Master Circular On Bank Finance To Non-Banking Financial Companies (NBFCs)

Master Circular On Bank Finance To Non-Banking Financial Companies (NBFCs)

Financial activities of the Non-Banking Financial Companies (NBFCs) are regulated by Reserve Bank of India under the provisions of Chapter III B of the Reserve Bank of India Act, 1934. With the amendment of Section 45 IA of the Reserve Bank of India Act, 1934 in January 1997 and amendment of the National Housing Bank Act, 1987 in August 2019, in terms of Section 29 A of the National Housing Bank Act, 1987, all Non-Banking Financial Companies including Housing Finance Companies (HFCs) have to be mandatorily registered with the Reserve Bank of India.

Background

Consistent with the policy of giving greater operational freedom to banks in the matter of credit disbursement and in the context of mandatory registration of NBFCs with the Reserve Bank of India (RBI), most of the aspects relating to financing of NBFCs by banks have also been progressively deregulated. However, in view of the sensitivities attached to financing of certain types of activities undertaken by NBFCs, restrictions on financing of such activities continue to be in force.

Gist of the Master Circular

This Master Circular consolidates instructions on the above matter issued up to January 04, 2022 by which more autonomy have been given to NBFCs registered with RBI and is summarized hereunder:

(a.) The ceiling on bank credit linked to Net Owned Fund (NOF) of NBFCs has been withdrawn where NBFCs are engaged in principal business of asset financing, loan, factoring and investment activities. Accordingly, banks may extend need based working capital facilities and term loans to all NBFCs and engaged in infrastructure financing, equipment leasing, hire-purchase, loan, factoring and investment activities subject to provisions of para 8 of these guidelines.

(b.) Now, banks may also extend finance to NBFCs against second hand assets financed by them.

(c.) Banks may formulate suitable loan policy with the approval of their Boards of Directors within the existing/prudential guidelines and exposure norms prescribed by the Reserve Bank of India to extend various kinds of credit facilities to NBFCs.

Bank Finance to NBFCs not requiring registration

In terms of “Master Direction – Exemptions from the provisions of RBI Act, 1934” dated August 25, 2016, few categories of NBFCs are exempted from certain provisions of the RBI Act, 1934 including the need for registration with the RBI. Such NBFCs need not to register with the RBI and the banks may take their credit decisions on the basis of  purpose of credit, nature ,  quality of underlying assets, repayment capacity of borrowers and  risk perception, etc.

Activities not eligible for Bank Credit

(a.) The following activities undertaken by NBFCs are not eligible for bank credit:

(i) Bills discounted/rediscounted by NBFCs, except for rediscounting of bills discounted by NBFCs arising from sale of commercial vehicles and 2-wheeler and 3-wheeler vehicles subject to the following conditions:

  • the bills should have been drawn by the manufacturer on dealers only,
  • the bills should represent genuine sale transactions as may be ascertained from the chassis/engine number and
  • before rediscounting the bills, banks should satisfy themselves about the bonafides and track record of NBFCs which have discounted the bills.

(ii) Investments of NBFCs in any company/entity by way of shares, debentures, etc. However, need-based credit may be provided to Stock Broking Companies against shares and debentures held by them as stock-in-trade.

(iii) Unsecured loans/inter-corporate deposits by NBFCs to/in any company.

(iv) All types of loans and advances by NBFCs to their subsidiaries, group companies/entities.

(v) Finance to NBFCs for further lending to individuals for subscribing to Initial Public Offerings (IPOs) and for purchase of shares from secondary market.

(b.) Leased and Sub-Leased Assets

Banks can extend financial assistance to equipment leasing companies but they should not enter into lease agreements departmentally with such companies as well as other NBFCs engaged in equipment leasing.

Bank Finance to Factoring Companies

Banks can extend financial assistance to the Factoring Companies which comply with the following criteria with the restrictions mentioned at Paragraph 4.1 (i) and 4.1 (iv) above if:

(a) The companies qualify as Factoring Companies and carry out their business under the provisions of the Factoring Regulation Act, 2011 with notifications issued by RBI from time to time.

