RBI Scrutinizes Payouts to Key Management Personnel in NBFCs and Transition of NBFCs into Banks

The Reserve Bank of India (RBI) is scrutinizing payouts to key management personnel in non-banking financial companies (NBFCs). This comes as a follow-up to the RBI’s circular issued on April 29, 2022, which required NBFCs in the “middle” and “upper” layers of its scale-based regulatory (SBR) framework to establish a board-approved compensation policy. The policy includes the establishment of a remuneration committee, guidelines for fixed-variable pay structures, and provisions for claw-back of compensation starting from April 1 of the previous year.
RBI’s Focus on Regulatory and Supervisory Deliverables for NBFCs
In its annual report for FY24, the RBI explicitly states that one of its key regulatory and supervisory deliverables for the coming year will be to “delineate the role of various committees” (audit committee of the board, nomination and remuneration committee, and risk management committee) in NBFCs, as outlined in the scale-based regulatory framework issued on October 22, 2021.
Emphasis on Proportion and Structure of Variable Pay
A key aspect of the RBI’s scrutiny is the adherence to norms regarding the proportion of variable pay in total compensation. The RBI has stated that the proportion of variable pay should be higher at the top of the organizational hierarchy. Furthermore, there should be a balance between cash and share-linked instruments in the variable pay, if share-linked instruments are included.
Variable Pay Based on Performance and Deferral Arrangements
The RBI emphasizes that variable pay should be truly variable and subject to reduction or elimination based on individual, business-unit, and company-wide performance. To achieve this, performance measures and their relation to remuneration packages should be clearly defined at the beginning of the performance measurement period. Additionally, a portion of variable pay may be deferred to align with the time horizon of risks. This deferral arrangement can apply to both cash and non-cash components of variable pay.
SBR Framework and its Objectives
The RBI’s scale-based regulatory (SBR) framework aims to eliminate arbitrage between banks and NBFCs, which could be detrimental to orderly growth and systemic stability. The framework consists of four layers: “base,” “middle,” “upper,” and “top.” The “base” layer includes NBFCs with assets of Rs 1,000 crore and below, while the “middle” layer comprises NBFCs with assets of Rs 1,000 crore and above. The “upper” layer is intended for specific identification, and the “top” layer remains empty unless the RBI deems an NBFC to pose potential systemic risk. The SBR framework enhances transparency and governance without imposing higher-level regulations. As of September 30, 2023, NBFCs in the “base,” “middle,” and “upper” layers constituted six percent, 71 percent, and 23 percent of the total assets of NBFCs, respectively.
Potential Transition of NBFCs into Banks
There is speculation that the RBI may be preparing some large NBFCs for potential conversion into banks in the future. The guidelines on ‘Compensation of Key Managerial Personnel (KMP) and Senior Management in NBFCs,’ issued on April 20, 2022, bring NBFCs in the “middle” and “upper” layers of the SBR framework on par with the senior management of private banks. This aligns with the earlier recommendations of the RBI’s Internal Working Group (IWG) on ownership guidelines and corporate structure for private banks, which suggested considering large corporate and industrial houses as bank promoters. Additionally, large NBFCs with assets of Rs 50,000 crore and above, including those owned by corporates, may be considered for conversion into banks.
IWG’s Recommendations and Future Outlook
The IWG was established to review ownership guidelines and corporate structure for private banks, with the objective of aligning the banking sector with the country’s goal of becoming a $5-trillion economy. The RBI accepted 21 of the IWG’s 31 recommendations, and the remaining recommendations are currently under examination. This has led some NBFCs, aspiring to obtain a private bank license, to believe that the possibility of conversion into banks is still open. Recent developments, such as the merger of the HDFC twins, have sparked renewed interest among certain large NBFCs in pursuing a bank license.