Prudential Norms for NBFC
The dynamic nature, endless compliances, and stiff competition make it hard for most NBFCs to operate seamlessly for long. Since these firms experience myriad and delicate transactions, they are bound to abide by RBI’s stringent norms to stay transparent, legitimate, and accountable. The prudential norms regulate NBFCs for stability, solvency, and financial soundness. The norms are primarily formulated to protect NBFCs from financial haywire and insolvency. On that note, let’s discuss Prudential Norms for NBFC Non-Deposit Taking in detail.
Prudential Norms are a big leap towards harmonization and protection of the NBFCs. It holistically regulates key aspects of NBFCs to make them robust and financially sound regardless of competition and operational intricacies. These include;
- Liquidity Ratios
- Minimum capital adequacy standards
- Lending restrictions
Prudential Norms for NBFC Non-Deposit Taking
Leverage Ratio
- Reserve Bank requires NBFCs (except NBFC-MFIs and NBFC-IFCs) to keep their leverage ratio at least 7 regardless of circumstances. NBFCs dealing with credit facilitation against gold jewelry must have 12% Tier I capital. The loan amount of such nature must account for 50% or above of financial assets.
Income recognition
- Income recognition here refers to maintaining transparency and standards concerning the company’s finances and cash flow within the purview of the recognized accounting standards. The standards also require timely income reporting such as interest, discounts, hire costs, rental fees, and other NPA charges as soon as they come into effect, not before that. Reservation is vital for incomes yet to be realized. For example, any income realized before the asset-losing performance must undergo reservation to avoid an accounting gap.
- For loans where a borrower has been awarded a repayment holiday for a certain period, the lender may recognize interest revenue on the accrual basis for an account tagged as “standard”.
- There is no need to reverse the interest accumulated during the moratorium period for a loan turned NPA post the moratorium period.
Income from investments
- The cash basis is the ground for computing the dividend income on corporate bodies’ shares and mutual funds’ units provided the estimation of the same is done on the accrual basis after the implementation of NBFC’s right. The corporate body must declare the dividend in the AGM.
- Earnings generated via debentures, corporate bonds, and government securities must be accounted for when they are realized (i.e. accrual basis) provided the interest rate is known and free from delinquency.
- The same rule applies to income from the corporate or public sector backed by the federal or state government’s assurance for repayment.
Accounting Standards
- NBFCs must follow the accounting standards and guidance notes as long as they are valid and do not overlap with RBI’s norms.
- All NBFCs must align with the Companies (Indian Accounting Standards) Rules, 2015 for financial statements’ preparation.
- The financial disclosure undertakings should comply with IndAS.
Accounting of Investment
Every eligible NBFC must abide by the following prudential norms for NBFC concerning accounting of investment:
- The BODs must oversee the development and implementation of investment policies boasting norms for investment categorization.
- The Board of the company must reinforce pragmatic criteria for investment classification into current and long-term investments. This rule also applies to securities investments.
- An inter-class transfer cannot happen without underlying grounds.
- NBFCs must adhere to norms concerning quoted current investments and their categorization.
- If the current investment revolves around unquoted equity shares, the application of breakup value or cost becomes pertinent.
- The same treatment applies to the unquoted preference shares; their valuation should align with face value or cost, whichever is lower.
- The valuation of government-assured bonds and investments into unquoted government securities should be equivalent to the carrying cost.
- The valuation of current investments unquoted in mutual fund units must be equivalent to the net asset value.
- Companies must leverage the carrying cost value of commercial papers.
- Referring to the ICAI-issued Accounting Standard is paramount when evaluating long-term investments’ value.
Need for Policy on Demand/ Call Loans
The Board of Directors disbursing or about to grant demand or call loans must underpin a robust company policy wherein the following inclusions are mandatory.
- A deadline by which demand or call loan repayment should be done.
- A loan with a repayment deadline of over one year requires written approval from the competent authority, reflecting the reason for the approval and interest rate.
- The same rule applies to demand or call loans lacking clarity on interest rates and attracting moratorium regardless of timeline. The interest applied to these loans shall be payable as advised i.e. either at monthly or quarterly rests.
- The renewal of such loans is not possible without periodic review reflecting apt compliance with the sanction’s terms.
- The sanctioned loan must undergo a loan performance review within six months of the sanction’s date.
Abiding to these norms is paramount as they are most important prudential norms for NBFC.
Asset Classification
Asset classification is considered among the key prudential norms for NBFC. The adherence to the following norms concerning asset classification is paramount for every NBFC except NBFC-MFIs:
Each NBFC performs apt categorization of its lease/hire purchase assets, loans, advances, etc to the following classes. While doing so NBFCs must consider credit vulnerabilities and dependence on collateral security.
- Standard assets;
- Sub-standard assets;
- Doubtful assets; and Loss assets.
- Provisioning for Standard Assets
Every eligible NBFC must reserve a standard asset amounting to .25 percent of the outstanding balance. The same asset shall fall outside the consideration when estimating net NPAs. The balance sheet must reflect the provision concerning the standard asset as “Contingent Provisions against Standard Assets”.
Prudential Norms for NBFC Concerning Liquidity Risk Management
These norms apply to NBFCs with an asset size of $100 crore or above. NBFCs falling outside the scope of these norms include
- Type I NBFC-NDs
- Non-Operating Financial Holding Companies
- Standalone Primary Dealers.
The BOD must ensure that standards are followed with no margin for error. The internal controls concerning these norms must undergo supervisory inspection for implementation. Ensuring apt liquidity risk management is among the key prudential norms for NBFC.
Multiple NBFCs
- No two NBFCs (founded by the same group of promoters) shall be treated as separate entities.
- To affirm the asset size category (below or above 500 crores) of a consolidation, the addition of assets of the NBFCs
To check which asset category applies to the consolidation, the addition of the total assets of the NBFCs in a group became vital for accurate estimation.
Each NBFC in the group must stay away from banned activities such as deposit acceptance and comply with provisions tied to asset categories.
The statutory auditor’s approval is vital for bringing the asset size into effect to comply with such a function.
Disclosures
Each applicable NBFC must implement norms concerning bad and doubtful debts in the balance sheet alongside the investment depreciation provisions.
Schedules
Every relevant NBFC must ensure the balance sheet reflects the details from the schedule in Annex III. While doing so considering the Companies Act of 2013 is vital.
Transactions in Government Securities
Each applicable NBFC dealing with Government securities must have a gilt and Demat account for transaction purposes.
Loans Against Own Shares
Eligible NBFCs must not secure loans against their shares as it is an offense.
Conclusion
From asset classification, maintaining transparency, and ensuring error-free bookkeeping to maintaining liquidity ratio, prudential norms for NBFC span almost every aspect that influences the working of such entities. Reserve Bank has introduced these norms to amplify the stability, solvency, and effectiveness of the NBFCs across India.
Read Our Article: NBFC Compliance Checklist: A Comprehensive Overview
