Guidance on NBFCs Compliances as Specified by the RBI

Non-Banking Financial Companies (NBFCs) are regulated by the Reserve Bank of India (RBI) and are required to comply with various directions, regulations, and guidelines issued by the RBI to ensure the stability and soundness of their operations. Some of the significant compliances mentioned by the RBI for NBFCs are going to discuss in the article.

Meaning of NBFC

NBFC is define under section 45I(f) of the Reserve Bank of India Act, 1934 means a financial institution involved in the business of loans and advances, stocks, hire-purchase, acquisition of shares, chit business, insurance business, or other business as notified by the RBI.

However, an NBFC does not include any institution whose principal business is agriculture activity, industrial activity, purchase or sale of goods, or providing any services and doesn’t hold any assets of customers other than its own.

Types of NBFCs

There are various types of NBFCs in India. The RBI classifies NBFCs into various categories depend on the type of activities they undertake. Some of its types are:

• Investment and Credit Company (ICC): An ICC is an NBFC that primarily deals in investing in shares, bonds, or debentures; Lending and Asset financial activities.
• Infrastructure Finance Company (IFC): An IFC is an NBFC that provides long-term finance for infrastructure projects.
• Core Investment Company (CIC-ND-SI): A CIC-ND-SI is an NBFC that holds more than 90% of its assets in the form of investments in shares, bonds, or debentures of other group companies.
• Microfinance Institution (MFI): An MFI is an NBFC that provides small loans and other financial services to low-income households.
• Factoring Company: Factors are NBFCs that primarily deal in factoring business, which involves buying accounts receivable of businesses and providing them with funds.
• Housing Finance Company (HFC): An HFC is an NBFC that provides finance for the purchase or construction of houses.
• Account Aggregators (NBFC-AA) – Involving the functions of account aggregation.
• Infrastructure Debt Fund NBFC (IDF-NBFC)- It provides the long-term debt flow into infrastructure projects.
• Peer to Peer Lending (P2P)- Involving the business of a peer-to-peer lending platform, majorly IT driven.
• Mortgage Guarantee Companies (MGC)

Applicability of Directions and Important Compliances

The directions given by the RBI are applicable to all NBFCs, unless particularly exempted by the RBI. NBFCs are needed to comply with the directions issued by the RBI in letter and spirit.

Furthermore, the directions given by the RBI are there with certain significant compliances that NBFCs must follow. These are:

• Annual Return: NBFCs are needed to submit an annual return to the RBI in the given format within 90 days of the end of the financial year.
• Audited Financial Statements: NBFCs are needed to prepare and submit audited financial statements to the RBI in the given format witing 6 months from the end of the financial year.
• Prudential Norms: NBFCs are needed to maintain the minimum capital adequacy ratio, maintain minimum liquidity requirements, and follow asset classification and provisioning norms as specified by the RBI.
• KYC Norms: NBFCs are required to follow the Know Your Customer (KYC) norms while opening accounts of customers.
• Fair Practices Code (FPC): The FPC outlines the standards and practices to be followed by NBFCs while conducting business activity. NBFCs are required to follow the FPC while dealing with customers.  
• Submission of Returns: NBFCs are needed to submit many periodic returns to the RBI. These involve monthly and quarterly retune on prudential norms, asset, classification, and provisioning, among others.
• Audit and Inspection: NBFCs are subject to periodic audits and inspections by the RBI to make sure the compliance with regulatory requirements.
• Anti-Money Laundering (AML) and Combating of Financing of Terrorism (CFT): NBFCs are required to follow AML/CFT instructions issued by the RBI to prevent money laundering and terrorist financing activities.

NBFCs must make sure about compliance with these directions and compliances to maintain their regulatory standing and ensure the soundness and stability of their operations.

Duties and Responsibilities of Auditors in relation to NBFCs

Auditors play a significant role in making certain stability in finance and transparency of NBFCs. The responsibilities of auditors in relation to NBFCs are as follows:

• Audit of Financial Statements: Auditors are responsible for auditing the financial statements of NBFCs to provide an opinion on the accuracy and reliability of the financial information presented. This includes verifying the financial transactions, accounting policies, and disclosures made by the NBFC in accordance with the applicable accounting standards and regulations.
• Reporting of Frauds: Auditors are required to report any frauds or irregularities detected during the audit to the management and the audit committee of the NBFC. They are also required to report to the RBI if the frauds are material or if there is any violation of regulatory norms.
• Compliance with Regulatory Norms: Auditors are required to verify and ensure that the NBFC is complying with the regulatory norms and guidelines issued by the RBI. This includes verifying compliance with the prudential norms, KYC norms, and anti-money laundering (AML) and combating of financing of terrorism (CFT) guidelines.
• Review of Internal Controls: Auditors are required to review the internal control systems of the NBFC to assess their effectiveness in preventing and detecting frauds, errors, and irregularities. They are also required to provide recommendations for improving the internal control systems.
• Certification of Compliance: Auditors are required to issue a certificate of compliance with regulatory norms to the NBFC, as prescribed by the RBI, at the end of each financial year.
• Communication with Shareholders: Auditors are required to communicate with the shareholders of the NBFC through the management on matters related to the audit, including any significant findings or issues identified during the audit.
• Continuing Professional Development: Auditors are required to maintain their professional competence and keep themselves updated with the latest developments in the accounting and auditing standards, regulations, and best practices.

