RBI to Limit Weak NBFCs to Avoid Busts
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It has been almost two decades since the corrective action framework was introduced to bring back fragile banks to health. The banking regulator has now mentioned that soon similar rules would apply to Non-banking Financial Companies (NFBC’s) as various high-profile shadow lenders crumbled in recent years.

The Reserve Bank of India (RBI) mentioned that the framework concerning NBFCs will be effective starting 1 October 2022, depending on their financial position on or post 31 March 2022.

RBI mentioned that there would be a Prompt Corrective Action (PCA) framework concerning NBFCs to intensify the supervisory tools related to NBFCs. As per RBI, there are three risk thresholds due to which an NBFC can be placed under PCA.

Threshold 1:

The Capital Adequacy Ratio (CAR) of an NBFC dips 300 basis points (bps) less than the regulatory minimum of 15%. NBFCs with CAR between 12% and 15% shall not cause an immediate PCA. PCA will kick in when the tier-I capital dips 200 bps less than the regulatory minimum ratio (currently 10%). Threshold 1 could also set in when the net Non-performing Assets (NPA) ratio is more than 6% but equal to or less than 9%.

Threshold 2

When CAR dips more than 300 bps, but up to 600 bps below 15%, i.e. the regulatory minimum or tier-I capital dips more than 200 bps but up to 400 bps below the minimum or the net NPA ratio increases 9%, but does not cross 12%.

Threshold 3

When the capital adequacy of an NBFC dips more than 600 bps below the regulatory minimum, tier-1 capital dips more than 400 bps below the minimum, or when the net NPA ratio increases above 12%. NBFCs will be subjected to different degrees of PCA limitations depending on the threshold triggered.

When an NBFC hits threshold 1, it will face limitations on dividend distribution, and its promoters will need to instil capital and bring down leverage. RBI will not allow them to issue guarantees or take other accidental liabilities on behalf of group firms, in the case of core investment firms.

Under threshold 2, an NBFC cannot open new branches. Under threshold 3, RBI will limit capital expenditure which excludes technological upgrades. Restrictions will apply to variable operating costs too. NBFCs placed under PCAs will be subjected to other RBI’s discretionary actions, such as special supervisory inspections and actions.

For any clarifications/feedback on the topic, please contact the writer at bhavana.pn@cleartax.in

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