Friday, September 9, 2016

NBFC Master Directions 2016: An Analysis

[The following guest post is contributed by Surbhi Jaiswal of Vinod Kothari & Co. She can be reached at surbhi@vinodkothari.com.]

On 1 September, 2016, the Reserve Bank of India (RBI) issued two new sets of master directions, namely the Master Direction - Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016 and the Master Direction - Non-Banking Financial Company - Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (Collectively referred to as “Master Direction”) for Non-Banking Financial Companies (NBFCs) wherein the RBI has compiled all its earlier fragmented regulations, namely prudential norms, fair practice codes, registration requirements, and so on that are applicable to an NBFC, so as to place them under one umbrella.

A few days earlier, the RBI had come out with a similar direction for Core Investment Company (CIC), namely the Master Direction - Core Investment Companies (Reserve Bank) Directions, 2016) (CIC Directions 2016) wherein it had consolidated all regulations applicable to a CIC under one roof.

Likewise, with the Master Directions in place, it will not be necessary to navigate across various circulars to understand the various regulations applicable to an NBFC. One will not have to look beyond these new directions. The Consolidation not only aids in more easily tracing the diverse regulations applicable to an NBFC, but it has also addressed the confusion pertaining to asset aggregation of multiple NBFCs in a group for determining the SI status. The same has been dealt below.

Multiple NBFCs

Pursuant to para 7.1 of the revised regulatory framework issued through a circular, CC No. 002 dated November 10, 2014, the concept of multiple NBFCs was introduced wherein the total assets of NBFCs in a group including deposit taking NBFCs, if any, will be aggregated to determine if such consolidation falls within the asset sizes of the two categories viz., NBFCs-ND (those with assets of less than 500 crore) and NBFCs-ND-SI (those with assets of 500 crore and above). The consequence of this consolidation was far-reaching. Where the total of the assets of all NBFCs in the group would go beyond Rs. 500 crores, prudential norms as applicable to an NBFC-ND-SI would become applicable to all small NBFCs in the group as well. This meant that such small NBFCs had to comply with the stringent norms of capital adequacy, credit concentration norms etc. The introduction of this requirement was carried out with the purpose of curbing the malpractice of various corporates, who would float various NBFCs carrying on the same business merely to escape the rigid requirements laid down by the RBI. The consolidation was faced with various hurdles, of which one pertained to the inclusion of assets of CICs in the group. Following were the views taken by the companies:

1.         Aggregation of assets of NBFCs and all CICs (SIs and Non-SIs): The rationale behind this approach is that CICs in their very foundation are nothing but NBFCs, therefore they are to be included in the asset aggregation process.

2.         Aggregation of assets of NBFCs and only CIC-SIs: The rationale was same as above, however, RBI by way of its FAQs on NBFCs clarified that CICs that were exempted from registration shall not be included in the asset aggregation process. The text of FAQs is as follows:

“Q 82. In terms of para 7.1 of the revised regulatory framework issued vide CC No. 002 dated November 10, 2014, total assets of NBFCs in a group including deposit taking NBFCs, if any, will be aggregated to determine if such consolidation falls within the asset sizes of the two categories viz., NBFCs-ND (those with assets of less than 500 crore) and NBFCs-ND-SI (those with assets of 500 crore and above). Regulations as applicable to the two categories will be applicable to each of the NBFC-ND within the group. Will this aggregation of assets apply to exempted category of CICs in the group?

Ans. No, the group requires to aggregate total assets of only those NBFCs which have been granted Certificate of Registration by the Bank. However, it must be ensured that the capital of the exempted category of CIC has not come, directly or indirectly, from an entity/ group company which has accessed public funds.” (Emphasis Supplied)
           
Therefore, companies only included the assets of CIC-SIs.

3.         Aggregation of assets of only NBFCs in the group: The rationale behind this approach was that CICs, even though are NBFCs, but are governed by different set of directions, therefore are not to be included in the asset aggregation process.

Master Directions clear the fog

The Master Directions have cleared the ambiguity regarding inclusion of CICs in the asset aggregation process. Para 2 of the Master Directions deals with the applicability of these Directions. It clearly spells out the category of NBFCs to which these are applicable. For ease of reference the text of the directions has been reproduced below.