(b) They derive at least 50% of their income from factoring activity,

(c) The receivables purchased/financed, irrespective of whether on ‘with recourse’ or ‘without recourse’ basis, form at least 50% of the assets of the Factoring Company ;

(d) The assets/income referred to above would not include the assets/income relating to any bill discounting facility extended by the Factoring Company,

(e) Credit limits extended by the Factoring Companies is secured by hypothecation or assignment of receivables in their favour.

Bank Finance to NBFCs not permitted for:

  •  Bridge loans/interim finance

Banks should not grant bridge loans of any nature or interim finance against capital/debenture issues and/or in the form of loans of a bridging nature pending raising of long-term funds from the market by way of capital, deposits, etc. to all categories of NBFCs.

  •  Advances against collateral security of shares to NBFCs

Shares and debentures cannot be accepted as collateral securities for secured loans granted to NBFC borrowers for any purpose.

  •  Restriction on guarantees for placement of funds with NBFCs

Banks not to execute guarantees covering inter-company deposits/loans thereby guaranteeing refund of all type of deposits/loans accepted by NBFCs/firms from other NBFCs/firms. However, banks are permitted to provide Partial Credit Enhancement (PCE) to bonds issued by NBFC-ND-SIs and Housing Finance Companies (HFCs) as per guidelines contained at para 2.4 of the Master Circular on Guarantees and co-acceptances dated November 09, 2021 as updated from time to time.

Prudential ceilings for exposure of banks to NBFCs

(a.) The definition and method of computation of exposure would be as prescribed in the circular on Large Exposures Framework dated June 03, 2019 and amendments made from time to time.

(b.) Banks’ exposures to a single NBFC (excluding gold loan companies) will be restricted to 20 percent of their eligible capital base (Tier-I capital). However, based on the risk perception, more stringent exposure limits in respect of certain categories of NBFCs may be considered by banks. Banks’ exposures to a group of connected NBFCs or group of connected counterparties having NBFCs in the group will be restricted to 25% of their Tier-I Capital.

(c.) The exposure of a bank to a single NBFC which is predominantly engaged in lending against collateral of gold jewellery (i.e., such loans comprising 50% or more of their financial assets), shall not exceed 7.5% of the bank’s capital funds (Tier-I plus Tier-II Capital). However, this exposure ceiling may go up to 12.5% of banks’ Capital Funds if the additional exposure is on account of funds already lent by such NBFCs to the infrastructure.

(d.) Banks may also consider fixing internal limits for their aggregate exposure to all NBFCs put together.

(e.) Banks should have an internal sub-limit on their aggregate exposures to all NBFCs, having gold loans to the extent of 50% or more of their total financial assets, taken together. This sub-limit should be within the internal limit fixed by the banks for their aggregate exposure to all NBFCs put together as prescribed in paragraph 7.4 above.

(f.) Infusion of eligible Capital Funds, after the published balance sheet date, may also be taken into account for computing exposure ceiling subject to obtaining an external auditor’s certificate on completion of the augmentation of capital and its onward submission to RBI (Department of Supervision) before reckoning the additions to Capital Funds.

(g.) Banks shall adhere to the intra-group limits in accordance with Guidelines on Management of Intra-Group Transactions and Exposures dated February 11, 2014.

Restrictions regarding investments made by banks in securities/instruments issued by NBFCs:

(a.) Banks not to invest in Zero Coupon Bonds (ZCBs) issued by NBFCs unless the issuer NBFC builds up sinking fund for all accrued interest and keeps it invested in Government bonds.

(b.) Banks are permitted to also invest in Non-Convertible Debentures (NCDs) with original or initial maturity up to 1-year issued by NBFCs. However, while investing in such instruments, banks should be guided by the extant prudential guidelines in force, ensuring the disclosure of the purpose for which the NCDs are being issued in the disclosure document and such purposes are eligible for bank finance.

Conclusion:

In view of policy measures to build scale and enhance NBFC’s contribution in 

Global Trade significantly, RBI has brought the master circular, efforts have been made to ease financing to needy borrowers through NBFCs while sensitivities attached to financing have simultaneously been taken care of. We hope this masterstroke would definitely accelerate the trade and economic activity as is expected by Government of India.

