Preventive strike

After the shock to the financial system from the IL&FS crisis, the Reserve Bank of India has been superseding the Boards of large non-banks seen to be on the brink of failure, recently initiating such rescue efforts at the SREI group and Reliance Capital. But in initiating such actions after a non-bank has defaulted on its obligations, RBI has been criticised for intervening too late to shore up public confidence, preserve value for stakeholders or woo acquirers to the entity. While there are only a few score banks, the financial system is home to over 9,400 NBFCs which are highly interconnected to both bond markets and banks. This is why RBI’s decision to introduce a Prompt Corrective Action (PCA) framework for NBFCs, on the lines of the one for banks that’s been around since 2002, is a welcome, if belated, attempt to institute an early-warning system on NBFC distress.

Compared to its norms for banks, RBI appears to have set somewhat liberal thresholds for NBFCs before they attract PCA norms. The framework will apply only to middle and upper layer NBFCs, deposit-taking NBFCs and Core Investment Companies. If the non-bank’s CRAR falls 300-600 basis points below the regulatory minimum, Tier 1 capital slips 200-400 basis points below norms or net NPAs soar beyond 6- 12 per cent, PCA kicks in. Based on how far an NBFC has strayed from these thresholds, RBI can impose dividend restrictions, mandate capital infusion and restrict capex or branch expansion. It also has discretion to initiate special audits or inspections, propose a bail-out scheme or file an insolvency application with the IBC. RBI has perhaps set relaxed norms for NBFCs in recognition of the fact that they lend to far riskier borrowers than banks. But the leeway offered may also allow an NBFC to land in considerable stress before it invites regulatory actions.

It is disappointing that the PCA norms for NBFCs will not immediately apply to government companies and leaves out all ‘base layer’ NBFCs. NBFCs promoted by the Central and State governments in India rely quite heavily on bond funds raised from public markets and sometimes on public deposits, with some undoubtedly in precarious financial shape. Given that public sector banks are very much under the PCA framework, there’s a strong case for applying it to government-owned NBFCs too. The decision to exclude the base layer of NBFCs — non-banks with a less than ₹1,000 crore asset base including P2P lenders, digital lenders, account aggregators and small lenders — from PCA needs re-evaluation too. RBI’s earlier discussion paper found that as many as 9,209 of the 9,425 registered NBFCs fall in this base layer. Given that the digital lending and fintech revolution in India is increasingly being powered by small NBFCs, P2P firms and such, allowing such a large number of them to get away with light-touch regulations may pose risks to public confidence in the financial system, too.

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