Part 02 — RBI Regulatory Framework

NBFC Regulation

NBFC lending to SMEs is attractive because NBFCs can specialise: machinery finance, merchant cash-flow loans, supply-chain finance, loan against property (LAP), school finance, doctor loans, used commercial vehicles, and small-ticket working capital. The regulatory price of that flexibility is that the entity must remain inside RBI’s registration, capital, conduct, KYC, asset-classification and outsourcing perimeter.

Registration and NOF

An NBFC is a company that carries on financial activity as its principal business and is registered with RBI under section 45-IA of the RBI Act. The lending category most relevant to SME lenders is NBFC-Investment and Credit Company (NBFC-ICC), created when RBI harmonised earlier asset finance, loan company and investment company categories. An applicant must obtain a Certificate of Registration (CoR) from RBI unless exempted.

Net Owned Fund (NOF) is the entry gate. RBI increased the minimum NOF for most new NBFCs from the historical ₹2 crore level to ₹10 crore in phases under SBR. For an SME lending start-up, that means a thinly capitalised “fintech NBFC” is no longer a casual licensing route; realistic capital planning must cover regulatory NOF, first-loss absorption, operating burn, technology, compliance staff and credit cost. Existing NBFCs that migrated from the old regime had glide paths; new applicants should check the current PRAVAAH/RBI application checklist and applicable category-specific direction before relying on legacy thresholds.

Layer-Wise Prudential Regulation

The anchor document is the Master Direction - Reserve Bank of India (Non-Banking Financial Company - Scale Based Regulation) Directions, 2023, October 19, 2023. SBR places NBFCs into Base, Middle, Upper and Top Layers. A small unsecured SME NBFC may begin in Base Layer, but a fast-growing lender with assets above ₹1,000 crore, public funds, group linkages or HFC/MFI/factor status can move into tighter Middle Layer rules. Large systemic NBFCs move into Upper Layer; RBI’s June 24, 2026 amendment changed the identification approach to an asset-size threshold of ₹1,00,000 crore and above and allowed eligible government-owned NBFCs to be considered (RBI press release, June 24, 2026).

The layer matters operationally:

Area	What SME teams feel in practice
Capital adequacy	Growth cannot be judged only by disbursement run-rate; CRAR, Tier I capital and risk weights constrain book growth.
Concentration	Single borrower, group and sector exposures affect anchor-led lending, dealer finance and LAP cluster exposure.
Governance	Middle/Upper Layer boards need stronger risk, audit, IT, nomination and remuneration governance.
Disclosures	Financial statement notes, related-party controls and liquidity disclosures become more formal.
Liquidity	ALM gaps matter where short bank lines fund 24-60 month SME loans.

Conduct and Fair Practices

NBFC customer-interface rules are not softer than bank rules. Fair Practices Code (FPC), transparent interest-rate policy, borrower communication in vernacular/local language where appropriate, and grievance channels are mandatory. For digital SME lending, the NBFC must comply with the RBI Digital Lending Directions, 2025: direct disbursal to the borrower’s bank account except permitted exceptions, repayment directly to the RE, LSP fee paid by the RE, KFS, cooling-off period, DLA reporting and data localisation.

For loan pricing, NBFCs typically use flat-looking customer rates of 16-28% reducing balance for unsecured business loans, 11-18% for secured LAP, and 12-22% for machinery or vehicle-backed loans depending on borrower quality, bureau, collateral and geography. These are market-practice ranges, not RBI caps. RBI’s concern is not a universal rate cap; it is Board-approved rate methodology, non-discriminatory application, APR disclosure and no hidden charges. If a lender cannot justify risk-based pricing through cost of funds, operating cost, credit cost, tenor and security, it has a conduct problem even if the rate is technically unregulated.

Prudential Norms

NBFCs must classify and provide for assets under applicable IRAC/provisioning directions. As of July 2026, the regulatory landscape has moved from the single 2023 SBR Master Direction into more modular RBI directions for NBFCs; where an official RBI web page could not be independently opened during this task, I have avoided quoting paragraph numbers and have cross-checked the title from public RBI notification mirrors. The practical rules remain the familiar ones covered in IRAC provisioning: 90 days past due (DPD) is the ordinary NPA trigger, income on NPAs is recognised on realisation, upgradation requires clearance of arrears, and provisions increase as an account moves from sub-standard to doubtful and loss.

For Ind AS NBFCs, Expected Credit Loss (ECL) is the accounting basis, but RBI prudential floors still matter. If accounting ECL is lower than the prudential requirement, the gap is not free capital; it is managed through an impairment reserve/prudential floor logic. This is one of the most common disconnects between finance teams and lending-product teams: the product may show contribution margin at disbursal, but the accounting and regulatory provision appears later through staging, DPD migration and portfolio seasoning.

Outsourcing, LSPs and Partnerships

Most SME NBFCs outsource something: sales connectors, field investigation, legal search, valuation, bureau pulls, eSign, bank-statement analytics, GST analysis, telecalling, field collections, cloud hosting, LOS/LMS modules or payment mandates. RBI’s digital lending direction restates the larger outsourcing principle: the NBFC remains responsible for acts and omissions of the LSP (RBI Digital Lending Directions, para 5). This affects contracts and systems. The LOS should store LSP ID, DLA ID, consent records, data-sharing scope, KFS version, assignment of recovery agent, complaint escalation, and evidence of direct fund flow.

Co-lending adds a second RE. From January 1, 2026, new co-lending arrangements must follow RBI’s 2025 Co-Lending Arrangements Directions: formal ex-ante agreement, minimum 10% share with each lender, blended interest/KFS disclosure, individual borrower accounts, escrow routing and 15-calendar-day transfer of partner share. That is covered in detail in co-lending directions.