COMMENTARY
excessively in posing potential systemic
RBI’s Scale-based Regulations
for NBFCs
A Bevy of Anomalies
Arvind Awasthi, Siddharth Shukla
Certain issues regarding the
scale-based regulation framework
for non-banking financial
companies laid out by the Reserve
Bank of India are scrutinised.
These pertain to divergence
with globally adopted definition
of systemically important and
differences in the usage of two
literally identical terms, namely
systemically important and
systemically significant, by the
RBI, coupled with irregularities
in the measurement of perceived
riskiness, the adoption of the
binary concept rather than
the continuum concept of
systemically important NBFCs
with regard to top 10 asset
size-based inclusion in the upper
layer, inclusion of systemically
significant NBFCs for a minimum
period of five years, supervision
on calibrated increment of
business, and the relevance
of the top layer.
Arvind Awasthi (drarvindawasthi@gmail.com)
teaches at and Siddharth Shukla
(shuklasiddharth44@gmail.com) is a research
scholar in the Department of Economics,
University of Lucknow.
Economic & Political Weekly EPW AUGUST 5, 2023
T
he Reserve Bank of India (RBI) on
22 October 2021 published the
scale-based regulation (SBR) for
non-banking financial companies (NBFCs).
The idea behind subjecting the sector to
SBR is to align the regulations in line
with the changing risk profiles of NBFCs
which have grown substantially and
have become systemically significant in
the past few years. For the purpose, the
NBFC sector will be classified into four
layers—base layer, middle layer, upper
layer and top layer. There are three bas-
es of division of these four layers, name-
ly size, activity, and perceived riskiness.
Companies populating the upper layer,
will be termed as systemically signifi-
cant and they will be identified based
on two criteria. First, top 10 asset-wise
NBFCs will always remain in the upper
layer, and second, a parametric scoring
methodology will be applied on the sam-
ple of 50 NBFCs, excluding the top 10,
which will be chosen on the basis of their
total exposure from the middle layer.
Once an NBFC is identified to be placed
in the upper layer, then it will be given
a period of a maximum of 24 months
to adhere to the enhanced prudential
regulations defined for the upper layer.
In the meantime, calibrated increment
in business will be allowed through
supervisory engagement.
NBFCs placed in the upper layer will be
subject to enhanced prudential regula-
tions for a period of at least five years even
if it does not meet the parametric criteria
for subsequent years from the date of its
inclusion in the layer. In order to move
out of the upper layer, the NBFC either
has to elude the criteria for classification
for five consecutive years or voluntarily
scale down its operations. At the end,
there will be a top layer which will con-
sist of those NBFCs from the upper layer
that RBI would consider to have grown
vol lViii no 31
risk and shall be made subject to higher
and intensive regulatory framework.
Anomalies in Regulatory
Framework
In this context, we observed six anomalies
in the regulatory framework for NBFCs
as laid out by the RBI and those practised
globally for identification and regulation
of systemically important NBFCs.
Divergence in the usage of systemi-
cally important in India and in the
rest of the world as well as dichotomy
in coexistence of systemically impor-
tant and significant: As regards the
first issue, globally, the term systemical-
ly important financial institution (SIFI)
came into practice after the global finan-
cial crisis of 2008 and European sover-
eign debt crisis of 2009 which were trig-
gered due to the simultaneous failure of
several financial institutions. This led
governments to extend bailout packages
to the financial institutions that they con-
sidered as too-big-to-fail (TBTF). There-
after, a debate on identifying the SIFIs
originated with the aim of pre-empting
the financial institutions which may be
an epicentre of the systemic risk and
subjecting them to enhanced prudential
norms in order to mitigate systemic risk
and avert the financial crisis. Before de-
fining the concept of systemically impor-
tant, it is necessary to understand the
term “systemic event.” The term “system-
ic event” is defined as disruption to the
flow of financial services caused by an
impairment of all or part of the financial
system and has the potential to cause se-
rious negative consequences for the real
economy (FSB 2009). Formally, the term
systemic risk refers to “the risk of experi-
encing an event such that the release of
bad information on, or failure of, one in-
stitution propagates across the system
resulting in further failures of other insti-
tutions” (De Bandt and Hartmann 2000).
