RBI’s New Master regulations for Upper Layer NBFCs: A Step to bridging the gap between a Banking & NBFC format
India’s financial system growing continuously and NBFC’s playing contributing major role in this regard. The central Bank of India i.e. Reserve Bank of India has decided to strengthen its control over the relief organizations of these lenders and decided that large NBFCs are required to allocate 0.25-2% of the loan amount for standardized assets as provisions based on asset classes such as SMEs, real estate and home loans.
BACKGROUND
The Reserve Bank of India (RBI) has issued a set of standards for the provision of standardized assets by the major NBFCs in light of the growing involvement of non-bank financial corporations (NBFCs) in the financial system. The Reserve Bank of India (RBI) recently announced new regulations for large Non-banking financial corporations (NBFCs) and changed reserve standards for standard investments, which are generally risk-free. These standards are a continuation of efforts to close the regulatory gap between banks and NBFC’s. The Central Bank of India’s i.e. RBI latest reserve standards are likely to reduce short-term liquidity, thereby affecting interest rates. Financial companies should keep in mind that this move could also lead to increased compliance requirements.
MEANING OF STANDARD ASSETS
“Standard asset” is defined as an asset that has no record of paying principal or interest in arrears and which shows no signs of deterioration or is at risk above normal business risk. Standard Assets should not be a non-performing asset (NPA).
UPPER LAYER NBFC’s
The top tier includes NBFCs that have been specifically identified by the RBI as worthy of increased regulatory oversight based on a number of different quantitative and qualitative metrics including:
- Size and Leverage
- Interdependence
- Complexity
- Nature and type of liabilities
- Group structure
- Sector penetration
The quantitative and qualitative parameters will weigh 70% and 30% respectively. The valuation methodology used to identify an NBFC as a high-quality NBFC is based on a set of NBFCs that meet the following criteria:
- The 50 largest NBFCs (excluding the 10 largest NBFCs by size of assets that exceed their total commitments, including loans), equivalent to a off-balance sheet exposures.
- NBFC reported as NBFC-UL in prior year.
- NBFC added to pool by regulators following supervisory assessment
RBI provisions require banks to set aside a minimum percentage of funds to cover expected credit losses .NBFCs are required to hold a 0.25% reserve. for outstanding loans on personal home loans and loans to small and micro businesses. For interest rate mortgages, CBFCs must initially withhold 2% of the amount and 0.4% one year after the rate reset. This means that teaser loans typically have lower interest rates in the early years, after which rates fall back to higher levels. The reserve rate will decrease to 0.4 percent per year from the date of the rate reset.
NEW PROVISIONING STANDARDS FOR DIFFERENT TYPES OF ASSETS
| Category of Assets | Rate of Provision (%) |
|
Individual housing loans and loans to SMEs |
0.25% |
| Housing loans extended at teaser (introductory) rates, that is, housing loans having comparatively lower rates of interest in the first few years after which the rates of interest are reset at higher rates | 2%, which will decrease to 0.40% after one year from the date on which the rates are reset at higher rates (if the accounts remain ‘standard’) |
| Advances to commercial real estate – residential housing (CRE – RH) sector | 0.75% |
| Advances to commercial real estate (CRE) sector (other than CRE-RH) | 1% |
| Restructured advances | As stipulated in the applicable prudential norms for restructuring of advances |
| All other loans and advances not included above, including loans to medium enterprises |
0.40% |
Commercial Real Estate Assets (CRE)” are loans to builders, property developers and others for the development and acquisition of properties such as office buildings, shops, mixed-use commercial space, hotels, land acquisition, etc. CRE -RH (Housing) is a subcategory of CRE that groups loans to developers and housing project developers. Such projects typically do not include commercial non-residential real estate.
IMPACT
Large NBFCs will now set aside a higher percentage of their expected outstanding commitment. The ‘reservation’ of the loan is usually the bank/NBFC posting a loss on a loan in advance. This may be part of the Bank/NBFC’s efforts to factor potential defaults into loan collections and fees to try to get a true picture of the Bank/NBFC’s financial condition. In the short term, higher reserves would mean a slight reduction in liquidity as more money would be set aside and not used for lending. This could contribute to a further tightening of interest rates. However, these reserves will play an important role in reducing systemic risk and enhancing long-term regulatory oversight, thereby strengthening the NBFC ecosystem. As a further step towards greater regulation for the NBFC – Upper Tier – standard standards for credit asset reserves have been set, ranging from 0.25% to 2%. This means that the top tier NBFC is required to hold a portion of its gross profits in reserve to be used in the event of adverse circumstances. The provisioning ratio across asset classes was based on the relative weight and priority of advances and inherent risks. Therefore the smallest percentage is 0.25 applies to individual home loans and loans to SMEs with a higher interest rate for purely commercial categories and riskier loan/asset categories. Central bank to tighten regulatory standards for NBFCs. Supply requirements for Residences & Non-residential banks were also changed to bring them in line with commercial banks.
This step will make our financial system more robust and our economic model stronger and more relevant. More regulation will close the gap between the bank format and the NBFC format, making the surviving NBFCs stronger at each stage. It should be noted that RBI regulations require NBFCs to follow certain rules to identify and disclose non-performing assets (NPAs) under asset classification standards. The rules for banks are a little different. Under the new standards, NBFCs will no longer have to earn bad credit on a monthly basis, but on a daily basis. Non- Performing Assets (NPAs) can only be set up for regular accounts after borrowers have paid off all arrears. According to their business model, NBFCs borrow money from banks and lend it to their concentrated customers. Higher NBFC defaults could pose a significant challenge for the banking sector. Therefore, the RBI is looking for ways to reduce the default settings. Despite all the new regulations and other changes in the industry, NBFCs play an important role even if you stick to auto financing. Vehicle financing is an important segment and NBFCs play an important role in it. Companies wishing to engage in all types of financing should consider becoming a bank.” These regulations represent a step towards regulating the Indian financial sector, particularly the fintech sector.
CONCLUSION
The new regulatory framework will fill the regulatory gaps between commercial banks and fill NBFCs/ Cooperatives Currently, many types of NBFCs have emerged in India in recent years and there is a need to standardize their regulation, which has been achieved by RBI with its ladder-based regulatory framework. In addition, compared to the most recent provisioning criteria, it is expected that higher provisioning would mean a slight reduction in liquidity in the short term as more money would be set aside and not used for borrowing. This in turn could increase interest rates. Over time, however, this decision will play an important role in reducing systemic risk and enhancing regulatory oversight, thereby strengthening the NBFC ecosystem. Large NBFCs should also consider that this decision is likely to increase the level of compliance requirements by the NBFC.
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