continues to be so. the fundamental premise has, however, been to allow operational flexibility to nbfcs and help them grow and develop expertise. 13. now, the non - banking sector has grown significantly and several nbfcs match the size of the largest urban cooperative bank or the largest regional rural bank. in fact, few of them are as big as some of the new generation private sector banks. further, they have become more and more interconnected with the financial system. nbfcs are the largest net borrowers of funds from the financial system and banks provide a substantial part of the funding to nbfcs and hfcs. therefore, failure of any large nbfc or hfc may translate into a risk to its lenders with the potential to create a contagion. failure of any large and deeply interconnected nbfc can also cause disruption to the operations of the small and mid - sized nbfcs through domino effect by limiting their ability to raise funds. liquidity stress in the sector triggered by failure of a large cic broke the myth that nbfcs do not pose any systemic risk to the financial system. 14. while we are aware that differential regulation in the nbfc sector is required to allow it to bridge the gap in last mile connectivity and exhibit dynamism, this premise remains valid till the time their scale of operations is low. as and when they attain the size and complexity which poses risk for the financial system, the case becomes 5 | page stronger for greater regulatory oversight. it is in this background that we have conceptualised the scale based regulatory framework aligning it with the changing risk profile of nbfcs while addressing systemic risk issues. a scale - based regulatory framework, proportionate to the systemic significance of nbfcs, may be optimal approach where the level of regulation and supervision will be a function of the size, activity, and riskiness of nbfcs. as regulations would be proportional to the scale of nbfcs, it would not impose undue costs on the regulated entities ( res ). while certain arbitrages that could potentially have adverse impact would be minimised, the fundamental premise of allowing operational flexibility to nbfcs in conducting their business would not be diluted. 15. under the proposed scale - based framework, nbfcs would be categorised into four layers - base layer, middle layer, upper layer, and a possible top layer. base layer will broadly be equivalent to

##bfcs have been increasingly playing a significant complementary role in financial intermediation and provision of last mile delivery of financial services. 6. non - banking financial entities, by their regulatory design, enjoy freedom to undertake a wider spectrum of activities as compared to banks for which the permissible activities are enshrined in the statute itself. this freedom, coupled with a light touch regulatory prescription, gives them a greater risk - taking capacity to engage in financial intermediation in the segments which are often underserved by other players. hence, even with large universal banking ’ s reach across the country, the nbfc sector has the ability to create a space for itself with customized services with a local feel. 7. apart from furthering the financial inclusion agenda, the added advantage of a well - functioning nbfc sector is that it can promote resilience in the financial system by being innovative and agile in offering tailored financial products and solutions as a supplemental source of credit alongside banks. it has to be noted that many recent financial sector credit delivery innovations, for example micro - credit and sachetisation of credit, were popularised by non - banking financial entities. this capability and freedom to innovate spurs competitive advantage in the financial services sector with the ultimate beneficiary in the process being the customer. 8. however, the reputation of non - banking financial sector has been dented in recent times by failure of certain entities due to idiosyncratic factors. the challenge therefore is to restore trust in the sector by ensuring that few entities or activities do not generate vulnerabilities which go undetected and create shocks and give rise to systemic risk through their interlinkages with the financial system. forestalling and where necessary, decisively resolving such episodes becomes a key focus of our regulatory and supervisory efforts. 3 | page scale based regulatory approach 9. before we discuss further, it would be interesting to make an assessment as to where the indian nbfc sector stands with respect to significance, activity and regulation as compared to global jurisdictions. the global monitoring report on nbfi by financial stability board ( fsb ) classifies non - banking financial activities into five economic functions, ( i ) collective investment vehicles, ( ii ) loan companies which depend on short - term funding, ( iii ) market intermediaries, ( iv ) entities which engage in facilitation of credit creation ( such as credit insurance companies, financial guarantors ) and ( v ),