Please also refer to previous Master Circular DBR.BP.BC.No.5/21.04.172/2015-16 dated July 1, 2015 on the captioned subject.

For more details on the topic, you may refer to Master Circular no RBI/2021-22/149/ DOR.CRE.REC. No.77/21.04.172/2021-22 dated January 05, 2022 of RBI or access the author at https://www.sunilkumargupta.com/ to explore more on other related topics.

Working of NBFCs Would Improve With Implementation of PCA Framework by RBI

Working of NBFCs Would Improve With Implementation of PCA Framework by RBI

Non-Banking Financial Companies (NBFCs) have been growing in size and have substantial interconnectedness with other segments of the financial system. Reserve Bank of India had introduced a Prompt Corrective Action Framework (PCA) for Scheduled Commercial Banks in 2002 and the same has been reviewed from time to time based on the experience gained and developments in the banking system. Accordingly, RBI has now decided to put in place a PCA Framework for NBFCs to initiate and implement remedial measures in a timely manner so as to restore its financial health for strengthening the supervisory tools applicable to NBFCs.

The PCA Framework for NBFCs, as summarized hereunder, comes into effect from October 1, 2022 based on the financial position of NBFCs on or after March 31, 2022. The objective of the PCA Framework is to enable supervisory intervention at appropriate time and is intended to act as a tool for effective market discipline. The PCA Framework does not preclude the Reserve Bank of India from taking any action as it deems fit at any time in addition to the corrective actions prescribed in the framework.

In terms of extant regulations, Government NBFCs have been provided time up to March 31, 2022 to adhere to the capital adequacy norms provided for NBFCs (Ref. Annex – I of Non-Banking Financial Company – Systemically Important Non-Deposit Taking Company and Deposit Taking Company (Reserve Bank of India) Directions, 2016). Accordingly, a separate circular would be issued in due course with regard to applicability of PCA framework to Government NBFCs. This framework will be reviewed after three years from the date of operation.

PCA Framework for NBFCs

A. The PCA framework is applicable to the following category of NBFCs:

(a) All Deposit Taking NBFCs [Excluding Government Companies] (NBFCs-D)

(b) All Non-Deposit Taking NBFCs in Middle, Upper and Top Layers 3 (NBFCs-ND),

[Including Investment and Credit Companies, Core Investment Companies (CICs), Infrastructure Debt Funds, Infrastructure Finance Companies, Micro Finance Institutions and Factors]; but [Excluding – (iNBFCs not accepting/not intending to accept public funds 4; (ii) Government Companies, (iii) Primary Dealers and (iv) Housing Finance Companies].

B. For NBFCs-D and NBFCs-ND, Capital and Asset Quality would be the key areas for monitoring in PCA framework. For CICs, Capital, Leverage and Asset Quality would be the key areas for monitoring in PCA framework.

C. For NBFCs-D and NBFCs-ND, indicators to be tracked would be Capital to Risk Weighted Assets Ratio (CRAR), Tier-I Capital Ratio and Net NPA Ratio (NNPA). For CICs, indicators to be tracked would be Adjusted Net Worth/Aggregate Risk Weighted Assets, Leverage Ratio and NNPA.

D.NBFC will generally be placed under PCA framework based on the audited Annual
Financial Results and/or the Supervisory Assessment made by the RBI. However, the RBI may impose PCA on any NBFC during the course of a year (including migration from one threshold to another) in case the circumstances so warrant.

E. The Reserve Bank of India may issue a press release when a NBFC is placed under PCA as well as when PCA is withdrawn vis-à-vis a NBFC.

F. Breach of any risk threshold may result in invocation of PCA as detailed under:

For NBFCs-D and NBFCs-ND (excluding CICs):

Indicator

Risk Threshold-1

Risk Threshold-2

Risk Threshold-3

CRAR

Up to 300 bps below the regulatory minimum
CRAR [currently, CRAR <15% but ≥12%]

More than 300 bps but up to 600 bps below regulatory minimum CRAR [currently, CRAR <12% but ≥9%]

More than 600 bps below regulatory minimum CRAR [currently, CRAR <9%

Tier I Capital Ratio

Up to 200 bps below the regulatory minimum
Tier-I Capital Ratio [currently, Tier-I Capital Ratio <10% but ≥8%]

