Provisioning and NBFC

Provisioning and NBFC

Subject: Economy

Section:  banking and finance

Context:

The Reserve Bank of India (RBI) on Monday unveiled norms for provisioning for loans extended by large non-banking financial companies (NBFCs) in the wake of the expanding role played by NBFCs in retail lending.

Details:

It also said the current credit exposures arising on account of the permitted derivative transactions will attract provisioning requirements as applicable to the loan assets in the ‘standard’ category, of the concerned counterparties.

Provisioning:

Under the RBI provisioning rules, banks have to put aside a minimum percentage of funds to cover anticipated losses in the future on account of lending. Banks/Financial Institutions are required to set aside a portion of their income as provision for the loan assets so as to be prepared for any contingent losses that may arise in the event of non-recovery of loans. 

The amount of provision to be kept by the bank/FI, will depend on the probability of loan recovery. This probability of loan recovery is identified based on the asset classification of the loan asset. The minimum provision that a bank has to create for various types of assets is as follows:

Exposure:

• Credit exposure is a measurement of the maximum potential loss to a lender if the borrower defaults on payment. It is a calculated risk to doing business as a bank. “Credit exposure” shall include funded and non-funded credit limits, underwriting and other similar commitments.
• Exposure limit determines the maximum amount a bank can lend to one business house. This is done to prevent the troubles at entities having a spillover effect on the bank which could lead to a systemic risk.
• The Reserve Bank of India has mandated the banks to fix limits on their exposure to specific industry or sectors and has prescribed regulatory limits on banks’ exposure to single and group borrowers in India. This measure of RBI is aimed at better risk management and avoidance of credit risks. In addition to credit exposure banks are required to observe certain statutory and regulatory exposure limits in respect of advances against / investments in shares, convertible debentures / bonds, units of equity-oriented mutual funds and all exposures to Venture Capital Funds (VCFs) as prudential norms.

Regulatory Structure for NBFCs:

NBFCs shall comprise four layers based on their size, activity, and perceived riskiness.

• NBFCs in the lowest layer – Base Layer (NBFC-BL).
• NBFCs in the middle layer –Middle Layer (NBFC-ML) 
• NBFC in the Upper level – Upper Layer (NBFC-UL) 
• The Top Layer is ideally expected to be empty and will be known as NBFC – Top Layer (NBFC-TL).

Base Layer

The Base Layer shall comprise of

(a) non-deposit taking NBFCs below the asset size of ₹1000 crore and

(b) NBFCs undertaking the following activities- (i) NBFC-Peer to Peer Lending Platform (NBFC-P2P), (ii) NBFC-Account Aggregator (NBFC-AA), (iii) Non-Operative Financial Holding Company (NOFHC) and (iv) NBFCs not availing public funds and not having any customer interface1.

Middle Layer

The Middle Layer shall consist of

(a) all deposit taking NBFCs (NBFC-Ds), irrespective of asset size,

(b) non-deposit taking NBFCs with asset size of ₹1000 crore and above and

(c) NBFCs undertaking the following activities (i) Standalone Primary Dealers (SPDs), (ii) Infrastructure Debt Fund – Non-Banking Financial Companies (IDF-NBFCs), (iii) Core Investment Companies (CICs), (iv) Housing Finance Companies (HFCs) and (v) Infrastructure Finance Companies (NBFC-IFCs).

Upper Layer

The Upper Layer shall comprise of those NBFCs which are specifically identified by the Reserve Bank as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology.

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.