Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs)

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) The Reserve Bank of India (RBI) has played a crucial role in regulating the NBFC sector over the years. With the sector s evolution and growth dynamically the regulator amends the regulations from time to time giving the sector the flexibility to operate efficiently. Previously NBFCs were classified into two categories: Systemically important Non-Systemically important However, On October 19, 2023, the Reserve Bank of India ( RBI ) has issued Master Direction Reserve Bank of India (Non- Banking Financial Company Scale Based Regulation) Directions 2023 ( SBR Master Direction ). The SBR Master Direction aims to harmonize the Previous Framework with the scale-based regulation of NBFCs, published by the RBI on October 22, 2021 ( SBR Framework ). As classified under the, the regulatory structure for NBFCs shall comprise of four layers based on their size, activity, and perceived riskiness into 4 (four) layers, namely, the Base Layer, the Middle Layer, the Upper Layer and the Top Layer. I.BASE LAYER: The Base Layer shall comprise of: 1.Non-deposit-taking NBFCs below the asset size of Rs. 1000 crore; and 2.NBFCs undertaking the following activities- a.NBFC-Peer to Peer Lending Platform (NBFC-P2P); b.NBFC-Account Aggregator (NBFC-AA); c.Non-Operative Financial Holding Company (NOFHC); and d.NBFCs not availing public funds and not having any customer interface. II.MIDDLE LAYER: The Middle Layer shall consist of: 1.All Deposit taking NBFCs (NBFC-Ds), irrespective of asset size; 2.Non-Deposit taking NBFCs with asset size of Rs. 1000 crore and above and; 3.NBFCs undertaking the following activities a.Standalone Primary Dealers (SPDs); b.Infrastructure Debt Fund- Non-Banking Financial Companies (IDF-NBFCs); c.Core Investment Companies (CICs); d.Housing Finance Companies (HFCs); and e.Infrastructure Finance Companies (NBFC-IFCs). CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) III.UPPER LAYER: The Upper Layer shall comprise of those NBFCs which are specifically identified by the RBI as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology as provided under the SBR Master Direction. The top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective of any other factor. IV.TOP LAYER: The Top Layer will ideally remain empty. This layer can get populated if the Reserve Bank is of the opinion that there is a substantial increase in the potential systemic risk from specific NBFCs in the Upper Layer. Such NBFCs shall move to the Top Layer from the Upper Layer. Regulatory changes under SBR for all the layers in the regulatory structure: a.Net Owned Fund- Regulatory minimum Net Owned Fund (NOF) for NBFC-ICC, NBFC-MFI, and NBFC-Factors shall be increased to Rs. 10 crore*. The following glide path is provided for the existing NBFCs to achieve the NOF of Rs. 10 crore. NBFCs Current NOF NBFC-ICC Rs. 2 Crore Rs. 5 Crore NBFC-MFI Rs. 5 Crore (Rs. 2 crore in North East Region) in North East Region) NBFC-Factors Rs. 5 Crore Rs. 7 Crore However, for NBFC-P2P, NBFC-AA, and NBFCs with no public funds and no customer interface, the NOF shall continue to be Rs. 2 Crore. It is clarified that there is no change in the existing regulatory minimum NOF for NBFCs- IDF, IFC, MGCs, HFC and SPD. *Note: there shall be no distinction in the NOF requirement for NBFCs registered in the North East Region. b.NPA Classification- The SBR Master Direction has revised the asset classification norms for NBFCs. The extent NPA classification norm stands changed to the overdue period of more than 90 Days for all categories of NBFCs. A glide path is provided to NBFCs in Base Layer to adhere to the 90 days NPA norm as under- By March 31, 2025 By March 31, 2027 Rs. 10 Crore Rs. 10 Crore Rs. 7 Crore (Rs. 5 Crore Rs. 10 Crore CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) NPA Norms Timeline >150 days overdue By March 31, 2024 >120 days overdue By March 31, 2025 >90 days By March 31, 2026 Explanation: The glide path will not be applicable to NBFCs which are already required to follow the 90 day NPA norm. c.Experience of the Board- The board of directors of any NBFC shall have at least 1 (one) director shall have relevant experience of having worked in a bank/NBFC. d.Ceiling on IPO Funding- There shall be a ceiling of Rs. 1 crore per borrower for financing subscription to Initial Public Offer (IPO). NBFCs can fix more conservative limits. Regulatory guidelines for NBFCs under Top Layer: NBFCs falling under Top Layer shall, inter alia, be subject to higher capital charge. Such higher requirements shall be specifically communicated to the NBFC at the time of its classification in the Top Layer. There will be enhanced and intensive supervisory engagement with these NBFCs. Regulatory changes under SBR for different layers in regulatory structure: Regulatory Revision Regulatory revision applicable to Base Layer (BL) Middle Layer (ML) Upper Layer (UL) Regulatory changes applicable to NBFC- ML and NBFC- UL Capital Guidelines Internal Capital Adequacy Assessment Process (ICAAP) N.A. NBFCs are required to make a thorough internal assessment of the need for capital, commensurate with the risks in their business. The internal assessment shall be on similar lines as ICAAP prescribed for commercial banks under Pillar 2 (Master Circular Basel III Capital Regulations dated July 01, 2015) CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) While Pillar 2 capital will not be insisted upon, NBFCs are required to make a realistic assessment of risks. Prudential Guidelines Concentratio n of credit/ investment N.A. The extant credit concentration limits prescribed for NBFCs separately for lending and investments shall be merged into a single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties. Further, the concentration limits shall be determined with reference to the NBFC s Tier 1 capital instead of their Owned Fund. The revised norms are indicated in the table below: Existing limit Revised limit Lend ing Invest ment Tota l Exposure Single borrow er/ Party 15% 15% 25% Single borrowe r/ Party 25% Single group of borrow ers/ Parties 25% 25% 40% Single group of borrowe rs/ Parties 40% NBFC-UL shall follow these norms till Large Exposure Framework is put in place for them. Extant instructions on concentration norms for