CENTRAL BANKING MODULE F QUIZ 1

NBFCs undertake financial activities such as lending, investment, leasing or other notified financial services, but they do not form part of the banking system in the same way as banks. In particular, an NBFC cannot accept demand deposits and is not part of the payment and settlement system in the same manner as a bank. The precise activities permitted depend on its registration and regulatory category.

Section 45-IA generally requires a company to obtain a Certificate of Registration from the RBI and meet the prescribed net owned fund requirement before commencing or carrying on the business of a non-banking financial institution, subject to statutory exemptions and applicable directions. Registration is not a blanket permission to undertake every financial activity; other laws and regulators may also apply.

The commonly used principal business test examines whether financial assets constitute more than 50 per cent of total assets and income from financial assets constitutes more than 50 per cent of gross income. Both limbs are assessed together. The test helps distinguish a company principally engaged in financial activity from a company whose financial transactions are incidental to its main business.

NBFCs do not automatically have the right to accept public deposits merely because they are registered with the RBI. Only NBFCs specifically permitted under the applicable regulatory framework may accept public deposits, and they must comply with prudential, rating, disclosure and other requirements. Many NBFCs are non-deposit-taking entities.

The SBR framework has four layers: Base Layer (NBFC-BL), Middle Layer (NBFC-ML), Upper Layer (NBFC-UL) and Top Layer (NBFC-TL). The layer depends on factors such as size, activity, risk and systemic significance. The Top Layer is intended for entities that may be placed there if the risks posed by the Upper Layer become significantly higher.

The Upper Layer is intended to capture NBFCs identified as warranting enhanced regulation because of their size, activity, complexity and systemic risk. RBI methodology considers relevant indicators and may identify entities beyond a simple asset-size ranking. Upper Layer entities are subject to additional regulatory requirements compared with lower layers.

RBI‘s SBR capital requirements prescribe a minimum CET1 ratio of 9 per cent of risk-weighted assets for NBFC-UL. CET1 is intended to consist of high-quality capital capable of absorbing losses while the entity remains a going concern. Candidates should distinguish this specific NBFC-UL requirement from other capital ratios and requirements that may apply to different NBFC categories.

The SBR framework strengthens governance in a manner proportionate to the layer and risk profile of an NBFC. Board-level oversight, risk-management arrangements, fit-and-proper standards, audit and compliance functions, and policies for related-party exposures are important controls. Exact committee requirements vary by layer, so an exam question should not assume that every committee requirement is identical for all NBFCs.

The SARFAESI Act provides a legal framework for eligible secured creditors to enforce security interests without first pursuing a conventional civil suit, subject to the Act‘s conditions, thresholds and exclusions. Amendments and notifications have extended specified provisions to qualifying NBFCs and adjusted the applicable secured-debt threshold. Eligibility and the currently applicable threshold must be checked against the latest legal text and RBI notifications.

The regulatory framework for HFCs has been aligned more closely with the RBI‘s NBFC framework, while recognising specific housing-finance features. RBI took over the principal regulatory role for HFCs from the earlier arrangement under which NHB had a major regulatory role. HFCs remain subject to the applicable RBI directions and any relevant statutory provisions.

Dividend distribution reduces the capital retained within a financial institution. Prudential conditions help ensure that an NBFC has adequate capital, acceptable asset quality and compliance with applicable regulatory requirements before distributing profits. A profitable accounting result alone does not necessarily mean that a dividend is permitted.

PCA is an early-intervention framework designed to address deterioration in an NBFC‘s financial condition before problems become more severe. It uses specified risk indicators and can lead to graded supervisory restrictions or corrective requirements. PCA is not intended to be an automatic declaration of insolvency; its purpose is to prompt timely remedial action.

PCA frameworks typically use indicators tied to financial soundness, such as capital adequacy, asset quality and leverage or other specified parameters, depending on the applicable framework and category. The purpose is to identify weaknesses early and require corrective action. Exact trigger thresholds must be read from the current RBI directions rather than inferred from a generic description.

Auditor eligibility, appointment, independence and tenure requirements support audit quality and reduce conflicts of interest. For regulated entities, the RBI‘s framework complements company-law requirements and may include approval, eligibility and rotation conditions. An auditor‘s role is to provide independent assurance, not to take over management‘s responsibility for financial statements or controls.

If an NBFC‘s liabilities mature before its loan assets generate cash, it may be unable to roll over funding even if its assets are ultimately recoverable. This maturity mismatch can create a liquidity crisis and force asset sales at a discount. Sound asset-liability management, diversified funding, liquidity buffers and stress testing help mitigate the risk.

The Special Liquidity Scheme was a temporary support mechanism introduced in 2020 to address liquidity pressures faced by eligible NBFCs and HFCs during the pandemic. It supported purchase of eligible short-term debt instruments through a special-purpose arrangement backed by a government guarantee. It was a crisis-period measure, not a permanent standing liquidity facility for all NBFCs.

RBI regulates and supervises NBFCs within its statutory remit to promote financial stability, protect depositors and customers where applicable, and ensure prudent conduct. Its tools include registration, directions, inspections, reporting requirements, enforcement and proportionate regulation. RBI supervision does not mean that every NBFC activity is identical to banking or that other regulators have no role in the financial system.

Certain entities are regulated primarily under other Acts or by other statutory regulators, and the RBI Act contains exemptions or specific treatment for some such entities. The precise exemption depends on the entity type and applicable legal provisions. Exemption from RBI registration does not mean the entity is unregulated; it remains subject to its governing framework.

The pandemic created borrower cash-flow stress, payment delays and uncertainty about asset quality while market funding conditions tightened for some NBFCs. Entities reliant on short-term wholesale funding were particularly exposed to rollover pressure. Effects varied by business model, borrower segment, capital strength and access to diversified funding.

A Financial Information User receives financial information through the Account Aggregator framework after the customer provides valid consent and the prescribed data-sharing process is followed. The information can support credit assessment and other permitted financial services. An FIU should not treat the framework as permission for unrestricted access to a customer‘s financial data.