It thus follows that any financial institu-
tion posing a threat of systemic risk to
the financial system is known as a SIFI. A
SIFI can be an independent and individ-
ual institution or a group of financial in-
stitutions on which special guard measures
are applied once they are designated as
25
COMMENTARY
SIFI. These measures could be revoked
after their business activities are stream-
lined so that they no longer pose a threat
of the systemic risk that could jeopardise
the financial stability of the system.
They can also then be de-designated
from the tag of SIFI. This in fact suggests
that enough freedom exists for the regu-
latory authority in designating and de-
designating not only individual firms
but also those non-bank entities that
represent a homogeneous financial group
in terms of their business activities and
of a homoscedastic asset size. As a matter
of policy response to the financial cri-
sis, the United States (US) passed the
Dodd-Frank Act on 21 July 2010 and
founded the Financial Stability Over-
sight Council (FSOC) under it with the
aim of supervising the systemic risk
flowing form NBFCs and designating
SIFIs. If material distress prevails at a US
NBFC, or the nature, scope, size, scale,
concentration, interconnectedness or
mix of activities of US NBFC could threat-
en the financial stability, then that par-
ticular entity must be designated as SIFI.
RBI has given the tag of systemically
important to NBFCs in 2006, prior to the
global practice of adopting the concept
of SIFI in the case of NBFCs in 2008. RBI
classified a set of NBFC-non-deposit (ND)
as systemically important based on their
asset size to extend prudential regula-
tions to them. RBI used the nomenclature
of systemically important to designate a
class of NBFC-ND having an asset size
greater than `100 crore which later was
revised to `500 crore in 2014 and in the
recently published SBR notification, this
asset size limit is recommended to be
revised to `1,000 crore with effect from
1 October 2022. The designation of sys-
temically important used in India is in
wide variance with what is used at the
global level (Awasthi and Shukla 2022).
The point of contention with the use of
this phrase of “systemically important” is
that although the use of “systemically im-
portant” predates the use of it in the
global economies, yet even after the global
acceptance of the use of the tag, the RBI
continued to use this tag in the previous
sense. Moreover, it needs to be men-
tioned that the dichotomous use was not
latent. For instance, Acharya et al (2013)
26
acknowledged that the financial institu-
tions that pose systemic threat to finan-
cial system are distinguished as SIFIs. He
also mentioned that the individual fail-
ure of NBFC-ND having an asset size
greater than `100 crore will not pose
any systemic risk to the financial system
and hence recognising the distinguished
category of NBFC-ND as systemically im-
portant might not be appropriate. Further,
he suggested that their collective failure
can pose the threat of systemic risk to the
financial system. Therefore, he regarded
the entire NBFC sector or a subgroup of
NBFC, say gold loan NBFCs, as systemi-
cally important. Despite pointing out a
view divergent from the RBI’s classifica-
tion of systemically important NBFC-ND,
he accepted the nomenclature used by the
RBI. Additionally, the stated hypothesis
of Acharya et al (2013), that failure of in-
dividual NBFC do not pose any threat to
financial stability was negated with the
Infrastructure Leasing and Financial Ser-
vices (IL&FS) company failing on its debt
obligation in 2018. This consequently
spread distress in the entire financial
system, compelling the government to
extend its support to prevent any further
chain of failures of financial institutions.
Therefore, it can be argued that failure
of a NBFC has the potential of spreading
systemic risk across the financial system.
The aforementioned facts are prima facie
evidence for questioning the adequacy of
the RBI approach for defining systemi-
cally important NBFCs in India.
