RBI must see how its recent interventions impact NBFCs before attempting further tweaks

| Updated on November 17, 2020

Further regulations for NBFCs at this juncture could throttle a sector that has a critical role to play in the ongoing economic recovery

NBFCs (non-banking finance companies) in India represent no fledging industry, having survived multiple economic cycles and scaled up to a fifth of the size of scheduled banks with assets of ₹51 lakh crore. By now, it is also well-acknowledged that NBFCs perform yeoman service to the economy by delivering last-mile credit to borrowers who are summarily ignored by banks, whether through microfinance and loans against jewellery or financing the trucking industry or family enterprises. But this has not stopped the RBI from periodically worrying over the risks to the financial system, should an NBFC grow too big or fail under its watch. This fear seems to have been resurrected by the recent failures of IL&FS and Dewan Housing Finance. In a recent paper, RBI Deputy Governor Rajeshwar Rao called for the principle of proportionality to be applied to NBFCs, asking for rules for systemically large NBFCs to be tightened, either to incentivise them to convert into banks or scale down if they pose ‘negative externalities’. But the RBI would do well to stay its hand on writing further regulations for NBFCs at this juncture, as this could throttle a sector that has a critical role to play in the ongoing economic recovery.

While it has become the norm for the RBI to bemoan the regulatory arbitrage between banks and NBFCs and ‘light-touch’ regulations, it must introspect on whether such gaps still exist after it tightened the screws on NBFCs. Rules framed in 2014 have already brought Tier-1 capital, provisioning and bad loan recognition norms for NBFCs in line with banks. The RBI has been quite frugal with deposit-taking NBFC licences and capped the quantum of deposits at 1.5 times their own funds. The boards of NBFCs have been tasked with closely monitoring asset-liability mismatches and liquidity risks. To pre-empt liquidity risks in the absence of SLR and CRR, NBFCs have been asked to hold a liquidity cover equal to a month’s cash outflows from December 2020. Large NBFCs are also now required to disclose granular details of maturity-wise cash flows on a quarterly basis.

With so many recent interventions, it appears prudent for the RBI to monitor the effect of these norms before attempting newer tweaks. Despite fears about systemic risks, it is worth noting that the IL&FS and DHFL failures did not in fact set off a domino effect in the sector. Instead, these episodes resulted in a spike in borrowing costs and a drying up of funding for the weaker players, who were forced to shrink their balance sheets. Clearly, bond market forces are working as they should to ensure the survival of the fittest. As the paper admits, the very uniqueness of the NBFC sector lies in its diversity and one-size-fits-all regulation may be counter-productive. Instead, the RBI must more strictly monitor NBFCs’ compliance with its rules and build supervisory capacity to scrutinise their voluminous filings to ward off systemic risks.

Published on November 17, 2020

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