The Hindu Business Line : Norms for NBFCs

In the past, a larger number of Indians with savings chose to remain outside the official banking system placing their trust in informal savings institutions offering higher deposit rates. Some of these institutions morphed into Non-Banking Financial Companies (NBFCs) whose runaway growth came to a head in the mid-1990s when some offered interest rates far higher than what the banks did and finally went bust or decamped with depositor funds. Only in 1998 did the Reserve Bank of India create prudential norms for deposit-taking NBFCs so as to curb malpractice. But as the financial system liberalised and disintermediation happened, both banks and corporates saw in NBFCs an attractive route for activities not permitted to the traditional banking system.

From a policy point of view, the NBFCs became a critical entity for newer financial services, thus diversifying offerings and increasing competition for the banking sector. Over the decades, NBFCs gained in importance because of the services they offered to a wider public than did the banks. And more recently foreign banks have been using them as vehicles to get around the regulatory roadblocks to branch expansion. But regulations and prudential norms have been uneven across the spectrum of NBFCs which is why a set of draft regulations issued by the RBI last weekend is welcome, specifically with relation to systemically important NBFCs and, critically, the relationship between the banks and NBFCs. This is an important development since non-deposit-taking NBFCs have so far been subject to "minimal regulation."

The RBI has capped borrowings of non-deposit-taking NBFCs with asset size of over Rs 100 crore to 10 times the net owned funds, introduced capital adequacy norms, and placed NBFCs promoted by foreign banks in India under regulatory supervision. All banks, domestic or foreign, will have to restrict their stake in the paid-up capital of a deposit-taking NBFC to 10 per cent. Overall the exposure to NBFCs, in general, has been restricted to 40 per cent.

With these steps, the RBI gets to the heart of the NBFC world, the core of the sector's successful intermediation in financial services. The impact then will be profound and it is for this reason that the apex bank should think of compensating, as it were, the affected players with more freedom in other areas. For instance, foreign banks should be permitted to open more branches than now and the ceiling for exposure to mega projects should be raised for public sector banks. Regulation, necessary as it has been in the NBFC sector particularly, must not constrict the volume of legitimate business in an expanding market that is in need of capital. Leash the beast, but do not choke it.