Further, the RBI has introduced a new
nomenclature of systemically significant
in the SBR framework. NBFCs are desig-
nated as systemically significant after
performing a parametric analysis on the
sample of 50 NBFCs selected from the
middle layer populated by NBFC-ND-SI
and NBFC-D along with inclusion of top
10 asset-wise NBFCs. This implies that the
group of systemically significant is a joint
set of systemically important non-deposit
taking NBFCs, which in essence means that
few NBFCs in the upper layer are those sys-
temically important NBFCs that have been
designated as systemically significant.
However, in literary sense, both the terms,
significant and important, are used as
synonyms which implies that the tag of
systemically significant and systemically
AUGUST 5, 2023
important are no different. But in the
RBI notification of SBR framework, they
have been used to designate different
sets of NBFCs posing varied degree of
systemic risk to the financial system.
There is a dire need to remove the di-
chotomy in the use of two literarily iden-
tical phrases and bring consistency in
the usage of same tag of “systemically
important” as it is used differently in In-
dia and in rest of the world.
Irregularities in the measurement of
perceived riskiness: As regards the sec-
ond issue pertaining to the measure-
ment and parameters of perceived riski-
ness, there is a parametric methodology
for its measurement with respect to the
upper layer, but there is no threshold de-
fined in the notification for each param-
eter. It is strange to notice that there is a
mention of determination of threshold
limits in the discussion paper put out by
the RBI on 22 January 2021 but no such
mention is made in the notification re-
leased by the RBI on 22 October 2021.
Defining the threshold is extremely im-
portant as every financial institution
poses a systemic threat of varying de-
gree to the financial system. But wheth-
er that degree of systemic threat poses
adequate potential risk to the financial
system depends on whether the param-
eters of systemic risk are over and above
certain threshold limit or not. Parame-
ters accompanied with the threshold
will result in the estimation of perceived
riskiness of an NBFC. Earlier, FSOC laid
out the three stage process for the deter-
mination and identification of companies
which may pose threats to the financial
system. In the first stage, six quantita-
tive thresholds were laid down to filter
NBFCs for further analysis. These were
defined as asset size limit of $50 billion,
15 to 1 leverage ratio, 10% short-term
debt ratio, etc. Moreover, while defining
the assessment methodology for global
systemically important insurers (G-SII),
International Association of Insurance
Supervisors (IAIS 2016) has laid down a
five-phase process for identification, where
in part B of phase II, they have determined
the threshold and divided the sample of
institutions into two groups—above and
below the quantitative threshold limit.
vol lViii no 31 EPW Economic & Political Weekly

The group above the quantitative thresh-
old limit will be subjected to further analy-
sis. Therefore, it can be convincingly
said that without the defined threshold,
measurement of perceived riskiness seems
to be standing on one leg. Additionally,
the RBI has adopted the parametric scor-
ing methodology in contrast with the glob-
al practice of adoption of an indicator-
based approach for identification of
SIFIs. The parametric scoring methodology
is comprised of quantitative and qualita-
tive parameters. Size and leverage, inter-
connectedness, and complexity are the
quantitative parameters with a cumula-
tive weightage of 70%, whereas nature
and type of liability, group structure and
segment penetration are the qualitative
parameters with a cumulative weight-
age of 30%. Considering this strange
mix of quantitative and qualitative pa-
rameters, the estimation of perceived
riskiness done by clubbing these param-
eters require statistical justification and
logical consistency before deriving any
inference about the risk profile of an
NBFC. A thorough and detailed study of
assessment methodologies of global sys-
temically important banks (G-SIBs), global
systemically important insurers (G-SII),
non-bank non-insurer global SIFIs (NBNI
G-SIFIs) and assessment methodology
for domestic SIBs laid down by the RBI
have revealed that an indicator-based
approach is being followed to identify
respective SIFIs. In each case, 100%
weightage is given to the quantitative
parameters and it is being mentioned
that qualitative parameters pertaining
to regulatory and supervisory judgment
will complement the process of identifi-
cation of SIFIs but these are considered
independent of the quantitative analy-
sis. Therefore, clubbing of quantitative
and qualitative parameters in the SBR is
strange, statistically unviable and not in
conformity with the global practices.
