Growth of India’s NBFCs means more compliances, regulations. Go digital to keep track

Over 4,000 NBFC regulatory updates are published by more than 2,000 websites every year. This makes it impossible for a compliance officer to keep track.

Representative Image: As of October 2022, 9,500 NBFCs were registered with the Reserve Bank of India (RBI) with a total asset size of Rs 42.05 lakh crore.

From gold to microfinance loans, and from personal to vehicle finance loans, Non-Banking Financial Companies (NBFCs) have been pivotal in promoting credit growth in the unorganised, un-banked, and under-banked sections of the economy. As of October 2022, 9,500 NBFCs were registered with the Reserve Bank of India (RBI) with a total asset size of Rs 42.05 lakh crore.

Typically, the growth of NBFCs is closely linked with a larger geographic branch footprint. The more the number of branches, the higher the reach and subsequently higher the Asset Under Management (AUM). Unfortunately, business growth also significantly increases compliance obligations at central, state and local levels. An NBFC operating in a single state at one location has to comply with at least 621 unique rules in a year with at least 35 one-time registrations and approvals.

Under the compliance categories—finance and taxation, secretarial, commercial, labour, environment, health and safety—industry-specific compliances are also applicable. This article dives deeper into industry-specific compliances.

Compliances and regulations

NBFCs must adhere to Master Directions and Master Circulars issued under the Reserve Bank of India Act 1934, such as the Information Technology Framework 2017, Know Your Customer (KYC) Direction 2016, and ‘Non-Banking Financial Company – Micro Finance Institutions’ 2015 among others. They must also adhere to Fair Practices Code (FPC) and publish those codes on their website. In addition, the borrowers must be informed in regional languages about the terms and conditions of their loans. The staff must be trained to refrain from taking any coercive action during the loan recovery process. The corporations are required to appoint an internal ombudsman, with quarterly and annual submissions of the complaints received and the decisions taken. In addition, all NBFCs must also comply with the various Video Customer Identification Process (V-CIP) compliance requirements as well.

Additionally, NBFCs are required to maintain records and file returns under the Prevention of Money Laundering Act 2002 and Prevention of Money Laundering (Maintenance of Records) Rules 2005. Similar requirements are there under RBI’s guidelines on Fair Practices Code along with other significant regulations. The sector is highly regulated, and the companies must comply with RBI regulations and follow the regulations issued by the Ministry of Corporate Affairs. Each regulation comes with its own set of procedures, documentation, filings and penalties.

Layers of NBFCs

The sector went through a major regulatory overhaul in 2021, when RBI notified the Scale Based Regulation (SBR) to align the regulatory requirements for NBFCs. It was because of the change in their risk profiles, and their evolution in terms of size and complexity. The framework came into effect in October 2022 and it has reclassified NBFCs under four layers: Base Layer, Middle Layer, Upper Layer, and Top Layer. This classification brings into its fold all microfinance institutions, gold loan companies, and vehicle financing companies, to name a few. The scale-based regulations determine which level an NBFC will belong to based on whether the company accepts deposits and whether it is systematically important or not.

The base layer consists of all systematically important and non-systematically important non-deposit-taking NBFCs with asset sizes under Rs 1,000 crore. It also includes peer-to-peer lending platforms, account aggregators, and non-operative financial holding companies, among others. Meanwhile, the middle layer is made up of all systematically important and non-systematically important deposit-taking NBFCs and non-deposit-taking NBFCs with asset sizes over Rs 1,000 crore. Infrastructure debt funds, credit investment companies, housing finance companies, and infrastructure finance companies among others are also part of the middle layer.

RBI holds the authority to move NBFCs into the top two layers based on certain parameters set by them from time to time. In addition, the top 10 eligible NBFCs, in terms of their asset size, will always remain in the upper layer regardless of any other factor. The top layer is inhabited by NBFCs that have seen a substantial increase in their potential systemic risk. NBFCs in the base layer are required to put in place a board-approved policy on the grant of loans to directors, senior officers, and relatives of directors. NBFCs that get put into the upper layer must determine internal exposure limits on important sectors to which credit is extended.

Complex compliance management

Housing finance companies have to deal with a plethora of returns and filings that have to be submitted to the National Housing Board (NHB), which can be quarterly (SARFAESI return, 20-Major exposure return, Schedule-IV return etc.), half-yearly (FDI norms compliance certificate), or annual (Statutory Auditor Certificate). Microfinance institutions are required to maintain margin caps not exceeding 10 per cent and ensure that the total indebtedness of a rural borrower does not exceed Rs 1,00,000. Gold loan companies are required to implement board-approved policies related to the storage and auction of jewellery in case of non-repayment to ensure transparency with adequate prior notice to the borrower.

The aforementioned compliances give us a peek into the complex and dynamic regulatory environment for NBFCs. Over 4,000 regulatory updates are published by more than 2,000 websites every year, which gives fluidity to the compliance ecosystem. But this makes it impossible for a compliance officer to keep track of all ongoing compliances, let alone worry about any updates or amendments that come through. In 2022, there had been more than 27 regulatory updates by RBI that affected the NBFCs. Compliance management for NBFCs is ad-hoc, paper-based, and people-dependent processes that fail to scale. As the NBFCs grow their geographical footprint, they need digital processes that create a transparent, accountable, and timely compliance ecosystem. Companies need to adopt these processes in their compliance management to stay on top of regulatory updates and compliance requirements. Technology-driven culture of compliance will go a long way in ensuring that the company stays on the right side of the law.

Rishi Agrawal is co-founder and CEO, TeamLease Regtech. Views are personal.

(Edited by Ratan Priya)