Non-Banking Financial Companies (NBFCs) and its Classification

The evolution of Non-Banking Financial Companies (NBFCs) in India has been quite significant over the years. Initially NBFCs were primarily involved in providing credit to small and medium-sized enterprises (SMEs), agricultural sectors, and retail borrowers who did not have access to formal banking services. Over the years, NBFCs diversified their services beyond lending. They started offering various financial products like vehicle financing, housing loans, personal loans, leasing, hire purchase, and more.

NBFCs played a crucial role in promoting financial inclusion by reaching out to underserved areas and segments of the population, providing them with financial services that were not easily accessible through traditional banking channels.

The regulatory environment governing NBFCs in India has undergone significant changes to ensure their stability and regulate their activities. The Reserve Bank of India (RBI) regulates and supervises NBFCs, imposing guidelines to ensure their financial health and protect the interests of depositors and investors.

NBFCs have experienced substantial growth, both in terms of the number of companies operating in this sector and the quantum of credit disbursed. They have become an important source of credit for various sectors, contributing significantly to the overall economic development of the country.

Like any financial sector, NBFCs face challenges such as asset-liability management, governance issues, regulatory compliance, and managing risks associated with lending practices. Regulatory reforms and periodic policy changes are aimed at addressing these challenges and ensuring the stability of the financial system.

With the advent of technology, many NBFCs have embraced digitalization, enabling them to offer services online, streamline processes, and reach a wider customer base more efficiently. Overall, the evolution of NBFCs in India showcases their transformation from niche lenders to significant players in the financial landscape, contributing to the country's economic growth and financial inclusion agenda.

What is NBFC (Non-Banking Financial Company)

NBFC is a company registered under the Companies Act, 1956/2013. These are financial institutions that offer various banking services but do not hold a full banking license. NBFCs provide services such as loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by the government or local authority, leasing, hire-purchase, insurance business, chit business, etc. They differ from traditional banks in that they cannot accept demand deposits and do not form part of the payment and settlement system.

NBFC Classification:

NBFCs are classified based on Liabilities, Assets and Size.

Liabilities Based Classification:

• NBFCs having Public Deposits (NBFCs-D)

• NBFCs not having Public Deposits (NBFCs-ND)

Asset Based Classification:

• Core Investment Companies

• Loan Companies

• Micro Finance Institutions

• Asset Finance Company

• Investment Company

• Infrastructure Finance Companies

• Factor

• Infrastructure Debt Funds

Size Based Classification:

• Non-Deposit taking NBFCs with the assets of Rs. 100 Crores and above are classified as Systematically Important Non-Deposit Taking NBFCs (NBFC-ND-SI)

• Non-Deposit taking NBFCs with the assets below Rs. 100 Crores are classified as Non-Systematically Important Non-Deposit Taking NBFCs (NBFC-ND-NSI)

Revised Structure/ Classification under Scale Based Regulation:

Under Scale Based Regulation, NBFCs are classified in four layers based on their size, activity, and perceived riskiness. NBFCs in the lowest layer shall be known as NBFCs-Base Layer (NBFCs-BL). NBFCs in middle layer and upper layer shall be known as NBFCs-Middle Layer (NBFCs-ML) and NBFCs- Upper Layer (NBFCs-UL), respectively. The Top Layer is ideally expected to be empty and will be known as NBFCs-Top Layer (NBFCs-TL).

Base Layer	The Base Layer shall comprise of: 1.     Non-deposit taking NBFCs below the asset size of ₹1,000 crore and 2.     NBFCs undertaking the following activities: (1)   NBFC-Peer to Peer Lending Platform (NBFC-P2P), (2)   NBFC-Account Aggregator (NBFC-AA), (3)   Non-Operative Financial Holding Company (NOFHC) and (4)   NBFC not availing public funds and not having any customer interface
Middle Layer	The Middle Layer shall consist of: 1.   All deposit taking NBFCs (NBFCs-D), irrespective of asset size 2.   Non-deposit taking NBFCs with asset size of ₹1,000 crore and above 3.   NBFCs undertaking the following activities: (1)   Standalone Primary Dealer (SPD), (2)   Infrastructure Debt Fund-Non-Banking Financial Company (IDF-NBFC) (3)   Core Investment Company (CIC), (4)   Housing Finance Company (HFC) and (5)   Non-Banking Financial Company-Infrastructure Finance Company (NBFC-IFC).
Upper Layer	The Upper Layer shall comprise of those NBFCs which are specifically identified by the Reserve Bank as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology. The list is available on RBI’s website.
Top Layer	The Top Layer will ideally remain empty. This layer can get populated if the Reserve Bank is of the opinion that there is a substantial increase in the potential systemic risk from specific NBFCs in the Upper Layer.

References to NBFC-ND, NBFC-ND-SI and NBFC-D:

From October 01, 2022, all references to NBFC-ND (i.e., non-systemically important non deposit taking NBFC) shall mean NBFC-BL and all references to NBFC-D (i.e., deposit taking NBFC) and NBFC-ND-SI (systemically important non-deposit taking NBFC) shall mean NBFC-ML or NBFC-UL, as the case may be.

These changes in references and classifications likely imply a simplification or reorganization of the regulatory framework for NBFCs, aiming for clearer distinctions and possibly more tailored regulatory measures for different categories of NBFCs based on their risk levels, activities, and systemic importance.

This shift in terminology and categorization may also reflect an effort by regulatory bodies to streamline regulations and enhance oversight to better manage the diverse landscape of non-bank financial entities.