Adoption of binary concept rather
than continuum concept of systemi-
cally important with regard to top 10
asset size-based inclusion in upper
layer: It is apt to mention that the con-
cept “systemically important” is a con-
tinuum rather than a binary distinction
(Thomson 2010). This implies that if a
Economic & Political Weekly EPW AUGUST 5, 2023
company is designated as SIFI, then there
is a procedure in place to de-designate it
as the concept of SIFI embodies cutting
down the size, interconnectedness, and
business activity of the institution till
the extent where no threat to financial
system stability is assured. Moreover, the
continuum distinction also implies that
apart from a particular financial institu-
tion, some other financial institutions
can also be designated as SIFI depending
upon their threat posing capacity to the
financial system. Therefore, the concept
of systemically important makes a com-
pany subject to designation, de-designa-
tion and re-designation in case it again
poses a threat to the financial system af-
ter being de-designated. However, inclu-
sion on the basis of asset size in the up-
per layer makes NBFCs permanently sub-
ject to enhanced prudential norms and
they tend to follow the binary distinction
instead of the continuum spirit. In addi-
tion to this binary distinction, the RBI
has also partially adopted the continuum
concept in the upper layer where it has
laid down a parametric scoring method-
ology for the inclusion of few NBFCs. In-
corporation of both binary as well as
continuum concept in the same layer is
indeed odd but true. Adoption of the
continuum approach is not fully incor-
porated in its true essence in the sense
that inclusion is being made conditional
for a fixed time period of at least five
years, provided the NBFC has not volun-
tarily readjusted its business, instead of
the global practice of periodic revalua-
tion for the purpose of de-designation of
the NBFC which is the chief aspect of the
continuum concept. This point is further
highlighted in the subsequent issue.
Designation for at least five years along
with a special provision are a devia-
tion from global practice: The fourth
issue pertains to the minimum period of
designation of SIFIs. In pursuance with
Section 113(d) of Dodd-Frank Act, FSOC
annually re-evaluates the designation of
SIFI given to NBFCs and allows to rescind
the tag if the company is no longer meeting
the standards of designation. Rescind-
ing of the tag will be implemented if the
council by a vote of not less than two-
thirds of voting members then serving,
vol lViii no 31
COMMENTARY
including an affirmative vote by the
chairperson of the council, agrees to do
so. This is not the case in India and NBFCs
once tagged as systemically significant
will have to adhere to enhanced regula-
tory norms for at least five years with the
leeway in the form of special provision
that they can move out even earlier if
there is a deliberate effort by the NBFC
Board to scale-down the operations of
NBFCs in the upper layer (NBFC-UL) along
with the rider that the relaxation to
move out earlier will be nullified if the
scaling-down of operation is because of
the adverse situation specific to the NBFC
that escalates its financial stress. Moving
out of the upper layer through special
provision here implies only downhill
movement, that is, movement towards
the middle layer. Additionally, NBFCs in
the middle layer whose parameters are
approaching the threshold of parametric
criteria for qualifying to the upper layer,
will be informed so, to enable them to
reorient their operations if they want to
continue residing in the middle layer
and do not want to graduate to the upper
layer. Therefore, averting the tag of sys-
temically significant also has implica-
tions with regard to restricting the busi-
ness of the NBFC to continue its working
in the middle layer. And once an NBFC
qualifies as NBFC-UL, it will be penalised
hardly and will be subject to stricter norms
which will act as a constraint in its
growth for a minimum of five years. The
tag of systemically significant will act as
a ceiling on its further growth. This
would not happen with just two or three
NBFCs, but with at least 10 + n NBFCs
which are supposed to be in the range of
25–30 companies. Such a huge number of
NBFCs placed under stricter prudential
norms for a minimum of five years will
severely hit their growth opportunities.