More than 200 bps but up to 400 bps below the regulatory minimum Tier-I Capital Ratio [currently, Tier-I Capital Ratio <8% but ≥6%]

More than 400 bps below the regulatory minimum Tier-I Capital Ratio [currently, Tier-I Capital Ratio <6%]

NNPA Ratio (including NPIs)

>6% but ≤ 9%

>9% but ≤12%

>9% but ≤12%

For Core Investment Companies (CICs)

Indicator

Risk Threshold-1

Risk Threshold-2

Risk Threshold-3

Adjusted
Net Worth/Aggregate Risk Weighted Assets

Up to 600 bps below the regulatory minimum ANW/RWA [currently, ANW/RWA <30% but ≥24%]

More than 600 bps but up to 1200 bps below regulatory
minimum ANW/RWA [currently, ANW/RWA <24% but ≥18%]

More than 1200 bps below regulatory minimum ANW/RWA [currently, ANW/RWA <18%]

Leverage Ratio

≥2.5 times but <3 times

≥ 3 times but <3.5 times

≥3.5 times

NNPA Ratio (including NPIs)

>6% but ≤ 9%

>9% but ≤12%

>12%

G. Exit from PCA and withdrawal of restrictions under PCA – Once a NBFC is placed under PCA, taking the NBFC out of PCA framework and/or withdrawal of restrictions imposed under the PCA framework will be considered: a) if no breaches in risk thresholds in any of the parameters are observed as per four continuous quarterly financial statements one of which should be Annual Audited Financial Statement (subject to assessment by RBI), and b) based on supervisory comfort of the RBI including an assessment on sustainability of profitability of the
NBFC.

H. The menu of corrective actions is as below:

Mandatory and Discretionary actions

Specifications

Mandatory actions

     Discretionary actions

Risk Threshold – 1

1. Restriction on dividend distribution/remittance of profits,

2. Promoters/shareholders
to infuse equity and reduction in leverage,

3. Restriction on issue of guarantees or taking on other contingent liabilities on behalf of group companies (only for CICs)

Common menu

  • Special Supervisory Actions
  • Strategy Related
  • Governance Related
  • Capital Related
  • Credit Risk Related
  • Market Risk Related
  • HR Related
  • Profitability Related
  • Operations/Business Related
  • Any Other

Risk
Threshold – 2

In addition to mandatory actions of threshold: Restriction on branch expansion

Risk
Threshold – 3

In addition to mandatory actions of threshold 1 & 2,

1. Appropriate restrictions on capital expenditure other than for technological upgradation
within board approved limits

2. Restrictions/reduction in variable operating costs

Common Menu for Selection of Discretionary Corrective Actions by the RBI are mentioned below:

1. Special Supervisory Actions

2. Strategy Related Actions

3. Governance Related Actions

4. Capital Related Actions

5. Credit Risk Related Actions

6. Market Risk Related Actions

7. HR Related Actions

8. Profitability Related Actions

9. Operations Related Actions

10. Any other specific action that the RBI may deem fit considering specific circumstances of the NBFC.

RBI would initiate suitable corrective actions including in particular mandatory and discretionary actions to check the wrong doings of the companies. Corrective measures are summarized in brief i.e.  may conduct Special Supervisory Monitoring Meetings  at quarterly or other identified frequency, special inspections/targeted scrutiny of the NBFC, restricted and
need based regulatory/supervisory approvals, review short-term strategy, medium-term business plans, identify achievable targets and set concrete milestones for progress and achievement, may recommend to promoters/shareholders to remove and bring in new management/board, restriction in expansion of high risk-weighted assets, preparation of time bound plan and commitment for reduction of stock of NPAs, restrictions on branch expansion
plans, PCAs would prove to be a milestone in the history of NBFCs and RBI will definitely have more control over NBFCs and would protect interest of the public funds at large.

For more details on the topic, you may refer to circular no RBI/2021-22/139DoS.CO.PPG. SEC.7/ 11.01.005/2021-22 dated Dec. 14, 2021 of RBI or access the author at:  www.sunilkumargupta.com/ to explore more on other topics.