different categories of NBFC, other than the changes indicated above, will continue to remain applicable. Sensitive Sector N.A. NBFCs shall fix Board-approved limits for SSE separately for: CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) Capital Market and Commercial real estate exposures. Exposure (SSE) While the Board is free to determine various sub-limits within the overall SSE internal limits, the following are specifically prescribed: A sub-limit within the commercial real estate exposure ceiling shall be fixed internally for financing land acquisition. Ceiling on IPO Funding. Housing Finance Companies shall continue to follow specific regulation on sensitive sector exposure, as are currently applicable in terms of Master Direction Non-Banking Financial Company Housing Finance Company (Reserve Bank) Directions, 2021 Granting loans and advances to directors, their relatives and to entities where directors or their relatives have major shareholding. Granting loans and advances to Senior Officers of the NBFC. While appraising loan proposals involving real estate, NBFCs shall ensure that the borrowers have obtained prior permission from government/ local governments/ other statutory authorities for the project, wherever required. Except for directorship in a subsidiary, Key Managerial Personnel9 shall not hold any office (including directorships) in any other NBFC-ML or NBFC-UL. A timeline of two years is provided with effect from October 01, 2022 to ensure compliance with these norms. It is clarified that they can assume directorship in NBFC-BLs. Regulatory restrictions on loans N.A. Key Managerial Personnel N.A. Independent Director N.A. Within the permissible limits in terms of Companies Act, 2013, an Independent Director shall not be on the CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) board of more than 3 NBFCs, at the same time (NBFC- ML or NBFC-UL). Note: There shall be no restriction to directorship on the Boards of NBFCs-BLs, subject to applicable provisions of Companies Act, 2013. Disclosures N.A. With effect from March 31, 2023, NBFCs are required to make additional disclosures in their Annual Financial Statements: Corporate Governance Report Disclosure on modified opinion Items of income and expenditure of exceptional nature Breaches in terms of covenants/default Divergence in asset classification and provisioning NBFCs are required to appoint a Chief Compliance Officer (CCO), who should be sufficiently senior in the organization hierarchy. NBFCs shall put in place a Board approved policy laying down the role and responsibilities of the CCO with the objective of promoting better compliance culture in the organization. NBFCs shall put in place a Board approved compensation policy. The guidelines shall at the minimum include: Chief Compliance Officer N.A. Compensatio n guidelines N.A. Constitution of a Remuneration Committee Principles for fixed/variable pay structures, and Malus/claw back provisions The Nomination and Remuneration Committee shall ensure that there is no conflict of interest. CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) The Board shall delineate the role of various committees (Audit Committee, Nomination and Remuneration Committee, Risk Management Committee or any other committee) and lay down a calendar of reviews. NBFCs shall formulate mechanism for directors and employees to report genuine concerns. The Board shall ensure good corporate governance practices in the subsidiaries of the NBFC. NBFCs with 10 and more branches are mandated to adopt Core Banking Solution. Other Governance matters N.A. a whistle-blower Core Banking Solution N.A. Note: A glide path of 3 years with effect from October 01, 2022 is being provided Regulatory changes applicable to NBFC- UL Capital Guidelines Common Equity Tier 1 N.A. N.A. NBFC-UL Common Equity Tier 1 capital of at least 9 percent of Risk Weighted Assets. shall maintain Leverage N.A. N.A. NBFC-UL will also be subject to leverage requirement. A suitable ceiling for leverage will be prescribed subsequently for these entities as and when necessary. Differential standard asset provisioning N.A. N.A. NBFC-UL shall be required to hold differential provisioning towards different classes of standard assets. CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) Large Exposure Framework N.A. N.A. Large exposure of an NBFC to all counterparties and groups of connected counterparties will be considered for exposure ceiling. Internal Exposure Limits N.A. N.A. Board of NBFC-UL shall also determine internal limits on other important sectors to which credit is extended. exposure Qualification of Members N.A. N.A. The composition of the Board should ensure mix of educational qualification and within the Board. Board experience Listing Disclosures & N.A. N.A. NBFC-UL shall be mandatorily listed within identification as NBFC-UL. 3 years of Disclosure requirement shall be put in place on the same lines as applicable to a listed company even before the actual listing, as per Board approved policy of the NBFC. Removal of Independent Directors N.A. N.A. NBFC-UL shall be required to report to the supervisors in case any Independent Director is removed/resigns completion of his normal tenure. before Regulatory changes applicable to NBFC- BL Risk Management Committee NBFC shall constitute a Risk Management Committee N.A. N.A. (RMC) CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in

Affluence Advisory Pvt. Ltd. Scale Based Regulation 2023 - Non-Banking Financial Company (NBFCs) either at the Board or Executive Level. The RMC shall be responsible evaluating the overall risks faced by the NBFC liquidity risk and will report to the Board. for including Disclosure Disclosure requirements shall be expanded, inter alia, to include types of exposure, related party transactions, and loans to Director / Senior Officers customer s complaints. N.A. N.A. and Loans directors, senior officers and relatives of directors to NBFC-BL shall have a Board policy on grant of loans to senior officers and relatives of directors and to entities where directors relatives have major shareholding. N.A. N.A. approved directors, or their Disclaimer:This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement CS Sachin Kotian | Affluence Advisory Pvt. Ltd. | Website - www.affluence.net.in |Email - connect@affluence.net.in