RBI tightens the grip on non-banking finance companies

The Reserve Bank of India may further tighten the regulatory screws on non-banking finance companies. The reason: it appears that the stiff regulation for banks has increased the incentive for exploiting regulatory arbitrage by moving business to NBFCs.

The central bank is also likely to plug regulatory gaps arising from NBFCs not being subject to any restrictions regarding investment in the capital market and setting up of subsidiaries.

Only last month, the banking regulator had tightened the prudential norm on capital adequacy for deposit taking NBFCs.

The RBI has prescribed that these companies will have to maintain higher capital adequacy ratio of 15 per cent with effect from March-end 2012, against 12 per cent now.

More attractive

The regulatory arbitrage arises from the fact that NBFC is a more attractive option as entry point norm for them (at present net-owned funds of Rs 2 crore) is low compared with that for banks (Rs 300 crore) and they are subject to relatively lighter regulation.

The RBI, in its recent financial stability report, observed that “some concerns remain especially in the context of the rapidly expanding NBFC sector.”

The regulator's concern stems from NBFCs not being subject to any restrictions regarding investment in the capital market, leading to enhanced market risk; no restrictions on setting up of subsidiaries, thereby allowing creating opaque structures.

Corporate governance

Further, the quality of corporate governance could give rise to serious concerns.

Another area of concern for the regulator is the definition of an NBFC in terms of its “principal business”. This makes it possible for an NBFC to conduct other non-financial activities by deploying funds in non-financial assets.

Emerging issues

In view of these regulatory concerns, the RBI has constituted a Working Group under the Chairmanship of Ms Usha Thorat, Director, Centre for Advanced Financial Research and Learning, to examine a range of emerging issues pertaining to regulation of the NBFC sector.

The scope of examination will, however, be within the current legislative framework.

Industry players have expressed surprise at the exclusion of representatives of deposit-taking companies from the Group.

“It is really surprising that representatives of deposit-taking companies have been left out. Hopefully, the group will provide a roadmap for consistent regulation of the sector, prescribe relaxation in risk weightage for productive assets, and suggest a long term financing window,” said Mr Mahesh Thakkar, Director-General, Finance Industry Development Council.

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