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Aarushi Varma is a 3rd year BSW LLB Student at Gujarat National Law University
Abstract:
The paper outlines the evolution of non-banking financial companies (NBFCs) in India and recent regulatory changes by the Reserve Bank of India (RBI) to strengthen oversight. It highlights the critical role of NBFCs in India’s financial system through specialized services. However, major NBFC collapses in 2018 raised concerns, prompting the RBI to tighten regulations for stability. In 2021, the RBI implemented an asset-based framework to categorize and regulate NBFCs. The 2023 RBI Master Directions consolidate rules for NBFCs to streamline compliance. New guidelines enforce stricter norms for outsourcing financial services to manage risks. The RBI now mandates registration and compliance for non-banks handling cross-border payments to improve monitoring. It emphasizes the rapid growth of India’s fintech sector through innovative models in digital lending and open banking, supported by government initiatives. Challenges like data privacy and security are noted, underlining the need for balanced regulations that enable innovation while protecting consumers. Overall, the paper provides insights into the evolving regulatory landscape for NBFCs and fintech players in India’s financial services sector. It stresses the rationale for tightened oversight to minimize systemic risks while nurturing growth opportunities.
NBFCs in India: Significance and Evolution
A Non-Banking Financial Company (NBFC) is a corporate entity established in accordance with the Companies Act of 1956 and 2013. NBFCs have played a crucial role in India’s financial system, introducing diversity and efficiency. These entities have evolved over time in areas such as operations, asset quality, heterogeneity, profitability, and regulatory framework. Consequently, customers find them convenient due to their quick decision-making, prompt services, and expertise in specialized segments. Additionally, NBFCs contribute to the resilience of the country’s financial system by serving as backup institutions during periods of stress in the banking sector. NBFC regulation is critical to ensure financial stability, consumer protection and sectoral growth.
Ensuring Stability: The Rationale Behind Strengthening Regulatory Oversight for NBFCs
In recent years, the Reserve Bank of India (RBI) has been tightening the rules for NBFCs. What invited the extra scrutiny from the RBI was the collapse of infrastructure behemoth Infrastructure Leasing & Financial Services (IL&FS) in 2018 and subsequent failures of leading NBFCs like Reliance Capital, Dewan Housing Finance Corp and SREI. This triggered a debate on the need for better supervision of NBFCs.
New Risk Based Layers for Regulation:
The regulator took a stance that NBFCs cannot grow beyond a size and need to limit their scope of activities within a limit. The RBI pitched that NBFCs which want to grow their business big need to apply for bank permits. The regulator brought in a layers-based approach to monitor big NBFCs. The regulator brought in a layers-based approach to monitor big NBFCs. In October 2021, RBI introduced a scale-based regulation framework for NBFCs based on their asset size, effective from October 2022.
Although the SBR Framework came into effect in October 2022, the regulatory alignment was pending. For NBFCs with assets between Rs 500 crore and Rs 1,000 crore, there was some confusion. Previously, they were regarded systemically significant, requiring them to follow strict standards. Credit concentration limits were in place under these standards, limiting lending and investment to a single company or group, specifically for systemically important NBFCs. The new scale-based laws provide clarity by modifying these criteria and applying them only to NBFCs in the middle and upper layers. There was ambiguity prior to the latest master directions, and even an NBFC with Rs 600 crore in assets had to follow concentration restrictions due to the residual influence of the earlier guidelines for systemically important NBFCs.
The Reserve Bank of India (RBI) released the Scale Based Regulation (SBR) Master Directions in October 2023 to align regulations across different categories of NBFCs under the SBR framework introduced in 2021. Previously, NBFCs were classified as systemically important (SI) or non-systemically important (non-SI) based on a Rs. 500 crore asset thresholds. The SBR framework replaces the earlier classification system of systemically important (SI) and non-systemically important (NSI) NBFCs based on their asset size. The recent Master Directions integrate rules for NBFCs of different types and asset sizes under the SBR framework, aiming to streamline compliance.
The SBR framework replaces this by categorizing NBFCs into four layers based on asset size: Base Layer (under Rs. 1000 crores), Middle Layer (above Rs. 1000 crores including all deposit taking NBFCs), Upper Layer (needing enhanced regulation) and Top Layer (facing heightened risk). The SBR Master Directions consolidate regulatory requirements for the different NBFC classifications, providing clarity on which provisions apply. For instance, non-deposit taking NBFCs with Rs. 500-1000 crore assets previously categorized as SI NBFCs are now Base Layer entities subject to related guidelines. Furthermore, existing regulations around stressed asset resolution, identifying non-cooperative borrowers, infrastructure project loan refinancing and reporting to the Central Repository of Information on Large Credits (CRILC) continue to specify implications for NBFCs-D, Factors and non-deposit taking NBFCs based on varying asset thresholds.
By integrating rules for NBFCs under one umbrella framework, the SBR Master Directions aim to streamline compliance standards, replacing the previous SI/non-SI classification system. Specific instructions are also outlined for other NBFC types like Microfinance Institutions, Housing Finance Companies and Peer to Peer lending platforms.
- Directions on Managing Risks and Code of Conduct in Outsourcing of Financial Services by NBFCs
The RBI Master Direction on outsourcing aims to strengthen risk management, governance, and reporting around external partnerships. It prohibits outsourcing certain core business functions and management oversight by financial institutions. Announced in 2023, it intends to unify and consolidate requirements for outsourcing financial services across multiple regulated businesses. Commercial banks, All-India financial institutions, non-banking financial firms, home finance companies, cooperative banks, and credit information companies are all covered by the directive.
