Context: Recently, the Reserve Bank of India (RBI) has proposed a four-layered structure for regulating non-banking finance companies (NBFCs). 

Key Points

• It is aimed at tighter capital, lending and governance norms.
• The new norms aim to prevent defaults such as those at Infrastructure Leasing & Financial Services (IL&FS) and Dewan Housing Finance Corp. Ltd (DHFL). 
• The regulatory framework for NBFCs is formulated on a scale-based approach.
• The regulator has sought feedback on the proposals before finalising norms.

About the proposed framework
Base layer: This layer will include the large number of small NBFCs in the country and will subject to the least regulation. It is because they have a limited impact on systemic stability. The proposals for this set of NBFCs include:

• Entry-level net owned funds required to be raised to Rs 20 crore from Rs 2 crore.
• NPA classification norm of 180 days will be harmonized to 90 days.
• Disclosure requirements will be widened by including disclosures on types of exposure, related party transactions, customer complaints.

Middle Layer: It will consist of NBFCs that currently fall in the ‘systemically important’ category along with deposit-taking non-bank lenders. Housing Finance Companies, Infrastructure Finance Companies, Infrastructure Debt Funds, Core Investment Companies. The proposals for this set of NBFCs include:

• It will be subjected to tighter corporate governance norms.
• No changes proposed in the capital-to-risk-assets ratio (CRAR) of 15% with a minimum Tier-I ratio of 10%.
• These NBFCs cannot provide loans to companies for buy-back of securities.
• NBFCs with 10 or more branches will be required to adopt core banking solutions.

Upper Layer: It will include about 25-30 NBFCs and will be subjected to bank-like regulation.

• It will have to implement differential standard asset provisioning and also the large exposure framework as applicable to banks.
• The concept of Core Equity Tier-1 will be introduced for this category and is proposed to be set at 9%.
• They will also be subject to a mandatory listing requirement.

Top Layer: This layer will be empty for now and will be populated with NBFCs, where the RBI may see an elevated systemic risk.

About Non-Banking Financial Company (NBFC)

• It is a company registered under the Companies Act, 1956.
• It is engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities.

The NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:

• NBFC cannot accept demand deposits;
• NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
• Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
• No Non-banking Financial company can commence or carry on business of a non-banking financial institution without obtaining a certificate of registration from the Bank.