Introduction to the Scale Based Regulation Framework
In October 2021, the Reserve Bank of India (RBI) introduced a revised regulatory framework for Non-Banking Financial Companies (NBFCs) based on a scale-based approach. Effective from October 1, 2022, the Scale Based Regulation (SBR) framework represents the most significant overhaul of NBFC regulation in India, moving away from a one-size-fits-all approach to a proportionate, activity-based regulatory structure.
The genesis of the SBR framework lies in the recognition that the NBFC sector has grown significantly in size, complexity, and interconnectedness with the broader financial system. The IL&FS crisis of 2018 and subsequent liquidity challenges highlighted the systemic importance of larger NBFCs and the need for differentiated regulation based on the risk each entity poses to the financial system.
The framework categorizes over 9,500 registered NBFCs into four layers, with progressively increasing regulatory requirements as the scale, complexity, and systemic importance of the NBFC increases. This article provides a comprehensive overview of the SBR framework, its implications, and what NBFCs must do to comply.
The Four-Layer Structure
Base Layer (BL) – Formerly NBFC-ND (Non-Systemically Important)
The Base Layer comprises NBFCs with an asset size below ₹1,000 crore, along with certain specialized categories. This layer includes NBFC-Peer to Peer Lending Platforms (P2P), NBFC-Account Aggregators (AA), Non-Operative Financial Holding Companies (NOFHC), and NBFCs without public funds and customer interface.
Key characteristics:
- Asset size below ₹1,000 crore
- Minimum Net Owned Fund (NOF): ₹10 crore (to be achieved by March 31, 2027)
- Light-touch regulation with basic prudential norms
- NPA classification at 180 days overdue (transitioning to 150 days, then 90 days)
- No requirement for Internal Capital Adequacy Assessment Process (ICAAP)
- Simplified governance requirements
Middle Layer (ML) – Formerly NBFC-ND-SI and Deposit-Taking
The Middle Layer is the most populated category, comprising all deposit-taking NBFCs irrespective of asset size, non-deposit taking NBFCs with asset size of ₹1,000 crore and above, and certain specialized entities like CICs (Core Investment Companies), IFCs (Infrastructure Finance Companies), IDFs (Infrastructure Debt Funds), and SPDs (Standalone Primary Dealers).
Key characteristics:
- Asset size of ₹1,000 crore and above (for non-deposit taking)
- All deposit-taking NBFCs regardless of size
- Minimum NOF: ₹10 crore (already applicable)
- Capital adequacy ratio: 15% (with Tier I capital at 10%)
- NPA classification: 90 days overdue
- Board-level risk management committee mandatory
- Compliance with Indian Accounting Standards (Ind-AS)
- Large Exposure Framework applicable
Upper Layer (UL) – Systemically Significant NBFCs
The Upper Layer consists of NBFCs specifically identified by the RBI as warranting enhanced regulation based on a set of parameters. The RBI publishes a list of UL NBFCs annually based on an assessment of their size, interconnectedness, complexity, and supervisory assessment.
Identification criteria:
- Top 10 NBFCs by asset size automatically qualify
- Additional NBFCs identified using a scoring methodology based on size, interconnectedness, complexity, and substitutability
- RBI retains discretion to include any NBFC based on qualitative assessment
- An NBFC in the UL shall remain there for a minimum of 5 years even if it no longer meets the criteria
Enhanced requirements for UL NBFCs:
- Common Equity Tier 1 (CET-1) capital: 9% of Risk Weighted Assets
- Mandatory listing within 3 years of identification as UL
- Compliance function headed by a Chief Compliance Officer (CCO)
- Independent directors: At least one-half of the board
- Compensation guidelines similar to banks
- Large Exposure Framework with stricter limits
- Mandatory Core Financial Services disclosure
Top Layer (TL) – Ideally Meant to Remain Empty
The Top Layer is ideally intended to remain empty and is reserved for NBFCs that the RBI perceives as posing extreme systemic risk. If an NBFC is identified for the Top Layer, it would be subjected to bank-like regulation, including higher capital requirements and direct supervisory oversight equivalent to scheduled commercial banks.
Key aspects:
- Intended to remain empty – serves as a deterrent
- Populated only if RBI identifies specific NBFCs posing extreme risk
- Would trigger bank-equivalent regulatory requirements
- Enhanced supervisory engagement and potential conversion requirement
Key Compliance Differences Between Layers
Enhanced Governance Requirements for UL/TL NBFCs
NBFCs classified in the Upper Layer face substantially elevated governance standards that bring them closer to banking-level regulation:
- Board composition: At least half the board must comprise independent directors, including an independent chairperson (mandatory if the NBFC is headed by a promoter)
- Committees: Mandatory Audit Committee, Nomination and Remuneration Committee, Risk Management Committee, and stakeholder relationship committee
- Chief Compliance Officer: A dedicated CCO must be appointed, not below the rank of General Manager, with direct reporting to the MD/CEO and the Board
- Compensation policy: Variable pay, claw-back provisions, and malus arrangements similar to those applicable to banks
- Stress testing: Mandatory stress testing framework with board oversight and periodic reporting to the RBI
- Disclosure: Enhanced disclosure requirements including a Core Financial Services (CFS) template published quarterly
Transition Timelines and NOF Requirements
The RBI has provided a glide path for NBFCs to meet the enhanced Net Owned Fund requirements:
- By March 31, 2025: Minimum NOF of ₹5 crore for all NBFC-ICC, NBFC-MFI, and NBFC-Factor
- By March 31, 2027: Minimum NOF of ₹10 crore for all NBFCs in the Base Layer
- NPA norms transition (BL NBFCs): 150 days overdue from April 2026, 90 days from April 2027
- UL listing deadline: Within 3 years of identification in the Upper Layer list
- Ind-AS compliance: All ML and UL NBFCs must already comply with Ind-AS
NBFCs that fail to meet the minimum NOF requirement within the stipulated timeline may face restrictions on accepting fresh deposits, making new loans, or even cancellation of their Certificate of Registration.
Impact on Existing NBFCs
The SBR framework has wide-ranging implications for the NBFC sector:
- Small NBFCs (BL): Must plan capital infusion to meet ₹10 crore NOF by 2027. Those unable to meet the requirement may need to explore consolidation, surrender their license, or restrict operations
- Mid-size NBFCs (ML): Need to strengthen risk management frameworks, ensure board-level oversight, and implement robust compliance functions. The Large Exposure Framework limits concentration risk
- Large NBFCs (UL): Face the most significant regulatory escalation – mandatory listing, CET-1 requirements, compensation guidelines, and governance standards equivalent to banks. This increases compliance costs but also enhances credibility and access to capital markets
- Industry consolidation: The higher NOF requirement is expected to drive consolidation in the sector, with smaller NBFCs either scaling up, merging, or exiting the market
- Technology investment: Enhanced reporting and disclosure requirements necessitate investment in regulatory technology (RegTech) solutions for automated compliance monitoring and reporting
Conclusion
The Scale Based Regulation framework marks a paradigm shift in how NBFCs are regulated in India. By adopting a proportionate, risk-based approach, the RBI aims to balance financial stability with the sector's growth aspirations. For NBFCs, the message is clear – as you grow in scale and complexity, so must your governance, risk management, and compliance infrastructure.
At Deepa Sharma & Associates, we specialize in NBFC compliance across all four layers of the SBR framework. Whether you need assistance with determining your layer classification, meeting enhanced NOF requirements, implementing governance frameworks, or preparing for mandatory listing, our team has the expertise to guide you through the transition seamlessly.
Contact us today for a compliance assessment tailored to your NBFC's position within the SBR framework.