Guest Post: Nachiket Mor Committee Recommends Bank – NBFC Convergence

[This post has been contributed by Shampita Das of Vinod Kothari &
Company. The author may be contacted at shampita@vinodkothari.com]
The Reserve Bank of India (RBI) in September, 2013 had set
up a ‘Committee on Comprehensive Financial Services for Small Businesses and
Low-Income Households’, under the Chairmanship of Dr. Nachiket Mor, Member on RBI’s
Central Board of Directors. The main objective of the Committee was to prepare
a detailed report on India’s vision for financial inclusion and financial
deepening and to review existing strategies and develop new ones to achieve the
objective of financial inclusion and financial deepening.
The RBI on 7
January 2014 released the Report
of the Committee on Comprehensive Financial Services for Small Business and Low
Income Households
 for public comments on or before 24 January 2014.
The Committee advocated convergence of certain regulatory aspects
between banks and non-banking finance companies (NBFCs) based on the principle
of neutrality on the lines of the Usha Thorat Committee recommendations.
Convergence
Recommendations of the Committee
The Committee, while providing the rationale for the
convergence of banks and NBFCs, noted the regulatory similarities between them
in terms of capital adequacy rules on credit risks, risk-weighting of assets,
provisioning & non-performing asset (NPA) norms and the applicability of
fair practices code. They pictured a scenario where NBFCs operate not merely as
shadow banks but as an integral part of the larger banking system. It gave the example
of the French banking legislation where irrespective of how credit institutions
fund themselves, they are considered banks, and, as such, subject to all
banking regulation.
The Committee suggested that the priority sector lending
norms and the lender of last resort facility should not be made applicable to
NBFCs.
The following will provide an overview of the regulations for
which convergence is suggested between NBFCs and banks:
Regulation: Duration to qualify for NPA
Banks: Non-repayment
for 90 days
NBFCs: Non-repayment
for 180 days
Recommendation: Case
for convergence. Risk-based approaches to be followed for both types of
institutions.
Regulation: Definition of sub-standard asset
Banks: NPA for a
period not exceeding 12 months
NBFCs: NPA for a
period not exceeding 18 months
Recommendation: Case
for convergence. Risk-based approaches to be followed for both types of
institutions.
Regulation: Remaining
sub-standard asset for a period of 12 months
Banks: Remaining
sub-standard asset for a period of 12 months
NBFCs: Remaining
sub-standard asset for a period of 12 months
Recommendation: Case
for convergence. Risk-based approaches to be followed for both types of institutions.
Regulation: Quantum
of provisioning for Standard Assets
Banks: 0.40%[1].
For direct advances to agricultural and Small and Micro Enterprises (SMEs)
sectors at 0.25%
NBFCs: 0.25%
Recommendation: Case
for convergence. Risk-based approaches to be followed for both types of
institutions. For agricultural advances, this would imply at least 0.40%.
Regulation: SARFAESI[2]
eligibility
Banks: Yes
NBFCs: No
Recommendation: Case
for convergence subject to strong customer protection
As can be seen from the above, the Committee has suggested
convergence of the regulatory norms with regard to classification of
non-performing assets, provisioning requirements and the eligibility under
SARFAESI Act, 2002.

Summary of the recommendations:

