The Hindu Business Line : Needed, a fair deal for NBFCs

The time has come for the RBI to make peace with NBFCs as a class. They are proven instruments of efficient and customer-friendly outreach in the credit space, not only for consumer durables, but also housing and transport, besides infrastructure. The regulators' role being not only to regulate but to spur economic growth, it is hoped that the NBFCs will be nurtured, not restricted, and that they will be allowed to continue to accept public deposits.

OVER the last decade or so, the Reserve Bank of India has been blowing hot and cold about non-banking finance companies (NBFCs). The RBI reacted to a series of defaults and misdemeanours by a few NBFCs, restricting their ability to take public deposits.

This unfortunately led to a collapse of many NBFCs which depended on a continuous inflow of deposits to meet redemption obligations. Subsequently, there seems to have been a better realisation of the role of NBFCs in financing the small-scale industry, particularly the transport sector.

The RBI in its latest monetary policy statement has cautioned that NBFCs should be encouraged to exit from public deposits, in essence saying NBFCs should not take public deposits. This is, indeed, extraordinary. The reasons given are that nowhere in the world are private financial institutions allowed to accept public deposits.

The fact is that non-bank finance institutions are active in other economies. They accept deposits in developed countries as well as in some developing countries, like Malaysia. The existence of thrift societies in the US and housing societies in the UK is well-known.

Thrift and savings associations are almost omnipresent in the US. Credit unions of employees are, in effect, self-help groups, present in every organisation. So are housing societies in the UK. They perform a useful role in garnering public savings and extending credit to those in need. The same is the situation with non-bank finance companies in Malaysia.

The position in the US is that as against deposits of $4,391 billion held by commercial banks, thrift institutions and finance companies hold $1,247 billion. These non-banks as a whole hold 28.4 per cent of the deposits of banks. In India, however, public deposits of NBFCs are only 0.003 per cent of banks in India.

Non-bank finance institutions in the US are even covered by deposit insurance even as they are subject to supervision by a special office of thrift supervision. These institutions handle a substantial channel of local savings and transfer them as loans to deserving borrowers, besides small and medium-scale industries, as well as housing needs. These institutions are also liberally allowed to access the capital market, where banks subscribe to bonds issued by them.

The situation in UK is broadly similar. Building Societies in the UK have a big share of business compared to their analogues in India, which hold deposits amounting to 18 per cent of total retail deposit balances.

They also are entitled to receive compensation from the Financial Services Compensation Scheme in the event of failure in the business of deposit-taking, among others. In Malaysia, non-bank finance companies' deposits as a percentage of bank deposits amount to 21 per cent. It is, therefore, wrong to argue that non-bank finance companies cannot access public deposits in other countries.

Again, the new-fangled notion of grameen banks and self-help groups is nothing but thrift societies in another form. Traditionally in India, chit funds have performed the role of collecting deposits from savers and lending money to those who are in need. Constrained as they are by numerous restrictions, they still perform a signal service in funding small and medium business, trade and transport

The fact is that NBFCs in India have played a useful role in financing various sectors of the economy, particularly those that have been underserved by the banks. No business flourishes unless there is a need for it and it fulfils the need efficiently.

The success of NBFCs bears testimony to its role. Anywhere in India, the small entrepreneur goes first to an NBFC for funds even before he approaches banks in view of the former's easy access, freedom from red-tape and quick response. The large expansion of the consumer durable business in India in the last few years would not have taken place if NBFCs had not entered the trade.

Similarly, housing activity has also been encouraged by NBFCs. The role of NBFCs in funding transport activities is well-known. Latterly, some NBFCs have been active in funding infrastructure quite successfully using the securitisation of obligations.

NBFCs in India have played a useful role in financing various sectors of the economy, particularly those that have been underserved by the banks. The tendency of regulators to deny access to these institutions to public deposit is a confession of inability to see the economic reality, which calls for a flexible and customer-friendly financial intermediary, which is what NBFCs and chit funds are.

