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It would be impossible to conceptualize India’s current financial system without considering the large footprint of non-bank financial corporations (“NBFC“), an important segment of our shadow banking system that complements traditional banking. NBFCs play a crucial role in expanding access to financial services and improving competition and diversification in the sector. Unlike banks which are subject to a detailed procedure and rigorous regulatory framework, NBFCs are not subject to excessively strict regulations.However, there are substantial risks associated with NBFCs due to their complexity, cross-jurisdictional nature and their interconnection with the banking system.
Banks remain one of the major sources of funding for NBFCs, making it imperative that NBFCs, their liquidity and their activities be regulated due to the close connection between these two financial players. It is mainly for this reason that the apex bank (“RBI“) issued the updated main circular on “Bank Financing to Non-Bank Financial Companies (NBFCs)” on January 5, 2022 (“Circular“).SCB“) given the sensitivities attached to certain types of finance activities undertaken by NBFCs. It should be noted that the circular also includes housing finance companies within the definition of NBFCs and will be applicable to them as well.
Main Circular Highlights
1. Authorized financing
1.1. SCBs in general can provide need-based working capital facilities as well as term loans to all NBFCs registered with the RBI and engaged in infrastructure financing, equipment leasing, hire-purchase , lending, factoring and investment activities subject to other provisions of the Circular.
1.2. The RBI has also authorized SCBs to lend to such NBFCs which are exempt from the RBI registration requirement based on the SCB’s assessment of factors such as the purpose of the credit, the nature and quality of the underlying assets, the repayment capacity of borrowers as well as the perception of risk, etc.
1.3. SCBs can also lend to factoring companies under certain conditions such as said company must derive at least 50% of its income from factoring business, carry on business in accordance with the Factoring Regulation Act 2011 and benefiting from financial assistance granted by factoring companies is guaranteed by pledging or assignment of receivables in their favour.
2. Restricted Funding
2.1. In the event that an NBFC undertakes/engages in any of the following activities, that NBFC will not be eligible for SCB credit:
- invoices discounted/rediscounted by NBFCs, except for the rediscount of invoices discounted by NBFCs resulting from the sale of commercial vehicles;
- unsecured loans/intercompany deposits by NBFCs to/within any company;
- all types of loans and advances from NBFCs to their subsidiaries, group companies/entities;
- for subsequent loans to individuals for subscription to initial public offerings (IPO) and/or for the purchase of shares on the secondary market;
- NBFCs engaged in equipment rental;
2.2. Interim funding
BCRs have been advised to refrain from granting bridging loans of any kind, or provisional financing against capital/bond issues and/or in the form of loans of a bridging nature pending the lifting of long-term funds in the market in the form of capital, deposits, etc. to all NBFCs.
2.3. Warranty Restrictions
BCRs are not permitted to execute guarantees covering inter-company deposits/loans, thereby guaranteeing the repayment of deposits/loans accepted by NBFCs/companies from other NBFCs/companies/trusts or any other institution.
3. Investments in transferable securities / instruments
3.1. SCBs are not permitted to invest in Zero Coupon Bonds (ZCBs) issued by NBFCs unless the NBFC issuer sets up a sinking fund for all accrued interest and keeps it invested in liquid investments/securities .
3.2. SCBs are permitted to invest in non-convertible debentures (NCDs) issued by NBFCs with an original or initial maturity of up to 1 year. However, when investing in such instruments, BCRs should be guided by applicable prudential guidelines.
3.3. Stocks and debentures (relating to secured loans made to borrowers of NBFC for any purpose) cannot be accepted by BCRs as collateral.
4. Other prudential standards
4.1. SCBs’ exposure to a single NBFC (excluding gold lenders) is limited to 20% of their eligible capital base. However, based on risk perception, more stringent exposure limits with respect to certain categories of NBFCs may be considered by SCBs.
4.2. Exposure to a group of related NBFCs or a group of related counterparties having NBFCs in the group will be limited to 25% of their capital base.
4.3. SCB’s exposure to a single NBFC that is primarily engaged in gold jewelery collateralized loans (i.e. such loans representing 50% or more of their financial assets) must not exceed 7, 5% of SCB’s own funds.
The Indian financial space has grown exponentially thanks to the successful and fast growing NBFC sector. The scale of their operations and the diversity of their financial intermediation testify to their adaptability and agility in transforming their business models to meet the needs of a growing economy. NBFCs rely on both secured and unsecured sources of borrowing for their financing needs. According to the 2021 RBI Bulletin, NBFCs have opted for longer-term borrowing to manage their asset-liability mismatch. Term loans accounted for more than four-fifths of NBFC’s bank borrowings at the end of December 2020, followed by working capital loans and cash credit.
It is evident that bank loans, debentures and commercial paper are the main sources of funding for NBFCs. While the operational freedom of SCBs and NBFCs in credit relief and other matters is important, the need for regulation and oversight of the various means of funding NBFCs cannot be ignored to mitigate and avoid liquidity risks. , asset mismatches, etc., which arise due to the complex and intertwined structure of traditional and contemporary banking systems. This circular is only one of the regulatory means to ensure financial discipline and transparency in the economy.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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