Introduction
It would be impossible to conceptualise India's current financial system without factoring the large footprint of non-banking finance companies ("NBFCs"), a significant segment of our shadow banking system which complements the traditional business of banking. NBFCs play a crucial role in broadening access to financial services and enhancing competition and diversification of the financial sector. Unlike, banks which are subject to a detailed and rigorous regulatory framework, NBFCs are not subject to inordinately stringent regulations. However, there are substantial risks associated with NBFCs due to their complexity, cross jurisdictional nature and their interconnectedness with the banking system.
Banks continue to remain one of the major sources of funds for NBFCs making it imperative that NBFCs, their liquidity and business are regulated owing to the close connection between these two financial players. It is primarily due to this reason, that the apex bank ("RBI") issued the updated master circular on 'Bank Finance to Non-Banking Financial Companies (NBFCs)' on 5th January 2022 ("Circular"). The Circular seeks to lay down RBI's regulatory policy regarding financing of NBFCs by scheduled commercial banks ("SCBs") in view of the sensitivities attached to certain types of financing activities undertaken by NBFCs. It should be noted that the Circular includes housing finance companies too within the definition of NBFCs and shall be applicable to them as well.
Highlights of the Master Circular
1. Permitted Financing
1.1. The SCBs in general may extend need based working capital facilities as well as term loans to all NBFCs registered with RBI and engaged in infrastructure financing, equipment leasing, hire-purchase, loan, factoring and investment activities subject to other provisions of the Circular.
1.2. The RBI has also permitted SCBs to lend to such NBFCs which are exempt from RBI's registration requirement depending on the SCB's assessment of factors like purpose of credit, nature and quality of underlying assets, repayment capacity of borrowers as also risk perception etc.
1.3. SCBs can also lend to factoring companies subject to certain conditions such as the said company should be deriving at least 50% of its income from factoring activity, conducting its business in accordance with the Factoring Regulation Act, 2011 and financial assistance extended by the factoring companies is secured by hypothecation or assignment of receivables in their favour.
2. Restricted Financing
2.1. In the event any NBFC undertakes/indulges in any of the following activities, such NBFCs shall not be eligible for credit from SCBs:
- bills discounted / rediscounted by NBFCs, except for rediscounting of bills discounted by NBFCs arising from sale of commercial vehicles;
- unsecured loans / inter-corporate deposits by NBFCs to / in any company;
- all types of loans and advances by NBFCs to their subsidiaries, group companies / entities;
- for onward lending to individuals for subscribing to initial public offerings (IPOs) and/or for purchase of shares from secondary market;
- NBFCs engaged in equipment leasing;
2.2. Interim Funding
SCBs have been advised to refrain from granting 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 any NBFCs.
2.3. Guarantee restrictions
SCBs are not permitted to execute guarantees covering inter-company deposits / loans thereby guaranteeing refund of deposits / loans accepted by NBFCs / firms from other NBFCs / firms / trusts or any other institutions.
3. Investments in securities / instruments
3.1. The SCBs are not allowed 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 liquid investments / securities.
3.2. The SCBs are permitted to invest in non-convertible debentures (NCDs) issued by NBFCs with original or initial maturity up to 1 year. However, while investing in such instruments, SCBs should be guided by the extant prudential guidelines in force.
3.3. Shares and debentures (in relation to secured loans granted to NBFC borrowers for any purpose) cannot be accepted by SCBs as collateral security.
4. Other prudential norms
4.1. The exposure of SCBs to a single NBFC (excluding gold loan companies) shall be restricted to 20% of their eligible capital base. However, based on the risk perception, more stringent exposure limits in respect of certain categories of NBFCs may be considered by SCBs.
4.2. The exposure to a group of connected NBFCs or group of connected counterparties having NBFCs in the group will be restricted to 25% of their capital base.
4.3. The exposure of SCB to a single NBFC which is predominantly engaged in lending against collateral of gold jewellery (i.e., such loans comprising 50 per cent or more of their financial assets), shall not exceed 7.5% of the SCB's capital funds.
Conclusion
The Indian financial space has witnessed exponential growth due to the well performing and fast growing NBFC sector. Their scale of operations and diversity in financial intermediation are testimony to their adaptability and agility in transforming their business models to suit the needs of a growing economy. NBFCs rely on both secured and unsecured sources of borrowings for their funding requirements. As per the RBI bulletin of 2021, NBFCs have moved towards longer term borrowings to manage their asset-liability mismatch. Term loans constituted over four-fifth of NBFC bank borrowings at end of December 2020, followed by working capital loans and cash credit.
It is evident that bank borrowings, debentures, and commercial paper are the major sources of funding of NBFCs. While operational freedom for SCBs and NBFCs in credit dispensation and other matters is important, one cannot ignore the need of regulation and supervision of various means of fundings to NBFCs to mitigate and avoid risks of liquidity, asset mismatch etc., that arise due to the complex and closely linked structure of traditional and contemporary banking systems. The present Circular is simply one of the regulatory means to ensure financial discipline and transparency in the economy.
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