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Reserve Bank of India’s recent regulatory measures will curtail lenders’ over-exuberance, enhance compliance culture, and safeguard customers. However, the drawback will be higher capital costs for institutions and impede growth, S&P Global said in a note.
“India’s regulator has underscored its commitment to strengthening the financial sector. But the increased regulatory risk could impede growth and raise the cost of capital for financial institutions,” said S&P Global credit analyst Geeta Chugh.
Combined with tight liquidity, the RBI’s new measures are likely to limit credit growth, which is seen declining to 14 per cent in FY25 from 16 per cent in FY24, reflecting the cumulative impact of all these actions.
RBI’s measures to check excessive risk-taking in various market segments such as increasing risk weights for NBFCs and unsecured consumer lending is expected to temper credit growth, CRISIL Market Intelligence and Analytics said in a note. Bank credit growth accelerated for the second consecutive month to 16.5 per cent in February 2024 from 16.1 per cent in January 2024.
Crisil estimates bank credit growth to dip to 13.5-14.5 per cent in FY25 from 14.5-15.5 per cent. Credit growth for NBFCs is expected to see a sharper slowdown to 15-16 per cent from 17-18 per cent in FY24, impacting overall pace of economic growth.
Regulatory actions
RBI’s actions reflect a commitment to improving governance and transparency, and indicate diminishing tolerance for non-compliance, customer complaints, data privacy, governance, know-your-customer (KYC), and anti-money laundering issues, S&P said.
Some of the recent measures include restraining IIFL Finance from disbursing gold loans, barring JM Financial Products from loans against shares, and asking Paytm Payments Bank to wind down operations. Earlier in December 2020, RBI had suspended HDFC Bank from sourcing new credit card customers after repeated technological outages.
“These actions are a departure from the historically nominal financial penalties imposed for breaches,” the note said, adding that RBI has also become more vocal in calling out detrimental conduct such as perfunctory credit underwriting, overvaluation of collateral, and governance issues.
“Governance and transparency are key weaknesses for the Indian financial sector and weigh on our analysis. RBI’s new measures are creating a more robust and transparent financial system,” Chugh said adding that increased transparency will create additional pressure on the entire financial sector to enhance compliance and governance practices.
The regulatory measures also show scant tolerance for any potential window-dressing of accounts, reflected in the action taken on provisioning requirements for AIFs that lend to the same borrower as the bank or NBFC.
Higher risk premiums
These measures are likely to lead to increased compliance costs for the sector, driving banks and NBFCs to better focus on policies and processes, ultimately enhancing the operational resilience of the system.
On the other hand, it may also curb the ability of smaller and weaker companies to compete in the market who may need to increasingly rely more on originate and distribute models, leveraging co-lending and direct assignments.
“We expect the investors in the financial sector will seek a higher premium for the increased regulatory risk associated with their investments. This risk stems from the potential for tighter regulation, such as business embargoes, which can dent a company’s earnings and reputation,” S&P Global said.
Finance companies are also vulnerable to confidence sensitivity and trust deficit can lead to funding constraints as risk premium charged by equity investors may increase, potentially affecting sector valuations.
“We expect the funding cost for the system could rise and potentially lead to longer lending processes for lenders,” Chugh said, adding that risk premiums have increased for companies with perceived governance issues and are therefore, at higher risk of regulatory action.
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