Implications of supervision on cali-
brated increment in business: As re-
gards the fifth issue, after designating
an NBFC-UL, the RBI has laid out that a
maximum period of two years will be
given to the NBFC as a transition period
for graduating from the middle layer to
the upper layer and to adhere to the stip-
ulations. During the transition period
of two years, a calibrated increment in
27
COMMENTARY

business will be allowed under the su-
pervision of RBI. Supervised and cali-
brated increment in business will dis-
courage NBFCs from taking risks and
growing in their size because as soon as
they will be ready to take off, their wings
will be clipped with supervision for two
years. In such a scenario, NBFCs would
prefer to stay in the middle layer than to
expand and move up to the upper layer
where the unbridled growth of an NBFC
will be pruned. Such caging of growth
will create a dismal climate for the in-
novative character of NBFC sector which
is their unique selling proposition.
Relevance of top layer: Finally with re-
spect to the sixth issue, the top layer is
made with the purpose of including those
NBFCs from the upper layer which the
central bank will consider as having ex-
panded in posing potential systemic risk.
Currently, the RBI has kept this layer
empty. The NBFCs placed in the top layer
will be subject to higher capital charges.
However, the RBI has not laid out any
parameters breaching which an NBFC
will be shifted to the top layer except for
the fact that a passing remark has been
made that it will include those NBFCs,
which in the RBI’s opinion, have grown
substantially in posing the systemic risk
to the financial system. Since the imposi-
tion of enhanced prudential norms will be
done at the upper layer and categorising
those companies as systemically signifi-
cant should be the last step in tackling
the potential systemic threat because
the basic motive behind identifying SIFIs
is to treat and mitigate the threat posed
by them. But the existence of the top
layer implies that the companies popu-
what is the relevance of naming the
companies in the upper layer as systemi-
cally significant, and second, if the us-
age of systemically significant contin-
ues, then what should be the jargon for
the companies populating the top layer?
In Conclusion
Scale-based regulations for NBFCs as laid
out by the RBI is out of kilter in many
ways with the globally established prac-
tice for the identification and regulations
of systemically important financial insti-
tutions. The first major deviation is the
usage of the term systemically important
in India and in rest of the world along
with the dichotomous use of two literal-
ly identical terms, systemically important
and systemically significant in the same
layer. Second, there are no thresholds
defined in the parametric methodology
for the identification of NBFCs in the up-
per layer along with coexistence of both
quantitative as well as qualitative pa-
rameters which requires statistical justi-
fication and logical consistency. Addi-
tionally, systemically important is a con-
tinuum concept rather than a binary
concept. Inclusion of NBFCs on the basis
of asset size in the upper layer is a classic
case of binary distinction. The RBI has
laid out a minimum five-year period for
NBFCs to reside in the upper layer which
is in wide divergence with the annual
Review of Women’s Studies
May 28, 2022
Performing Art/Performing Labour: Gender, Body,
and the Politics of Culture
re-evaluation of the tag of systemically
important in the US. Moreover, aversion
to move up to the upper layer will also
be a discouragement to the NBFC-ML to ex-
pand its business. NBFCs identified for the
upper layer will have a transition peri-
od to adhere to enhanced regulations,
and in the meantime, a calibrated incre-
ment in business will be allowed which
has a penalising implication for those
companies showing good performance by
taking care of their idiosyncratic as well
as systemic risk determinants. Finally,
there is no methodology laid out for the
inclusion of NBFCs in the top layer. Exist-
ence of the top layer implies that few
companies will have higher perceived
riskiness than those classified as system-
ically significant which defeats the pur-
pose of such categorisation. Moreover,
no nomenclature is suggested for com-
panies having the highest perceived
riskiness among all NBFCs. Existence of
top layer has no parallel in the world.
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