We have discussed the provisions about the different layers of NBFCs, changes in net owned funds, requirements of experience of the Board and certain other requirements in Part I. Now, this Article shall focus upon the forthcoming capital guidelines, prudential regulations, as well as governance norms. As discussed earlier, these changes are effective from October 1, 2022 unless stated otherwise.
Changes in the capital guidelines
In case of NBFC-ML and NBFC-UL, internal capital adequacy requirement is required to be checked internally. The principles which are prescribed for Commercial Banks under the Internal Capital Adequacy Assessment Process of Pillar 2 of the Basel III frame are required to be followed.
For NBFC-UL, there are additional requirements of maintaining Common Equity Tier 1 capital of at least 9 per cent of Risk Weighted Assets, ceiling of leverage, and differential asset provisioning. RBI shall come up with guidelines to further clarity these matters.
Changes in the prudential guidelines
In case of NBFC-ML and NBFC-UL, RBI has clubbed the prescribed limits of concentration of lending and investment. Further, these limits are to be calculated as a % of the Tier I capital.
The revised limits shall be 25% exposure in case of a single borrower/ party and 40% in case of a single group of borrowers/ parties.
Further, the exposure to capital market (direct and indirect) and commercial real estate shall be reckoned as a sensitive exposure for NBFCs. NBFCs shall fix Board-approved internal limits separately for capital market and commercial real estate exposures.
Further, there are restrictions which RBI shall propose with reference to:
- Granting loans and advances to directors, their relatives and to entities where directors or their relatives have major shareholding.
- Granting loans and advances to the senior officers of the NBFC.
- In case of loan proposals involving real estate, the disbursements shall be made only after the borrower has obtained requisite clearances from the government authorities.
In case of NBFC-UL, the Board is required to put in place the internal policy for exposure limits on other important sectors.
Changes in the governance norms
The governance norms have the most far-reaching changes for all types.
For NBFC-BL
RBI has proposed the following norms:
- Constitution of a Risk Management Committee (RMC) either at the Board or executive level. The RMC shall be responsible for evaluating the overall risks faced by the NBFC including liquidity risk and shall report to the Board.
- Disclosure requirements to include types of exposure, related party transactions, loans to Directors/ Senior Officers and customer complaints.
- Framing a Board approved policy on grant of loans to directors, senior officers and relatives of directors and to entities where directors or their relatives have major shareholding.
For the second and third point above, RBI shall issue a detailed circular.
For NBFC-ML and NBFC-UL
RBI has proposed the following norms:
- Except for directorship in a subsidiary, Key Managerial Personnel shall not hold any office (including directorships) in any other NBFC-ML or NBFC-UL. They can be directors in NBFC-BL. A period of two years is provided with effect from October 01, 2022 to ensure compliance with this.
- An independent director shall not be on the Board of more than three NBFCs (NBFC-ML or NBFC-UL) at the same time. Further, the Board of the NBFC shall ensure that there is no conflict arising out of their independent directors being on the Board of another NBFC at the same time. A period of two years is provided with effect from October 01, 2022 to ensure compliance with this.
- Appointment of a Chief Compliance Officer (CCO), who should be sufficiently senior in the organization hierarchy. NBFCs shall put in place a Board approved policy laying down the role and responsibilities of the CCO.
- Putting in place a Board approved compensation policy to align the compensation to the risks. The Nomination and Remuneration Committee shall ensure that there is no conflict of interest.
- The Board shall delineate the role of various committees and lay down a calendar of reviews.
- NBFCs shall formulate a whistle blower mechanism for directors and employees to report genuine concerns.
- The Board shall ensure good corporate governance practices in the subsidiaries of the NBFC.
- NBFCs with 10 and more branches shall adopt Core Banking Solution within a period of 3 years from October 01, 2022.
Additional disclosures for NBFC-ML and NBFC-UL
NBFC-ML and NBFC-UL shall make the following additional disclosures in their Annual Financial Statements with effect from March 31, 2023:
- Corporate Governance report containing composition and category of directors, shareholding of non-executive directors, etc.
- Disclosure on modified opinion, if any, expressed by auditors, its impact on various financial items and views of management on audit qualifications.
- Items of income and expenditure of exceptional nature.
- Breaches in terms of covenants in respect of loans availed or debt securities issued including incidence/s of default.
- Divergence in asset classification and provisioning above a certain threshold to be decided by the Reserve Bank.
Additional norms for NBFC-UL
- The composition of the Board should ensure mix of educational qualification and experience within the Board. Specific expertise of Board members will be a prerequisite depending on the type of business pursued by the NBFC.
- Mandatory listing within 3 years of identification as NBFC-UL. The Company is required to make disclosures like a listed company even before the actual listing as per its Board approved policy.
These additional governance norms shall bring a proper alignment between the risks and rewards of NBFCs. These norms are indicative of the shift towards a partial parity between the banking and NBFC sectors of the economy.
– Team Efficax