The series of actions taken by the Reserve Bank of India (RBI) in the recent past against banks and NBFCs highlights the flagrant violation of regulations by these entities to drive the heady growth in their retail loan portfolios. It is just as well that the central bank is taking pre-emptive action when the credit boom is still going strong.

By first carrying out limited review of the books of the regulated entities and then clamping down on lenders found deploying sharp practices to show larger loan book or more clients, the RBI is ensuring that banks and NBFCs get ample time to rectify their processes. This will help avert systemic risk and protect clients’ interests. Retail loans of banks and NBFCs have grown to ₹51.7-lakh crore accounting for 32 per cent of gross bank credit towards the end of 2023, up from ₹24.3-lakh crore four years ago. The growth has been especially high in NBFCs at an annual rate of 33 per cent. Recent strictures against IIFL and JM Financial Products show that there could be high risk in the NBFC retail loan book. IIFL Finance was found to be sanctioning gold loans which were far higher than the amount warranted by the purity of the gold pledged by borrowers. The company was also not adhering to RBI’s guideline on loan-to-value ratio. This shows that the gold loans may not be secured by the required underlying asset.

JM Financial appears to have inflated its loans against shares and debentures. The RBI circular also points towards governance failure at this entity as it was found to be using Power of Attorney given by clients to apply to primary equity offers, operate their demat and bank accounts and to take loans from itself (JM Financial) to make these applications. Clearly, the central bank cannot be complacent about the secured retail loans either. The RBI has been increasing its scrutiny on retail loans for some time. In the monetary policy statement in October 2023, the governor had warned banks and NBFCs on the rising risks in their retail portfolios and asked them to strengthen internal checks. Last November, risk weights for some categories of personal loans and on bank lending to NBFCs were increased. In December, regulated entities were told not to invest in alternative investment funds (AIFs), which had invested in debtors of the banks or NBFCs. But, as the latest orders against Paytm Payments Bank, IIFL and JM Financial show, ensuring compliance is not going to be a cake walk.

The special audits by RBI of JM Financial and IIFL’s books should be completed fast and action taken if violation of regulations is found. It is hoped that the strictures against the companies will serve as a warning to other lenders too. It is notable that the RBI and Securities and Exchange Board of India are collaborating on these issues. RBI’s limited review of the books of JM Financial was prompted by information shared by SEBI. Similarly, SEBI had shared information about financial institutions evergreening loans through AIFs. Such collaboration can help keep out systemic risks from getting entrenched.