RBI releases prompt corrective action framework for NBFCs

The Reserve Bank of India (RBI) released the prompt corrective action (PCA) framework for non-banking financial companies (NBFCs).24 The PCA framework enables supervisory intervention and requires the supervised entity to implement measures for restoring its financial health. RBI noted that NBFCs have grown in size and have substantial interconnectedness with other segments of the financial system. The PCA framework seeks to strengthen the supervisory tools applicable to NBFCs.

The framework will be effective from October 1, 2022. It will be reviewed after three years of being in operation. Key features include:

▪ Applicability: The framework will apply to all deposit-taking NBFCs (excluding government companies), and all non-deposit taking NBFCs in: (i) middle layer (asset size of at least Rs 1,000 crore), (ii) upper layer (NBFCs identified by RBI as warranting enhanced regulatory requirement), and (iii) top layer (NBFCs contributing to a substantial increase in the potential systemic risk). The framework will not apply to certain nondeposit taking NBFCs such as government companies and housing finance companies.

▪ Monitoring of NBFCs: NBFCs will be monitored based on certain metrics under the framework. For both deposit and non-deposit taking NBFCs, capital and asset quality would be the key areas for monitoring. For core investment companies (under non-deposit taking NBFCs), RBI will also monitor leverage (ratio of assets to capital) in addition to the above two metrics. NBFCs will be generally placed under PCA based on audited annual financial results and/or supervisory assessment of the RBI.

▪ Corrective actions: Once an NBFC is placed under PCA, it will be subject to certain mandatory and discretionary actions based on its risk threshold. Mandatory actions include: (i) restriction on dividend distribution/remittance of profits, (ii) promoters/shareholders to infuse equity and reduce leverage, and (iii) restriction on branch expansion. Discretionary actions include: (i) RBI recommending promoters/shareholders to bring in new management/board, (ii) submission of proposals to raise more capital, (iii) preparation of plan to reduce stock of non-performing assets, and (iv) restrictions in borrowings from debt market.