Para 2 of the Non-Banking Financial Company - Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 states the following:

“2. Applicability

(1) The provisions of these Directions shall apply to the following:

(i) every Systemically Important Non-Deposit taking Non-Banking Financial Company (NBFC-ND-SI) registered with the Bank under the provisions of RBI Act, 1934;

(ii) every Deposit taking Non-Banking Financial Company (NBFC-D) registered with the Bank under the provisions of RBI Act, 1934;

(iii) every NBFC-Factor registered with the Bank under section 3 of the Factoring Regulation Act, 2011 and having an asset size of ` 500 crore and above;

(iv) every Infrastructure Debt Fund – Non-Banking Finance Company (IDF-NBFC) registered with the Bank under the provisions of RBI Act, 1934;

(v) every Non-Banking Finance Company – Micro Finance Institutions (NBFC-MFIs) registered with the Bank under the provisions of RBI Act, 1934 and having an asset size of ` 500 crore and above;

(vi) every Non-Banking Finance Company - Infrastructure Finance Company (NBFCIFC) registered with the Bank under the provisions of RBI Act, 1934 and having an asset size of ` 500 crore and above.

(2) The Category of NBFCs as mentioned at points (i) to (vi) above are hereafter referred to as ‘applicable NBFCs’, for the purpose of these Directions. Specific directions applicable to specific categories of NBFCs registered as NBFC-Factors, 5 IDF-NBFCs and NBFC-MFIs are as provided for under respective Chapters in these Directions (Emphasis Supplied)
XXX”

Further, para 2 of the Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016 states the following:

“2. Applicability

 (1) The provisions of the Directions shall apply to the following:

(i) every non-banking financial company not accepting / holding public deposits which is not systemically important (as defined in paragraph3 (xxviii) of the Directions;

(ii) every NBFC-Factor registered with the Bank under section 3 of the Factoring Regulation Act, 2011 and having an asset size of below ` 500 crore;

(iii) every Non-Banking Finance Company – Micro Finance Institution (NBFC-MFI) registered with the Bank under the provisions of RBI Act, 1934 and having an asset size of below ` 500 crore;

(iv) every Non-Banking Finance Company - Infrastructure Finance Company (NBFCIFC) registered with the Bank under the provisions of RBI Act, 1934 and having an asset size of below ` 500 crore.

(2) The Category of NBFCs as mentioned in points (i) to (iv) above are hereinafter referred to as ‘applicable NBFCs’, for the purpose of these Directions. Specific directions applicable to specific categories of NBFCs registered as NBFC-Factors, NBFC-IFC and NBFC-MFIs are as provided for under respective Chapters in these Directions.
XXX” (Emphasis Supplied)

On reading the applicable section, it is apparent that CICs do not come under these Regulations at all. Further, Para 15 of the Master Direction lays down the requirement of asset aggregation of NBFCs in the group. It states that:

“15. Multiple NBFCs

Applicable NBFCs that are part of a corporate group or are floated by a common set of promoters shall not be viewed on a standalone basis. The total assets of the NBFCs in a group including deposit taking NBFCs, if any, shall be aggregated to determine if such consolidation falls within the asset sizes of the two categories i.e. those with asset size of below 500 crore and those with asset size of 500 crore and above. Regulations as applicable to the two categories shall be applicable to each of the non-deposit taking NBFC within the group. For this purpose, Statutory Auditors are required to certify the asset size of all the NBFCs in the Group. However, NBFC-D, within the group, if any, shall be governed under the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Direction, 2016 and Prudential Norms and other Directions as applicable to deposit taking NBFCs.”

On reading the above it is clear that the assets of only Applicable NBFCs are required to be aggregated and Applicable NBFCs have been defined and the same does not include CICs.

It is only correct as CICs have their own set of directions which covers the Regulations applicable to a CIC. Further, inclusion of CICs in the aggregation process meant that where the total asset size would go beyond Rs. 500 crores, prudential norms, as applicable to SIs would become applicable to CIC as well. This was very counter-intuitive as CICs have to follow a different set of directions wherein they have to comply with their own specific requirements pertaining to capital, leverage etc. Moreover, they were specifically exempted under the earlier SI directions from complying with various prudential requirements, so the intention of RBI was definitely not to bring CICs within the purview of SI directions. Therefore, the inclusion of CICs in asset aggregation process of NBFCs was completely unwarranted as they would do nothing but inflate the asset size. The Master Directions have therefore made the position very clear.

Further, there was a minor change in para 4.7 of Annex XII of the Master Direction pursuant to which disclosure of the impact of prior period items on the current year's profit and loss would have to be made in the notes to accounts. Previously, disclosure of impact was not mandatory; however the same is mandatory now.

Conclusion

As stated earlier, the nature of the Master Directions is largely a consolidating one, so there are no major changes in the regulations. The RBI is merely following the trend of consolidating the provisions under one umbrella. This is nothing but beneficial, since with these new directions in place one will not have to look beyond them to understand the provisions applicable to an NBFC.

- Surbhi Jaiswal

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