The tendency of regulators to deny access to these institutions to public deposit is a confession of inability to see the economic reality, which calls for a flexible and customer-friendly financial intermediary, which is what NBFCs and chit funds are.

In fact, many banks are forming NBFCs to take advantage of their greater flexibility in dealing with customers. The fact that some NBFCs were found abusing their position in the 1990s seems to have scared the regulator out of its wits. The answer lay in better regulation, supervision and prudential norms.

The RBI has now strengthened its machinery of registration and supervision and extended prudential norms to NBFCs. Denying access to deposits would seem a case of throwing the baby out with the bathwater. On the contrary, the RBI should apply its mind to strengthening the functioning of NBFCs, if necessary, facilitating better access to the capital market.

It is, however, interesting to note that the RBI is thinking of using in some form an instrumentality like the NBFC to extend its credit reach. Observations in recent RBI reports show that the central bank would prefer to use microfinance credit agencies dedicated to serving SME clusters.

The RBI's Report on Trend and Progress of Banking in India 2004 mentions that "banks should extend wholesale financial assistance to non-governmental organisations/microfinance intermediaries and work as innovative models for securitisation of MFIs' receivable portfolios. Such micro-credit institutions can take the form of NBFCs funded by individuals or a group of banks, but not permitted to take public deposits".

A strange requirement, indeed, of exclusion from public deposits! The recommendation of setting up an institution in the form of NBFC is significant, although excluding such institutions from deposit-taking is not correct.

NBFCs have, indeed, served a useful purpose as instruments for extending outreach of credit in the Indian countryside. To ignore them but recreate them in the form of microfinance institutions or NGOs of the same kind is being ritualistic.

After all, let us recognise that NBFCs have a set of characteristics that have made them an effective form of financial intermediation. It is these characteristics that the RBI wants to incorporate in its version of microfinance groups. The path of wisdom is to incorporate NBFCs as such into India's financial structure rather than reinventing them in another form.

There are, of course, some persistent problems for NBFCs, apart from deposit-taking. These relate to flexible handling of their capital issues. Both SEBI and the RBI need to revisit their case for relaxations with sympathy, especially since they are rated and supervised. These specific relaxations are more a matter of confidence-building. The requests made by NBFCs deserve sympathetic treatment by both the securities market regulator and the central bank.

In short, NBFCs are vitally needed to give the Indian economy a much-needed boost by enabling easier access to credit. As it is, public and private sector banks are finding it difficult to extend their reach for various reasons. It behoves the RBI and the Government to look at the problems faced by NBFCs with sympathy rather than with a recollection of the past follies of a few institutions.

The time has come for the RBI to "make" peace with NBFCs as a class. They are proven instruments of efficient and customer-friendly outreach in the credit space — not only for consumer durables, but also housing and transport, besides infrastructure.

These are also critical areas in which the Government is vitally interested as part of boosting economic growth. I hope the regulators will not forget that their role is not only to regulate but to spur the growth of the economy. The NBFCs' request to be allowed to continue to accept public deposits deserves to be nurtured, not restricted.

Over the years, in its developmental role, the RBI has been attempting to expand credit by exhortation. But public sector banks have proved that even with their best efforts they are able to reach only a limited extent of credit expansion.

The experiment of Regional Rural Banks, Urban Cooperative Banks and Kisan Credit Cards has also been a mixture of success and failure. It is in this background that the proven successful record of credit growth, exemplified by the NBFCs, deserves to be replicated at least in respect of their better features by the banking system.

Commercial banks by their very nature cannot take on all the features of NBFCs, but they can collaborate with NBFCs by extending credit and participation in the securitisation.

While the flow of bank finance will help, it will be more important to remember that NBFCs started by accessing public deposits. These can be an additional window for savings. All this would of course require a change of mindset on the part of both our regulators and policy-makers.

If something works, and works well, why discard it? NBFCs are working well and they deserve to be encouraged, not fettered.

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