Changes have been made in the circular dated October 2021 titled “Scale Based Regulation (SBR): A Revised Regulatory Framework for NBFCs”, according to which a Larger Exposure Framework (LEF) has been prescribed for NBFCs in the upper tier.
According to reserve Bank of IndiaThe statement “Tier I Capital” for the purposes of the Guidelines shall have the same meaning as defined in the circular dated October 2021.
Further, RBI directs that the profit earned during the year shall be treated as Tier I capital for the purpose of LEF after making necessary adjustments as per the guidelines applicable to NBFC-UL.
Also, NBFC-ULs are directed to obtain an external auditor’s certificate on completion of the increase in capital and submit the same to RBI (Department of Supervision) before computing the increase in capital funds.
In the new guidelines, the RBI announced the term ‘control’, which means the right to appoint majority directors or to control management or policy decisions by a person or persons, either personally or in concert, directly or indirectly. by virtue of, including by virtue of, their shareholding or management rights or shareholders’ agreements or voting agreements or in any other manner.
Further, RBI declared that “group of linked counterparties” means two or more (natural or legal) persons who satisfy at least one of the conditions – controlling relationship and economic interdependence.
First, the control relationship criteria are satisfied automatically if one entity has more than 50% of the voting rights of another entity.
Whereas for establishing linkages on the basis of economic interdependence, NBFC-ULs should, at a minimum, consider the following criteria as per RBI.
1. Where 50% or more (on an annual basis) of one counterparty’s gross receipts or gross expenses is derived from transactions with the other counterparty;
2. Where a counterparty has guaranteed the exposure of the other counterparty in whole or in part or is liable by other means, and the exposure is so significant that the guarantor is likely to default if a claim occurs;
3. Where a significant part of one counterparty’s production/product is sold to another counterparty, which cannot be easily replaced by other customers;
4. When the expected source of funds to repay the debts of both the counterparties is the same and neither counterparty has any other independent source of income from which the debt can be serviced and fully repaid;
5. Where it is likely that one counterparty’s financial problems will cause difficulties for the other counterparty in terms of full and timely repayment of liabilities;
6. Where the insolvency or default of one counterparty is likely to be connected with the insolvency or default of the other party;
7. When two or more counterparties rely on the same source for most of their funding and, in the event of the common provider’s default, an alternative provider cannot be found – in this case, one counterparty’s funding problems unilateral or two-way dependence on one main funding source to another.
8. In order to avoid cases where the economic interdependence will not be thoroughly examined commensurate with the size of the exposure, NBFC-UL is required to identify potential related counterparties on the basis of economic interdependence in all cases where all exposures are accounted for. The sum exceeds 5% of an individual counterparty’s eligible capital base, and not in other cases.
In particular, RBI has stated that the term ‘large exposure’ shall mean the sum of all exposure values of an NBFC-UL, as measured in accordance with paragraph 6 of these Directions, to a counterparty and/or a group of linked counterparties. for, if it is equal to or more than 10 per cent of the eligible capital base of NBFC-UL.
The mentioned guidelines are applicable to NBFC-ULs both at the single level and at the consolidated (group) level. Further, exposure will include both on-balance sheet and off-balance sheet exposures by NBFC-UL.
Meanwhile, the sum of all exposure values of an NBFC-UL to a single counterparty should not exceed 20% of the eligible capital base of the NBFC-UL at all times. RBI may allow an additional 5% exposure to the Board of NBFC-UL over 20% but not exceeding 25% of the eligible capital base of the NBFC-UL, subject to conditions.
However, RBI allows Infrastructure Finance Company (IFC) to further increase the exposure limit to 5% of Tier I capital for exposure to a single counterparty.
With reference to groups of connected counterparties, RBI states that all exposure values of NBFC-UL shall not exceed at all times 25% of the available eligible capital base of NBFC-UL for the group of linked counterparties. However, IFCs are allowed to exceed the exposure limit of up to 10 per cent of their Tier I capital for exposure to a group of related counterparties.
The above guidelines will be effective from October 1, 2022.