Auditors play a critical role in ensuring the financial stability and transparency of NBFCs by providing an independent and objective assessment of the financial statements and internal control systems, verifying compliance with regulatory norms, and reporting any irregularities or violations detected during the audit.

NBFCs Compliances as Specified by the RBI

NBFCs are regulated by the RBI and are needed to comply with many directions, instructions and regulations issued by the RBI to ensure the soundness and stability of their functions. Some of the key compliances specified by the RBI for NBFCs are as:

• Minimum Capital Adequacy Ratio (CAR): NBFCs are required to maintain a minimum CAR of 15% of their risk-weighted assets. The CAR is a measure of a company‘s financial strength and ability to absorb losses.
• Liquidity Norms: NBFCs are required to maintain a minimum level of liquidity to meet their obligations as they arise. The liquidity requirements are specified based on the nature and size of the NBFC’s business.
• Asset Classification and Provisioning Norms: NBFCs are required to classify their assets into standard, sub-standard, doubtful, and loss categories based on their quality and performance. They are also required to make adequate provisions for their non-performing assets (NPAs).
• KYC Norms: NBFCs are required to follow the KYC norms while opening accounts of customers. This includes obtaining the customer’s identity and address proof, verifying their credentials, and maintaining records of the same.
• Fair Practices Code (FPC): NBFCs are required to follow the FPC while dealing with customers. The FPC outlines the standards and practices to be followed by NBFCs while conducting business activities.
• Anti-Money Laundering (AML) and Combating of Financing of Terrorism (CFT): NBFCs are required to follow AML/CFT guidelines issued by the RBI to prevent money laundering and terrorist financing activities.
• Prudential Norms on Income Recognition, Asset Classification, and Provisioning: NBFCs are required to follow the prudential norms on income recognition, asset classification, and provisioning as specified by the RBI.
• Submission of Periodic Returns: NBFCs are required to submit various periodic returns to the RBI, including monthly and quarterly returns on prudential norms, asset classification, and provisioning, among others.
• Audit and Inspection: NBFCs are subject to periodic audits and inspections by the RBI to ensure compliance with regulatory requirements.
• Corporate Governance: NBFCs are required to comply with the corporate governance guidelines issued by the RBI, which includes maintaining a proper board structure, appointing independent directors, and ensuring transparency and accountability in their operations.

NBFCs are required to comply with various directions, regulations, and guidelines issued by the RBI to maintain their regulatory standing and ensure the stability and soundness of their operations.

Regulatory Changes by Scale-Based Regulation Framework (SBRF)

The RBI introduced the SBRF in November 2019 to replace the previous regulatory framework that was based on asset size. The SBRF is aimed at improving regulatory efficiency and promoting the growth of small NBFCs while ensuring that large NBFCs are subject to more stringent regulations. Some of the key regulatory changes introduced by the SBRF are as follows:

• Constitution of Risk Management Committee (RMC): The board is able to concentrate on risk management, NBFCs introduces RMC, which is either at the Board level or executive one. The RMC shall be manageable for examining the whole risks faced by the NBFC involving liquidity risk and will report to the Board.
• NPA Classification: This norm denotes to move the overdue period of more than 90 days for all sections of NBFCs. A path has been given to NBFCs in Base Layer to attach the 90 days NPA norm by 31st March, 2026.
• Initial Public Offer (IPO) Funding: For the financial subscription to IPO shall be a ceiling of INR 1 Crore to each borrower, but NBFCs are confirmed to fix more limits on conservative.
• Net Owned Funds (NOF): As per the recent regulatory changes by the RBI, the regulatory minimum NOF for NBFC-ICC, NBFC-MFI and NBFC-Factors has been increased to INR 10 crore. This means that these NBFCs are required to maintain a minimum NOF of INR 10 crore to operate as an NBFC.

However, the RBI has provided a glide path for the existing NBFCs to achieve the minimum NOF of INR 10 crore by 31st March 2027. This means that the existing NBFCs have time till 31st March 2027 to increase their NOF to the minimum required level.

Takeaway

In India, NBFCs are a significant section of the financial industry as they play a vital role in giving credit to many parts of the economy. But, being a part of the financial sector, NBFCs are subject to a wide range of regulations and compliances, as specified by the Reserve Bank of India (RBI). The recent changes in the regulatory framework have increased the regulatory minimum Net Owned Fund (NOF) for NBFC-ICC, NBFC-MFI, and NBFC-Factors to INR 10 crore, while the NOF requirement for NBFC-P2P, NBFC-AA, and NBFCs with no public funds and no customer interface remains at INR 2 crore.

It is crucial for NBFCs to ensure compliance with these regulatory requirements, as non-compliance can result in regulatory action by the RBI, which can have a negative impact on the operations and reputation of the NBFC. Therefore, it is important for NBFCs to establish robust compliance mechanisms, including internal controls, policies, and procedures, to ensure compliance with regulatory requirements and maintain the confidence of various stakeholders.