Allow some NBFCs to decouple from banks

The RBI recently adjusted risk weights for retail-unsecured and services-NBFC loans, signalling a cautious approach to rein in the rapid expansion in these sectors. The move aims to align lending rates with the long-term mean, though analysts project only a marginal increase of 25-65 basis points.

Despite the expected minimal impact on capital adequacy ratios, the RBI’s decision responds to a surge in retail lending across diverse institutions, from banks to fintechs and NBFCs. This trend, reminiscent of pre-2008 financial crisis scenarios, involved fierce competition and indiscriminate lending practices, potentially jeopardising financial stability. The RBI’s intervention underscores a proactive stance, aiming to prevent the pitfalls of unbridled lending and maintain a balanced economic landscape.

In the past decade, annualised growth in unsecured bank loans, including credit cards, surged 21 per cent, outpacing the overall loan growth of 9.5 per cent, particularly in industries with a mere 3 per cent growth. Lenders, in pursuit of unsecured customers, increasingly extended loans to individuals with low credit scores, with estimates indicating that 12 per cent of non-banking financial company (NBFC) retail customers fall into the subprime category, posing a significant concern for banking regulators.

Total credit flow

The RBI subtly signals this risk without causing disruption, urging lenders to align their risk appetites with caution. Historically, financial companies tend to expand risk appetites during upcycles, leading to collapses when the cycle shifts. India’s homogenous financial sector, where 62 per cent of total credit flow comes from bank lending, exacerbates the issue. Corporate debt issuances contribute 20 per cent, and NBFCs (including housing finance companies) account for 18 per cent. The underdeveloped corporate debt market, limited participation from asset owners like pension funds and insurance companies, and minimal retail investments in mutual funds and capital markets make banks the primary source of growth capital. While NBFCs seem like an alternative source, they heavily rely on banks for capital, with approximately 55 per cent of non-deposit taking NBFC liabilities linked to banks. This financial sector architecture poses a systemic risk, where a mishap in a bank/NBFC can trigger a contagion affecting both industries.

For India to become a developed nation, smooth and large volumes of credit would be necessary. Banks alone may fall short in meeting this demand. Hence it is critical to diversify sources of credit within the economy. In large economies like the US, China and Germany, banks account for less than 45 per cent of credit and bond markets supply 30-45 per cent of it. Hence it is important to decouple banks and NBFCs.

As an alternative source, NBFCs can tap the corporate debt market. However, in the absence of adequate liquidity, this market is highly skewed in favour of a handful of large issuers with credit ratings exceeding AA, crowding out the rest. While a lot of steps are underway to strengthen India’s corporate debt market, this is expected to be a time-consuming initiative.

As an alternative, some of the large NBFCs with proven track records can be provided with deposit-taking licences. This will allow them to raise cheap funds through time deposits from the public. It can be a win-win situation, with NBFCs finding an alternative to bank credit, and household savers getting access to high yielding savings instruments.

The writer is Chief Economist, Piramal Group

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