking NBFCs with asset size less than ₹500 crore.
  4. Framework for Revitalizing Distressed Assets in the Economy shall apply to non-deposit taking NBFCs with asset size less than ₹500 crore.
  5. Early Recognition of Stress and Reporting to Central Repository of Information on Large Credits (CRILC) reporting by all NBFC-Factors, NBFC-D and non-deposit taking NBFCs of asset size of ₹500 crore and above. 

As the financial landscape continues to evolve, the RBI’s proactive approach ensures that the NBFC sector remains well-updated. 

Upon further perusal of the SBR Master Directions, it can be noticed that there are certain regulations that were issued under the SBR Framework that have not been consolidated, such as follows:

  1. Compliance Function and Role of Chief Compliance Officer (CCO) – NBFCs
  2. Implementation of ‘Core Financial Services Solution’ by Non-Banking Financial Companies (NBFCs)

Further, there are specific master directions on information technology framework, fraud reporting, etc. that have not been consolidated. It may also be noted that para 4.2 clarifies that the SBR Master Directions consolidate the regulations as issued by Department of Regulation (DoR); any other directions/guidelines issued by any other Department of the RBI, as applicable to an NBFC shall continue to be adhered to. Accordingly, the aforesaid regulations that were issued by the Department of Supervision (DoS) or Department of Non-Banking Supervision (DNBS) have not been consolidated and are neither listed in the Repeal Section of the SBR Master Directions. There does not seem to be any reason for the aforesaid regulations to be repealed, and hence, it seems that only those circulars and notifications that are issued by the DoR have been considered while compiling the regulations, including those introduced under the SBR Framework. Considering that there are standalone notifications on the aforesaid issued by the DoS or DNBS, therefore, the said regulations should also continue to be applicable.


Our YouTube Series realting to the topic: Tattva

Our Resources on SBR can be accessed here:

Implementation of Compliance Function by NBFC-ML

Eliza Bahrainwala, Executive| eliza@vinodkothari.com

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Our related resources on the topic:-

  1. Enhanced Corporate Governance and Compliance Function for larger NBFCs
  2. Compliance Risk Assessment

Our Resource Centre on SBR:

Display of information on repossession under SARFAESI

– Eliza Bahrainwala, Executive, finserv@vinodkothari.com

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