RBI’s Prompt Corrective Action for NBFC – Will It Contain the Future Risk

Post providing Framework of Prompt Corrective Action (PCA) for Scheduled Commercial Banks (SCBs) earlier in November, Reserve Bank of India has now come out with similar framework for   Non-Banking Financial Companies (NBFCs).

Framework is imperative for strengthening the financial system as today size of many of the NBFC’s are larger than the banks and poses a deep systemic risk to the financial ecosystem. According to certain estimate top 20 NBFC combined market cap will be bigger than the combined market cap of listed PSU Banks.

Financial eco-system is interconnected directly and indirectly. Risk posed by any one segment of financial eco-system has the potential to risk the entire eco-system, including spill over impact on the wider economy.

PCA framework will strengthen the supervisory capability of RBI and keeping a check on the functioning of the NBFC. Framework is comprehensive and have breadth to cover Deposit Taking NBFCs and Non-Deposit Taking NBFC, barring few exceptions.

Framework will cover Core Investment Companies (CICs), Investment and Credit Companies, Infrastructure Finance Companies, Infrastructure Debt Funds, Micro Finance Institutions on the parameters of Capital, Leverage and Asset Quality 

Framework enables RBI to put any NBFC under the corrective action based on the circumstances warranting such requirement. However, in normal case the framework will be applicable based on the result of Apart from applicability of framework on the basis of outcome of the audited Annual Financial Results.

Three stages of risk threshold have been prescribed for the NBFC under the corrective framework and RBI will restrict NBFC based on the risk threshold. If the NBFC breach the requirement of regulatory minimum CRAR by 300 bps and requirement of regulatory minimum Tier I Capital Ratio by 200 bps, it will be placed under the Risk Threshold-1. If it breaches the limit of CRAR by 600 bps minimum and Tier I Capital Ratio by 400 bps, it will be placed under the Risk Threshold-3.

NBFC falling under Risk Threshold 1 will be restricted from paying dividend and issuance of guarantees. Shareholders will have to infuse liquidity and reduce the leverage. NBFC under Risk Threshold 2 will be additionally restricted from opening new branches. NBFC under Risk Threshold 3 will be further required to reduce Capex and Opex.

Post the recent crises, RBI is working pre-emptively to arrest the risk in the NBFC space. Framework is a recent example in this direction. RBI will engage with the Board of NBFC on various aspects requiring appropriate action and has the power to recommend constitution of new Management. Under the framework, RBI can remove or supersede the Board and impose restrictions on the managerial compensation.  However impact of new regulations, remains to be seen and will be proved in times to come. 

Bureau Galactik Views

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