Beyond the EU: DORA and NIS 2 Directive's Global Impact
nbfc.docx
1. lending to Non-Banking Financial Companies (NBFCs) in India:
1. Regulatory Framework:
a. Reserve Bank of India (RBI): The RBI is the main regulatory authority
governing NBFCs in India. It formulates and enforces regulations to
maintain financial stability, safeguard depositor interests, and ensure the
smooth functioning of the NBFC sector.
b. Prudential Norms: RBI has established prudential norms to govern NBFC
lending. These norms encompass various aspects, including capital
adequacy, asset classification, provisioning requirements, and exposure
limits. The aim is to maintain the financial soundness of NBFCs and
minimize potential risks.
2. Types of NBFCs:
NBFCs in India are classified into different categories based on their
activities and functions:
a. Asset Finance Companies: These NBFCs primarily provide finance for the
purchase of physical assets like vehicles, machinery, equipment, etc.
b. Loan Companies: These NBFCs focus on granting loans and advances to
individuals and businesses.
c. Investment Companies: These NBFCs primarily invest in securities,
stocks, and other financial assets.
d. Infrastructure Finance Companies: These NBFCs specialize in financing
infrastructure projects, such as power, transportation, telecommunications,
and more.
e. Microfinance Institutions: These NBFCs provide small loans and financial
services to low-income individuals and microenterprises.
f. Housing Finance Companies: These NBFCs focus on providing financing
for the purchase, construction, or renovation of housing properties.
g. Non-Operative Financial Holding Companies (NOFHC): These entities
hold the shares of banking subsidiaries and are mandated for certain
types of NBFCs that wish to set up banking operations.
Each category has specific regulatory requirements and limitations based
on the nature of their activities.
3. Eligible Lenders:
a. Banks: Banks, both scheduled and non-scheduled, are the major lenders
to NBFCs. They provide financial support to NBFCs through direct lending
or by purchasing their debt securities.
b. Other NBFCs: Some NBFCs also engage in lending to other NBFCs. The
RBI imposes regulations on such lending to ensure adequate risk
management and exposure limits.
2. c. Institutional Investors: Institutional investors like mutual funds,
insurance companies, pension funds, and other qualified entities may
participate in lending to NBFCs by investing in their debt instruments.
4. Prudential Exposure Limits:
The RBI has set exposure limits to prevent excessive concentration of risk.
These limits restrict the maximum amount of exposure a lender can have
to a single NBFC or a group of connected NBFCs. These exposure limits
differ based on factors such as the type of lender and the credit rating of
the NBFC.
5. Due Diligence:
Lenders conduct comprehensive due diligence before lending to NBFCs.
This includes evaluating the NBFC's financial position, assessing the quality
of its assets and liabilities, examining the management team's expertise,
scrutinizing risk management practices, and conducting overall viability
assessments.
6. Credit Rating and Creditworthiness:
Lenders consider the credit rating assigned to an NBFC as an important
parameter while assessing its creditworthiness. Credit rating agencies
analyze various factors such as financial performance, asset quality,
management capabilities, and corporate governance to assign credit
ratings to NBFCs. Higher-rated NBFCs generally have easier access to
funding at favorable interest rates.
7. Co-lending Model:
The RBI introduced a co-lending model to boost credit flow to priority
sectors. Under this framework, banks and NBFCs collaborate to provide
loans to sectors such as agriculture, MSMEs, housing, and others. The co-
lending model aims
8. Risk Management and Prudential Norms:
a. Capital Adequacy: NBFCs are required to maintain a minimum level of
capital adequacy to ensure the stability of their operations. The capital
adequacy ratio is calculated as the ratio of owned funds to risk-weighted
assets, and NBFCs must comply with the prescribed minimum capital
adequacy norms.
b. Asset Classification and Provisioning: NBFCs follow asset classification
and provisioning norms similar to banks. Loans and assets are categorized
into different categories based on their repayment status (such as
standard, sub-standard, doubtful, and loss assets), and appropriate
provisions are made to cover potential losses.
3. c. Liquidity Management: NBFCs are required to maintain sufficient
liquidity to meet their obligations. They need to have proper liquidity risk
management systems in place, including maintaining a liquidity coverage
ratio (LCR) to ensure they can handle any liquidity stress.
d. Risk Management Framework: NBFCs are expected to establish robust
risk management frameworks that encompass various risks such as credit
risk, market risk, liquidity risk, and operational risk. This includes
implementing appropriate risk assessment processes, setting risk limits,
and establishing risk monitoring mechanisms.
9. Reporting and Regulatory Compliance:
a. Statutory Reporting: NBFCs are required to submit periodic reports and
financial statements to the RBI, including information on their financial
position, asset quality, capital adequacy, and other regulatory compliance
details. These reports help the regulator monitor the overall health of the
NBFC sector.
b. Regulatory Inspections: The RBI conducts regular inspections and audits
of NBFCs to ensure compliance with regulatory guidelines. These
inspections cover various aspects, including risk management practices,
asset quality, governance, and compliance with prudential norms.
10.Credit Risk and Collateral:
Lenders assess the credit risk associated with lending to NBFCs. They evaluate
factors such as the quality of the NBFC's loan portfolio, historical repayment
track record, industry risks, and the overall economic environment. Collateral,
such as assets pledged by the NBFC, may be considered as security for the loan,
depending on the terms and conditions of the lending arrangement.
11.Default and Resolution:
In cases of default by an NBFC borrower, lenders follow the established legal
and regulatory processes for debt recovery and resolution. Depending on the
severity of the default, lenders may initiate recovery actions, such as
restructuring the loan, enforcing collateral, or resorting to legal remedies.
12.Role of Credit Rating Agencies:
Credit rating agencies play a crucial role in assessing the creditworthiness of
NBFCs. Their ratings provide insights into the financial strength, repayment
capacity, and overall risk profile of the NBFC. Lenders often consider these
ratings while making lending decisions and determining interest rates.
4. It's important for lenders to stay updated with the evolving regulatory landscape
and guidelines issued by the RBI regarding lending to NBFCs. Additionally,
conducting thorough due diligence, understanding the risk profile of the NBFC,
and ensuring compliance with prudential norms are essential for a sound
lending relationship with NBFCs in India.