The purpose is to harmonise current guidelines to provide regulated organisations with a comprehensive reference point for outsourcing financial services. The RBI Master Direction covers various regulated entities such as banks, financial institutions, NBFCs and housing finance companies who are required to outsource some of their financial activities to external service providers in a responsible manner.
These regulated entities (RE) remain accountable for the outsourced activities that have been contracted to service providers even though the direct tasks are handled by an external party. The RE must ensure comprehensive agreements covering service level expectations, risk management and close monitoring mechanisms. They need to evaluate the capacity and track record of potential service providers before selecting them. The service providers should have adequate financial strength and technical expertise to handle the financial service with effectiveness and efficiency as per standards set by the RE. They are required to deploy appropriate systems, data privacy protocols, audit trails and submit reports as well compliance certificates to the RE regarding discharged activities. The service providers must operate under the ambit of policies and instructions mandated by the RE.
Further, the guidelines prohibit outsourcing entities having any significant ownership or control from someone holding key positions in the regulated company to avoid potential conflict of interests.
- RBI Direct Regulation of Cross-Border Payments
The RBI guidelines seek to provide structured oversight of non-bank entities handling import/export transactions by mandating registration, capital thresholds, account segregation and reporting protocols. RBI has introduced direct oversight for entities involved in cross-border payments through the ‘Regulation of Payment Aggregator – Cross Border’ circular on October 31, 2023. These entities are now designated as Payment Aggregator-Cross Border (PA-CB), categorized into export-only, import-only, and export-import PA-CBs.
Existing and new non-bank PA-CBs must obtain RBI authorization as payment system operators by April 2024, while banks undertaking these activities are exempt. Operational PA-CBs need a minimum net worth of Rs 15 crore, rising to Rs 25 crore by 2026. They can facilitate payments up to Rs 25 lakhs per transaction while adhering to governance, technology, security, fraud management norms and RBI guidelines for domestic payments. Import PA-CBs require an Import Collection Account and export PA-CBs need an Export Collection Account with an authorized dealer bank. Compliance obligations cover customer due diligence, KYC procedures, foreign trade policies and FIU-Ind registration before seeking RBI approval. Entities handling both domestic and cross-border payments must maintain separate import, export, and escrow accounts. The guidelines aim to enhance oversight of cross-border transactions through a structured compliance framework.
Charting the Path Ahead: Navigating Opportunities and Challenges in India’s Fintech Landscape
The fintech industry’s widespread adoption and the financial services sector’s rapid digitalization are driving a fundamental upheaval of the global business landscape. Fintech is transforming and improving the financial sector rather than displacing it. Numerous partnerships between fintech companies and banks are utilizing technology to improve traditional banking processes.
Fintech is expanding rapidly in India due to a number of causes, including growing incomes, greater access to mobile devices, increased usage of digital media, and government initiatives. Lend Tech, Open Banking, Wealth Tech, and Neo Banks are just a few examples of fintech-enabled services that are revolutionizing the financial services industry by streamlining credit access, improving interoperability, using AI for risk analysis, and succeeding in the digital-first banking sector. Despite its groundbreaking nature, fintech faces challenges, with data privacy and application security being critical concerns. However, India’s fintech sector has witnessed remarkable growth, with over 7,500 startups attracting over USD 30 billion in funding. The sector is poised to capture nearly USD 350 billion in enterprise value by FY 2026-27.
While challenges such as regulatory clarity, funding access, and cybersecurity risks persist, addressing these concerns is crucial for sustained growth. A streamlined regulatory regime, improved digital infrastructure, and financial inclusion initiatives are essential for nurturing innovation and ensuring trust in the fintech sector. Within Indian fintech, insurtech and wealthtech are seeing the emergence of startups leveraging analytics and AI for customized, low-cost offerings. Digital lending models using alternative data for credit scoring are enhancing access. Appropriate regulation seeks to find the right balance whereby innovation and competition can thrive responsibly to broaden access. Strong foundations of trust, transparency and security are vital for fintech to sustainably bridge economic divides.
The emergence of financial influencers, or “finfluencers,” is a noteworthy phenomenon that adds a new level to the communication of financial information. The Securities and Exchange Board of India (SEBI) has proposed measures, including registration requirements, adherence to specific guidelines, and a ban on unregistered finfluencers partnering with mutual funds and stockbrokers for promotional activities, in order to regulate finfluencers and ensure accurate information. This regulatory action attempts to reduce possible risks connected with unregulated influencers giving biased or deceptive advice, improve investor protection, and increase transparency. It is anticipated that registered influencers will provide their contact information and proper disclosures on their posts, fostering a more genuine and reliable financial information landscape.
India’s fintech sector has experienced significant innovation in recent years, but laws have not kept up. Regulators such as SEBI and the Reserve Bank of India (RBI) have established a fintech department and innovation center, as well as a regulatory sandbox for the controlled testing of technologies, in an effort to promote innovation while protecting consumers. Rules cover various areas, including digital lending, credit/debit cards, data privacy, and prepaid instruments, aiming to prevent predatory practices. The regulators are working closely with the government on supportive policies, including tax reliefs and simplified compliance. Recent legislation, such as the Digital Personal Data Protection Bill, 2022, and Payment Regulation Act Amendment Bill, 2023, aims to empower the RBI with more authority over payment systems and data protection. The robust growth of India’s fintech sector, financial inclusion, and stability depend on well-considered rules that strike a balance between innovation and consumer interests. Early industry and government consultation methods adopted by regulators can guarantee that fintech technologies responsibly lead to better efficiency and affordability.
