Home / Industry / Banking /  RBI will rein in fragile NBFCs to avert busts
Listen to this article

Nearly two decades after introducing the prompt corrective action framework to nurse wobbly banks back to health, the banking regulator on Tuesday said similar rules would soon apply to non-banking financial companies following several high-profile shadow lenders collapsing in recent years.

The framework for NBFCs will take effect on 1 October 2022, based on their financial position on or after 31 March 2022, the Reserve Bank of India said in a statement. It will cover all deposit-taking NBFCs, and middle, upper, and top non-deposit taking NBFCs.

“NBFCs have been growing in size and have substantial interconnectedness with other segments of the financial system. Accordingly, it has now been decided to put in place a PCA framework for NBFCs to further strengthen the supervisory tools applicable to NBFCs," RBI said.

The regulator introduced PCA for weak banks in 2002, with restrictions on loans, dividends and new branches, and has fine-tuned it over the years. Currently, Central Bank of India is the only lender under PCA, which has seen the entry and exit of several banks over time. During this period, NBFCs have posted rapid growth. Still, the sector has also witnessed the collapse of large shadow lenders such as Infrastructure Finance and Leasing Services Ltd (IL&FS) and Dewan Housing Finance Corp. Ltd. The new rules aim to increase supervision of NBFCs and allow the central bank to impose curbs on entities that miss benchmarks on capital requirements, non-performing assets and leverage.

The central bank listed three risk thresholds that could result in an NBFC being placed under PCA.

Threshold 1 is when an NBFC’s capital adequacy ratio (CAR) falls 300 basis points (bps) below the regulatory minimum of 15%. NBFCs having CAR between 12% and 15% will not trigger an immediate PCA.

If the tier-I capital, or core capital, falls 200 bps below the regulatory minimum ratio, which stands currently at 10%, again, PCA will kick in.

Importantly, the first risk threshold will also be triggered if the net non-performing assets (NPA) ratio is greater than 6% but less than or equal to 9%.

Threshold 2 will be triggered if CAR falls more than 300 bps, but up to 600 bps below the regulatory minimum of 15%, or tier-I capital falls more than 200 bps but up to 400 bps below the minimum or the net NPA ratio rises above 9%, but does not cross 12%.

Threshold 3 will apply when an NBFC’s capital adequacy falls more than 600 bps below the regulatory minimum, tier-1 capital falls more than 400 bps below the minimum, or if the net NPA ratio rises above 12%.

NBFCs will face varying degrees of PCA restrictions based on the threshold triggered.

An NBFC which has hit threshold 1 will face restrictions on dividend distribution, and its promoters will be asked to infuse capital and reduce leverage. The central bank will also restrict them from issuing guarantees or taking other contingent liabilities on behalf of group companies, in the case of core investment companies.

Under threshold 2, NBFCs will not be allowed to open new branches, while under threshold 3, RBI will put restrictions on capital expenditure, excluding technological upgrades. There would also be restrictions on variable operating costs.

These NBFCs will also face other discretionary actions from RBI, such as special supervisory actions and inspections.

“The thresholds around total capital adequacy and tier-I capital for classification of an NBFC in the PCA category are liberal; however, some entities could breach the net NPA criterion of more than 6% if their asset quality does not improve. Among large NBFCs with asset sizes more than 25,000 crore), ICRA notes that about three entities are in breach of the net NPA criterion as of September 2021. However, all these entities have established parentage," said A.M. Karthik, vice-president and head of financial sector ratings at ICRA Ltd.

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Recommended For You
Edit Profile
Get alerts on WhatsApp
Set Preferences My ReadsFeedbackRedeem a Gift CardLogout