Banking on NBFCs

| Updated on November 22, 2020

The RBI panel’s recommendations are mostly well rounded but for a few blind spots

Haunted perhaps by the IL&FS and DHFL meltdowns, the Reserve Bank of India is pushing for the conversion of large non-banking finance companies into banks. It seems to favour more uniformity of entities in the financial sector, no doubt for regulatory convenience, and for a higher share of the private sector — which accounts for 30 per cent of deposits and 36 per cent of advances — in the banking sector. The internal working group set up to review the ownership structure in the financial sector has suggested the relaxation of existing ownership norms for the conversion of NBFCs into banks. Striking a tightrope between dilution of ownership (to prevent misuse by powerful promoters) and ensuring that promoters stay interested with “skin in the game”, the panel rightly moots a promoter stake of 26 per cent, against the present 15 per cent, after the usual 40 per cent per cent stake during the initial lock-in period. This has been a long-standing demand of bank promoters.

While NBFCs with an asset size of ₹50,000 crore and credible operating experience can apply for a banking licence, payments banks too have been incentivised to convert to small finance banks. For the latter, a track record of three years is good enough. A significant incentive is that banks currently under a non-operative holding financial company structure can exit from such a structure if they do not have other group entities in their fold. Further efforts to encourage new entrants include a suggestion that industrial houses can be allowed to set up banks, provided the laws and supervision systems prevent transactions between connected entities. This is a matter on which the central bank has to tread carefully given the opacity with which some large business houses operate, with the promoter family usually dominating the management. The regulations should be so framed that only groups with a professional and transparent management known for strong governance clear the bar.

The push to convert NBFCs into banks is based on some flawed assumptions. It should not be forgotten that NBFCs serve the last mile ignored by banks and account for a quarter of non-food credit. It is futile to expect NBFCs (90 per cent of the 9,600 in existence do not accept deposits) to be attracted by low cost deposits alone, when the other bank regulations such as CRR and priority sector lending obligations will apply. The assumption that NBFCs are prone to fly below the radar should be reviewed after the new, tighter regulation. Banks, from YES Bank to Lakshmi Vilas, too got away with excesses. Governance is related to the RBI’s supervision capacity, rather than to ownership pattern or even the promoters’ stake. A key problem with the report is its sole emphasis on creation of a bank, without addressing the question of how to deal with banks which are hurtling towards closure or chaos. The two are intertwined.

Published on November 22, 2020

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