RBI’s New Provisioning Norms for Large NBFCs to Increase Compliance Requirements

Posted by Written by Naina Bhardwaj Reading Time: 4 minutes

The Reserve Bank of India (RBI) has recently announced fresh regulations for large non-banking financial companies (NBFCs), altering provisioning norms for standard assets, which are usually risk-free. These norms are a continuation of moves to bridge the regulatory gap between banks and NBFCs. The latest provisioning norms from India’s central bank are expected to reduce liquidity in the short term, thereby affecting interest rates. Financial businesses must note that this move can also lead to an increase in their compliance requirements.

On June 6, 2022, the Reserve Bank of India (RBI) released provisioning norms for standard assets by upper-layer (large) non-banking financial companies (NBFC-UL). According to the regulations, these large or upper layer NBFCs will have to set aside a loan amount in the range of 0.25 – 2 percent for standard assets as provisions, depending on different asset categories like small and micro enterprises (SMEs), real estate, and housing loans.  

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Provisioning of loans refers to recognition by the NBFC of loss on a loan ahead of time. Through provisioning in advance, NBFCs can account for potential defaults and expenses in order to ascertain their financial standing. The new norms on standard asset provisioning will come into effect from October 1, 2022. Currently, large NBFCs make standard asset provision at a flat rate of 0.4 percent.

This move is aimed at regulating these finance companies, given their increasing role in the financial system. The latest norms trail a comprehensive set of guidelines earlier released by the RBI with respect to NBFCs. In October 2021, RBI had introduced a scale based regulatory framework for NBFCs. The structure consists of four layers based on size, activity and perceived riskiness – base layer, middle layer, upper layer, and top layer. The intent behind these regulations is to bring more stability to the shadow banking sector, which has so far been excluded from regulatory oversight.

What is a standard asset?

As per definition by the RBI, a standard asset is one which does not disclose any problems and does not carry more than normal risk attached to the business. Such an asset should not be a non-performing asset (NPA).

What is an upper layer NBFC?

The upper layer shall comprise of those NBFCs that are specifically identified by the RBI as warranting enhanced regulatory supervision based on a set of various quantitative and qualitative parameters, which include:

  • Size and leverage
  • Interconnectedness
  • Complexity
  • Nature and type of liabilities
  • Group structure
  • Segment penetration

The quantitative and qualitative parameters shall have weightage of 70 percent and 30 percent, respectively. Scoring methodology for identification of an NBFC as upper layer NBFC shall be based on the set of NBFCs fulfilling the following criteria:

  • Top 50 NBFCs (excluding top 10 NBFCs based on asset size, which automatically fall in the upper layer) based on their total exposure including credit equivalent of off- balance sheet exposure.
  • NBFCs designated as NBFC-UL in the previous year.
  • NBFCs added to the set by supervisors using supervisory judgment.

What are the new provisioning norms for different assets?

Category of assets

Rate of provision (percent)

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%

It must be noted that the asset category ‘commercial real estate (CRE)’ consists of loans to builders, developers, and others for creation and acquisition of real estate, such as office buildings, retail space, multi-purpose commercial premises, hotels, land acquisition, etc. For this asset category, the prospects for repayment, or recovery in case of default, will depend primarily on the cash flows generated by the asset by way of lease or rental payments, sale etc. Further, loans for third dwelling unit onwards to an individual will be treated as CRE.

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CRE–RH is a sub-category of CRE that consist of loans to builders and developers for residential housing projects. Such projects should ordinarily not include non-residential commercial real estate.

However integrated housing project comprising of some commercial spaces like shopping complex, school etc. can also be specified under CRE-RH, provided that the commercial area in the residential housing project does not exceed 10 percent of the total Floor Space Index (FSI) of the project. In case the FSI of the commercial area in the predominantly residential housing complex exceed the ceiling of 10 percent, the entire loan should be classified as CRE and not CRE-RH.

Current credit exposures to attract provisioning requirement

The RBI has also specified that the current credit exposures arising on account of the permitted derivative transactions shall also attract provisioning requirement, as applicable to the loan assets in the ‘standard’ category. Current credit exposure is the replacement cost of derivatives transactions, that is, their market value, in case the counterparty defaults.

How will this move impact India’s economy?

These regulations are a step in the direction of regulating the Indian financial sector, particularly the Fintech sector. The new regulatory framework will bridge the regulatory gaps between commercial banks and NBFCs/cooperatives. At present, multiple types of NBFCs have mushroomed in India over the last few years, and it is imperative to bring uniformity in their regulation, which was achieved by the RBI through their scale based regulatory framework.

Additionally, with respect to the latest provisioning norms, it is expected that in the short term, higher provisioning would imply a slight reduction in liquidity as more money would end up being set aside and not used for lending. This could in turn lead to an increase in interest rates. However, over time, this move will play a major role in mitigating systemic risks and improving regulatory oversight, further strengthening the NBFC ecosystem.

Large NBFCs must also note that this move will likely result in an increased level of compliance requirements by the NBFCs.

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