NBFC Scale-Based Framework

The NBFC Scale-Based Framework represents a major regulatory reform in India’s non-banking financial sector, aimed at aligning regulation with the size, complexity, and risk profile of Non-Banking Financial Companies. Introduced to address structural vulnerabilities and systemic risks, the framework marks a shift from uniform regulation to a proportionate, risk-sensitive supervisory approach. It has important implications for banking stability, financial intermediation, and the long-term development of the Indian economy.

Background and Need for the Scale-Based Framework

The NBFC sector in India has grown rapidly in scope and importance, emerging as a key source of credit for retail borrowers, small businesses, infrastructure projects, and niche market segments. NBFCs often complement banks by operating in areas where traditional banking faces operational or risk-related constraints.
However, episodes of financial stress within the NBFC sector exposed weaknesses such as excessive leverage, asset–liability mismatches, governance lapses, and regulatory arbitrage. Applying identical regulatory norms to all NBFCs, regardless of size or systemic relevance, proved inadequate. In response, the Reserve Bank of India introduced the Scale-Based Framework to strengthen oversight while preserving the sector’s developmental role.

Concept and Structure of the Scale-Based Framework

The NBFC Scale-Based Framework classifies NBFCs into distinct layers based on quantitative and qualitative criteria such as asset size, complexity of operations, interconnectedness, and risk profile. Regulation and supervision intensify progressively as NBFCs move up the layers.
The framework is built on the principle that regulatory requirements should be proportionate to the risks posed by an institution. Smaller NBFCs with limited systemic impact are subject to lighter regulation, while larger and more complex NBFCs face stricter prudential and governance norms.

Layers under the NBFC Scale-Based Framework

The framework divides NBFCs into four broad layers.
The Base Layer consists of small, non-deposit-taking NBFCs with limited asset size and simple business models. These entities pose minimal systemic risk and are subject to basic prudential and governance requirements.
The Middle Layer includes NBFCs that are larger in size or engaged in activities that warrant higher regulatory scrutiny. These entities face enhanced capital, asset classification, provisioning, liquidity, and governance norms compared to the Base Layer.
The Upper Layer comprises systemically important NBFCs identified based on size, complexity, and interconnectedness. These NBFCs are subject to bank-like regulatory standards, including stricter capital requirements, governance norms, and supervisory oversight.
A potential Top Layer is envisaged for NBFCs that pose extreme systemic risk. This layer is not permanent and is activated only if an NBFC’s risk profile significantly deteriorates, necessitating the highest level of regulatory intervention.

Regulatory Objectives of the Framework

The primary objective of the Scale-Based Framework is to enhance financial stability by preventing the accumulation of systemic risk within the NBFC sector. By identifying and regulating high-risk entities more closely, the framework aims to reduce the probability and impact of financial contagion.
Another key objective is to promote sound governance and risk management practices as NBFCs grow in size and complexity. The framework encourages orderly growth by ensuring that regulatory expectations evolve alongside institutional expansion.
At the same time, it seeks to avoid over-regulation of small NBFCs, thereby supporting innovation, competition, and financial inclusion.

Prudential and Governance Norms

Under the Scale-Based Framework, prudential norms such as capital adequacy, asset classification, provisioning, and exposure limits become progressively stricter across layers. Upper Layer NBFCs are required to maintain stronger capital buffers and more sophisticated risk management systems.
Governance standards are also enhanced, particularly for Middle and Upper Layer NBFCs. These include stronger board oversight, separation of key management roles, fit and proper criteria for directors, and improved compliance and audit mechanisms.
Such measures are intended to address governance failures that have historically contributed to financial instability in the sector.

Impact on Banking and Financial Intermediation

The Scale-Based Framework has important implications for the banking system, given the close linkages between banks and NBFCs through lending, co-lending, securitisation, and capital market exposure. Stronger regulation of larger NBFCs reduces spillover risks to banks and enhances overall financial system resilience.
For financial intermediation, the framework ensures that NBFCs continue to play a complementary role to banks while operating within a disciplined regulatory environment. It promotes responsible credit expansion and better alignment between risk-taking and capital strength.

Contribution to the Indian Economy

NBFCs are critical to India’s economic development, particularly in supporting consumption, small enterprises, infrastructure financing, and financial inclusion. The Scale-Based Framework strengthens the foundation of this contribution by ensuring that growth is sustainable and not driven by excessive risk.
A stable and well-regulated NBFC sector enhances investor confidence, improves credit flow, and supports efficient resource allocation. This, in turn, contributes to economic growth, employment generation, and balanced regional development.