The Reserve Bank of India’s (RBI) ‘upper layer’ tag is likely to weigh on some non-banking financial companies(NBFCs) given the higher regulatory compliance that comes with the category. The increased compliance requirements may discourage some non-bank lenders from climbing into the upper-layer, say experts.
“In the short term, lenders fear whether they will be able to compete with banks because the cost structures will go up, the compliance requirements will go up,” Bhavik Hathi, managing director, Alvarez & Marsal said, adding that these entities may actually lose out on business if they are unable to get the right kind of customers, right pricing, and reduce their borrowing costs to match the bank’s borrowing costs.
Earlier this month, RBI released its updated list of upper layer NBFCs based on the scale-based regulations for non-bank lenders. This list has 15 NBFCs including Bajaj Finance, Shriram Finance, LIC Housing Finance, and L&T Finance among others. The list does not include Shanghvi Finance, which featured in the 2022 list.
The central bank had issued the scale-based regulations for non-bank lenders in 2021 with an aim to align the regulatory framework for NBFCs in light of the changing risk profile of these entities.
The scale-based regulations classify non-bank lenders into base layer, middle layer, upper layer, and top layer.
While the top layer will ideally remain empty, RBI can place NBFCs into this layer if there is a substantial increase in the potential systemic risk from specific lenders in the upper layer.
On the other hand, the upper layer comprises of those NBFCs which are specifically identified by the RBI as warranting enhanced regulatory requirement on the basis of a set of parameters and scoring methodology. The top ten eligible NBFCs in terms of their asset size shall always reside in the upper layer, irrespective of any other factor.
NBFCs in the upper layer entail a new regulatory superstructure as these have large potential of systemic spill-over of risks and can impact financial stability.
For instance, NBFCs in the upper layer need to get listed within 3 years of identification. Hence, unlisted NBFCs that feature in the upper layer must draw up a board approved road map for compliance with disclosure requirements of listed companies.
Further, NBFCs in the upper layer are required to report to RBI in case any independent director is removed or resigns before the completion of their normal tenure. Previously, these lenders were not required to report this development.
“The higher prudential regulations and intensive supervision that are imposed on NBFCs in the upper layer are proportionate to their systemic significance, however, such stringent regulatory framework could discourage NBFCs from making the climb to the upper layer,” said. Siddharth Srivastava, Partner, Khaitan & Co.
While recent media reports state that Tata Sons is exploring options to shed its upper layer tag, there is also buzz that Bajaj Finance is uncomfortable with its inclusion.
NBFCs were successful so far due to the regulatory arbitrage that they had in comparison to banks. These lenders are used to a certain cost structure, organizational structure, and technology architecture.
With the scale-based norms coming in, the upper layer NBFCs will probably be the most impacted as they would now make a lot of changes like tier-1 capital, provide for standard assets, adhere to single partly exposure norms, and listing norms. These additional compliance requirements will alter the way they do business and could disrupt their operations significantly for the next two-to-three years, say experts.
“Given that Upper Layer NBFCs are now required to face bank-like regulatory supervision, NBFCs may be figuring out ways to avoid being classified as Upper Layer NBFCs,” says Nand Gopal Anand, Partner, J. Sagar Associates.
On the other hand, Saraf and Partners’ Partner Abir Lal Dey feels that some NBFCs may opt to restructure their existing business in order to meet their compliance requirements. There could be a possibility for consolidation to augment the business without compromising the stipulations under the regulations.