NBFC regulation: RBI’s suggestions on changes to CIC framework are welcome

| Updated on November 07, 2019 Published on November 07, 2019

But the RBI should be careful about the manner in which the rules are implemented

It is now fairly obvious that the fast-paced growth in non-bank finance companies over the last few years is partly due to some companies bending the rules and, at times, flouting them as well. The RBI working group under Tapan Ray, that was given the task to review one of the troublespots in the NBFC regulatory framework — core investment companies (CICs) — has made some good suggestions. While the supervision of CICs can improve going ahead, these regulations, if adopted, may not be able to fix the damage already done. The CICs, which hold at least 90 per cent of their net assets as investment in equity, debt or loans in group companies, were under less stringent regulation; it was believed that these entities would be taking lower risk since they have exposure to group entities alone. But the loopholes in the rules have been exploited by some groups, leading to regulatory problems.

For instance the expanded definition of ‘Group’ in the regulation — that includes subsidiaries, joint ventures, associates, promoters and related parties — led to CICs dealing with many unregulated entities. Many groups had multiple CICs, and each CIC would raise funds independently to invest in group companies or other CICs. Thus funds were being raised by CICs, step-down CICs as well as by group companies, increasing the group-level gearing. Since some group entities are not governed by any regulator, it was difficult to gauge the extent of leverage in these entities. Also, while CICs are currently restricted to dealing only with group entities on the asset side, there is no such restriction on liabilities. They can borrow from markets, mutual funds and other investors through commercial papers, non-convertible debentures and inter-corporate deposits, for investing in or lending to group companies. The suggestion to restrict the number of layers of CICs in a group to two, will help in multiple ways including reducing leverage, improving transparency and making regulation easier. Stipulating that capital contribution by a CIC in a step-down CIC, over and above 10 per cent of its owned funds, should be deducted from its adjusted networth, will help rein in the borrowings of these entities. The suggestions regarding mandating a group risk management committee, audit committee and nomination and remuneration committee will help improve governance of such groups and ensure that shareholder wealth is protected.

While the changes will certainly help improve governance in CICs, the RBI should be careful about the manner in which the rules are implemented. The glide path of two years given to existing CICs to reduce the adjusted networth and for step-down CICs to stop investing or lending to other CICs may not be enough. Periodic on-site inspection by the RBI is a good idea as is off-site reporting of disclosure relating to leverage at the CIC and the group level. But the RBI should ensure that the changes do not lead to fresh problems.

Published on November 07, 2019
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