Faced with failure of IL&FS and Dewan Housing, which threatened the stability of the financial system, the Reserve Bank of India (RBI) has now proposed banks-like stiffer regulations for large non banking finance companies (NBFCs) in India.
The objective is to avoid failure of NBFC in future. NBFCs today are as big as any mid-sized banks and deal in unsecured loans like consumer durables, small ticket size loans, credit cards, housing finance, car loan, infra financing etc. In fact, the entire NBFC space has a balance sheet size of close to 35 lakh crore, which is around one fifth of the banking system.
In the late 2000 decade, NBFC problems were more on the asset quality side, whereas the failure of IL&FS and Dewan Housing has exposed the asset liability mis-matches as these NBFCs borrowed short term funds and lent long term. In addition, there are linkages with mutual fund and insurance industry as they borrowed funds from them.
The new regulations call for a new approach to regulatory framework. The RBI has said that large NBFCs based on balance sheet size or business model (riskier business) would be put in an upper layer which will have a new regulatory supervisory framework.
The new regulatory framework would include higher capital adequacy, leverage requirement, liquidity position, standard asset provisioning and governance structure including board and remuneration policies.
The RBI has proposed a new four-layered NBFC structure which would include - Base Layer, Middle Layer, Upper Layer and a possible Top Layer.
"There is also a Top Layer, which is ideally supposed to be empty," says RBI. In other words, if certain NBFCs lying in the upper layer are seen to pose extreme risks as per supervisory judgement, they can be put to significantly higher regulatory and supervisory framework.
The RBI has felt that common equity tier 1 capital (CET 1) requirement could also be introduced for NBFCs in the upper layer to enhance quality of regulatory capital. It is proposed that CET 1 may be prescribed at 9 per cent within the Tier I capital. In addition to the CRAR requirements, NBFCs will also be subjected to leverage requirement to ensure growth is supported by adequate capital.
In the governance area, the RBI has said that board members should be qualified for their position. "The composition of the Board should ensure mix of educational qualification and experience within the Board," says RBI. The removal of Independent Directors before completion of their normal tenure will be subject to approval by supervisors.The NBFCs will also provide detailed disclosure on group companies including consolidated financial position and details of related party transactions. Similarly, the remuneration policies for director, CEOs, etc. will be framed on the lines as applicable to private sector banks.
Many of the well performing NBFCs from Bajaj, Mahindras, Tatas , Aditya Birla are actually well stock with capital and also follow a good governance practises.