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Q.   What is scale-based regulation of Non-Banking Financial Companies (NBFCs)? Explain why larger financial institutions require stricter regulatory oversight. (15 Marks, 250 Words)

Introduction

Scale-Based Regulation (SBR) is the RBI’s risk-sensitive framework under which regulatory intensity increases with an NBFC’s size, activity, complexity, interconnectedness and perceived systemic risk. Effective from October 2022, it replaces a broadly uniform approach with proportionate supervision.

Four-layer regulatory structure

  • Base Layer: Non-deposit-taking NBFCs with assets below ₹1,000 crore and specified low-risk entities.
  • Middle Layer: All deposit-taking NBFCs, non-deposit-taking NBFCs with assets of ₹1,000 crore or more, and entities such as Housing Finance Companies, Core Investment Companies and Infrastructure Finance Companies.
  • Upper Layer: Systemically significant NBFCs identified through RBI’s scoring methodology; the ten largest eligible NBFCs by assets are included automatically.
  • Top Layer: Normally remains empty but may include Upper-Layer entities showing substantially heightened systemic risk.

Why larger institutions require stricter oversight

  • Systemic contagion: Their failure can transmit stress to banks, mutual funds, bond markets and group companies.
  • Public exposure: Large deposit, borrowing and customer bases magnify losses and affect confidence.
  • Complexity and opacity: Multiple subsidiaries, related-party transactions and off-balance-sheet exposures make risk harder to detect.
  • Concentration risk: Large exposures to particular borrowers or sectors can intensify economic shocks.
  • Moral hazard: Expectations of rescue may encourage excessive leverage and risk-taking.
  • Financial stability: Liquidity mismatches can trigger fire sales and market-wide funding pressures.
  • Consequently, Upper-Layer NBFCs face stronger capital, provisioning, governance, disclosure, large-exposure and listing requirements.

Conclusion

SBR balances innovation and credit delivery with financial stability by imposing lighter compliance on smaller, low-risk NBFCs and bank-like prudential discipline on systemically important institutions.

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