1. NPA recognition and provisioning requirements: As in the case of
banks, different customer-asset combinations behave very differently from each
other and it is recommended that the regulator specify NPA recognition and
provisioning rules, including for standard assets, at the level of each
asset-class and require that all NBFCs conform to these mandates. Similar to
banks, the Committee suggested that on standard assets provisioning levels as
well as asset classification guidelines specified by RBI would need to reflect
the underlying level of riskiness of each asset class (combination of customer
segment, product design, and collateral) and not be uniform across all the
asset classes.
2. SARFAESI Act, 2002: At present only ‘secured creditors’, which
includes banks and public financial institutions, can approach the Debt
Recovery Tribunal (DRT) for recovery of its debts. NBFCs have not been notified
by the Central Government to fall within the definition of secured creditors
under SARFAESI Act and accordingly were not eligible to make an application to
the DRT for recovery.
In view of the parity between
banks and NBFCs, the Committee suggested that NBFCs be notified as ‘secured
creditors’ under the SARFAESI Act as to allow them access to the DRT Forum for
recovery of their debts.
Other general
recommendations of the Committee
In addition to the convergence of certain regulatory aspects
of banks and NBFCs the Committee has also put forth certain other suggestions
with respect to NBFCs.
1. Multiple definitions of NBFCs
should be consolidated into two categories – (core investment companies (CICs)
and another category for all other NBFCs. However it specified that benefits
available to specific types of NBFCs to continue even after consolidation, on a
pro-rata asset basis. The Committee believes that having a number of categories
of NBFCs creates room for regulatory arbitrage, and hinders the evolution and
growth of NBFCs.
2. Addressing of wholesale
funding constraints faced by NBFCs in a systematic manner by:
a. Developing
a clear framework by RBI and SEBI for (qualified institutional buyers (QIBs)
and Accredited Individual Investors to participate in the debt market issuances
of NBFCs so as to deepen capital market access for NBFCs. It also suggested
that investors such as mutual funds, insurance companies, provident and pension
funds and private accredited investors could complement bank funding to this
sector.
b. Providing
benefits of ‘shelf prospectus’ for 1 year to all issuers including NBFCs.
Presently Section 60A of the Companies Act, 1956 provides that only public
sector banks, scheduled banks and public financial institutions are eligible to
avail the facility of shelf prospectus. The SEBI (Issue and Listing of Debt
Securities) (Amendment) Regulations, 2012 prescribes a limit of 180 days for
any issuer going for private placement of debt.
Such a
recommendation will be in line with Companies Act, 2013 which provides that entities
as approved by SEBI are eligible to take advantage of ‘shelf prospectus.’
c. Permission
for raising external commercial borrowing (ECB) in Rupees for all institutions.
For non-rupee ECB funding, eligibility should be linked to size and capacity to
absorb foreign exchange risk rather than specific NBFC categories. Presently,
norms on ECBs are rigidly defined and eligibility varies across different
categories of NBFCs.
d. The
criteria for availing refinance from NABARD, NHB, SIDBI and credit guarantee
facilities should be based on nature / area of activity rather than the
institution type. Currently such refinance schemes are restricted by
institution type rather than activity, thus violating the neutrality principle
as far as NBFCs are concerned.
e. Current
capitalisation slabs on foreign equity funding should be relaxed and money
laundering concerns should be mitigated by levying additional reporting
requirements on Banks/Authorised Dealers (AD).
3. For better on-going risk
measures, NBFCs shall disclose their stress test results both at an overall
balance sheet level as well as at a segmental level at least annually.
4. NBFCs should adopt core
banking systems so as to enable better off-site supervision.
Comparison with Usha
Thorat Committee
The RBI on 12 December 2012 placed the draft
guidelines on the recommendations
made by the Working Group on the Issues
and Concerns chaired by Smt. Usha Thorat, former Deputy Governor, Reserve Bank
of India, on its website for public comments. Though the draft guidelines are
yet to be notified, they are in line with the recommendations made by the
Nachiket Mor Committee with respect to asset classification and provisioning
norms. The following gives an overview of both the recommendations:
Regulation: Classification
of NBFCs
Usha Thorat
Committee:
NBFCs should be classified under 2 categories –
(1) Exempted NBFCs (based on
asset size); and
(2) Registered NBFCs
Nachiket Mor
Committee:
Suggests consolidation of NBFCs into 2 categories:
(1) CICs; and
All other NBFCs
Regulation: Liquidity
Management
Usha Thorat
Committee:
Recommends all registered NBFCs maintain high quality liquid
assets in cash, bank deposits available within 30 days, money market
instruments maturing within 30 days, investment in actively traded debt
securities equal to the gap between total net cash inflows and outflows over
the 1 to 30 day time bucket as the liquidity coverage requirement. SLR
requirement for deposit taking NBFCs to continue.
Nachiket Mor
Committee:
Recommends the SLR requirement to be done away with.
Regulation: Asset
classification
Usha Thorat
Committee:
Classification of loans to NPA should be brought in line
with that of banks i.e. within 90 days of default – for all registered NBFCs.
To be implemented in a phased manner.
Nachiket Mor
Committee:
Asset classification of doubtful assets, sub-standard assets
and NPA should be brought in line with banks, as provided above.
Regulation: Provisioning
of Standard Assets
Usha Thorat
Committee:
Raise the provisioning for standard assets from 0.25% to
0.40% w.e.f. 31st March, 2014
Nachiket Mor
Committee:
Should be brought in line with that of banks. However for
agricultural advances the provisioning requirements at 0.40%.
While some of the recommendations of the Nachiket Mor
Committee are similar to those of Usha Thorat Committee recommendations, the
key would be to see how many of these come to effect and get implemented.

– Shampita Das



[1] http://rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=8128#55
[2]
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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