Regulating NBFCs

| Updated on January 27, 2021

RBI’s proposed regulation for NBFCs is not disruptive, but seems to focus on systemic risk

After dropping broad hints about the need to tighten the screws on non-banking finance companies (NBFCs) post the IL&FS and Dewan Housing Finance (DHFL) failures, the Reserve Bank of India has floated a discussion paper that doesn’t seem to materially disrupt the sector’s regulatory regime. It suggests classifying NBFCs into four layers based on size and activity so that they can be subjected to differing degrees of regulation. Most players appear to be rather relieved about the paper, which has kept off recommending a Cash Reserve Ratio or a Statutory Liquidity Ratio requirement for NBFCs to bring them on a par with banks.

After raising the minimum capital requirement for NBFC licences to ₹20 crore (from ₹2 crore), the paper suggests sweeping all NBFCs with less than ₹1,000 crore assets, P2P lenders and account aggregators into a ‘base’ layer. These firms will follow 90-day NPA recognition norm and raised disclosure standards, but otherwise there’s little change in their ground-rules. The middle layer made up of larger NBFCs, deposit-taking firms, housing finance firms and investment companies, will see tighter loan exposure norms, three-year auditor rotation and Basel Pillar-III disclosures. This may not pose much hardship to established players. The RBI has reserved its most stringent rules for the 25-30 ‘upper layer’ NBFCs that will be identified based on size, leverage, interconnectedness and complexity. These will be subject to capital, provisioning and exposure rules identical to or even more stringent than for banks. This proposed regulatory regime certainly has positive aspects. It recognises that rather than the quantum of an NBFC’s loans, it is the complexity of its lending operations and reliance on banks/markets for funds that puts the system at risk. It acknowledges that weak governance was at the root of the DHFL and IL&FS episodes and proposes new rules on board composition, compensation and auditor appointment. The ₹1,000-crore threshold for the base layer seems to be an admission that too much regulation can stifle the growth of smaller firms that fulfil a felt need for last-mile credit delivery. The paper expects 9,209 of the 9,425 non-deposit taking NBFCs to fall in the base layer — so a majority of the existing NBFCs may get away with lighter regulations.

The flip side of the paper though, is that it continues to focus wholly on the systemic risk aspect of NBFC failures, while ignoring the risks to consumers from proliferating non-banks. The recent exposes on digital lending apps tying up with small NBFCs to indulge in a range of dubious lending practices flags the damage that even tiny NBFCs, if inadequately supervised, can cause. Apart from shoring up its supervisory capacity, it is perhaps time for the central bank to acknowledge that the consumer protection aspect of financial services may merit an independent regulator on the lines of the UK Financial Conduct Authority or the US Consumer Financial Protection Bureau.

Published on January 27, 2021

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