The Hindu Business Line : Simplicity, transparency of products key for NBFCs

NBFCs or non-banking financial companies are suddenly in news. Especially, ever since the RBI set a cat among the pigeons by floating `for comments' a `draft circular' titled `Financial regulation of systemically important NBFCs and banks' relationship with them'. In this context, Mr Robin Roy, Principal Consultant, PricewaterhouseCoopers (P) Ltd takes on a few questions from Business Line.

How are NBFCs important to us?

All participants in the financial ecosystem have the inherent ability to have an impact on the financial system. Except for issuing cheques and opening savings bank/current accounts, NBFCs can do almost all things that a bank does. They are thus not part of the primary payment and settlement system in the country.

Why the sudden interest to regulate them?

In keeping with global best practices in regulation and supervision, the regulator would like to adopt an activity-based supervision rather then entity-based supervision, wherein all players performing similar activities are provided a level-playing field and subject to regulatory `equity'.

What explains the popularity of NBFCs?

More the disintermediation, more the benefits to the end customer. Financial services have become commoditised, and so the cost of distribution is the key metric to service the customer cost effectively. Here, NBFCs have played an important role in terms of increased reach. They are present in locations where a more `heavy cost' structure like a bank would perhaps be hesitant. Their operating costs (barring funding costs) and staff costs are more competitive than other organised intermediaries.

Which explains why banks used the NBFC structure?

Yes. Also, to go around the current set of regulations, many banks have used the NBFC structure, and provided capital market related services with a much lower capital base. A case of `regulatory arbitrage', you may say.

Do you foresee NBFCs responding to developments on the Basel front?

Capital adequacy in the post Basel period is related to the risk in loan assets. Risk weightages need to be applied `uniformly' across the system for similar asset classes. This is expected to continue till the banks and NBFCs develop and use their own internal credit rating models, based on historical data and pass the `user test' for such models with flying colours, whereby efficient credit processes can be rewarded with lower capital requirements.

Rationale of the latest missive from the RBI?

The proposed guidelines for NBFCs are to treat the deposit-taking and the non-deposit taking ones more distinctively. There is perhaps an intuitively deep logic in this approach. The ecosystem could have three different situations calling for suitable responses: First, the imperfect deposit and perfect loan markets, where the intermediary pays higher rate of deposits, and deposits are positively correlated to interest rates. Second, the perfect deposit and imperfect loan markets; research shows that large, especially urban, areas face a very interest-elastic deposit market. And the third, imperfect deposit and imperfect loan markets, where the intermediary offers lower rate on loans, and loan rates are inversely related to loan levels.

Where the competitiveness of operations are not a direct result of good distribution models, but are buffeted by `imperfect' conditions, a level-playing field by itself, may not provide economic benefits to end customers. A firm conclusion, however, as to the right intermediation model would be premature.

On the challenges before NBFCs?

Yes, NBFCs would need to also address a host of non-regulatory challenges in the future. For instance, with responsibilities and ethics of NBFCs already under close political scrutiny, simplicity and transparency of products will be a key ingredient of success. Many NBFCs may have to spend the rest of this decade positioning themselves to meet the demand for long-term products. All institutions must build a high performance culture centred around the customer. Rising competitive pressures will force institutions to differentiate themselves more aggressively, even as cost efficiency continues to be key.

How can NBFCs leverage technology?

Upgrading technology to track risk exposure accurately and swiftly across the whole firm will be crucial. CRM (customer relationship management) will move towards a more proactive role. And security will be a key differentiator.

The outlook on the reporting aspects?

A truly global footprint ensures a hugely complex compliance challenge. Enterprise wide risk management systems will then have to mature and proliferate. NBFCs would need to appreciate that greater reporting visibility will empower both ratings agencies and investors even more.