Should regulations hinge on business size?

R Anand | Updated on June 30, 2020 Published on June 30, 2020

Reorient approach The regulatory system should be so designed that all compliances can be carried out online   -  tumsasedgars

Currently, they are based on nature of business and follow a one-size-fits-all model. Such an approach hurts smaller players

Size matters but small is also beautiful. In the context of business this statement rings a bell in all management classrooms. Indian businesses have grown and evolved by starting small and taking all the baby steps required in the days of licence quota Raj. Post 1991, the corporate sector leapfrogged into a different orbit of growth and provided the platform for both the manufacturing and services sectors to make a mark in India and in the global arena.

The Indian regulatory framework had to keep pace with this frenetic pace of activity and despite facing criticisms of being reactive in nature, they have managed to hold their own considering all the odds. Regulations that exist now are designed on the basis of nature of business and largely catering to a one-size-fits-all approach.

The new normal which stares at our face is posing the question: Should regulations be on the basis of size? This question is more relevant now in the context of the present crisis, where smaller players are bearing the brunt more than the larger players.


The core strength of our progress is manufacturing, which constitutes around 15 per cent of our GDP. Players is this sector can be large/medium/small. For convenience, we can take small to represent the MSME sector. It is a given that without the MSME sector, the large players cannot flourish.

There are 63 million MSMEs in this country employing 124 million people. The bane of the MSME sector is the absence of long-term equity, crippling effect of debt overhang and increased cost of compliance. Some of these are addressed in the recent stimulus package. All companies have to deal with multiple regulations irrespective of their size. However, larger companies have the necessary internal fire-power and wherewithal to deal with increased cost of compliance which, in today’s context, includes dealing with increased cost of litigation.

But the MSME sector cannot handle these multiple regulators on a regular basis. It needs support not only in funding but also relief from the clutches of too many regulators. There must be a different set of regulations both at the Centre and State levels which are simple and less burdensome to comply.

It is a pity that bulk of the time of those running MSMEs is spent either at the doorstep of banks or in the corridors of government offices. The regulatory system should be so designed that all compliances can be carried out online and the sector should focus on producing the right products and selling them at the right price.

Banks and NBFCs

A mirror image of the size issue discussed above relates to banks and NBFCs. There are large, medium, small banks. The largest bank, SBI, has an asset size of around ₹37.49-lakh crore, and one of the smallest, Dhanalaxmi Bank, has an asset size of about ₹12,000 crore.

The Banking Regulations Act applies uniformly to all banks irrespective of the size. A significant aspect is that the regulations are so rigorous that non-compliance is severely dealt with. The problem of NPAs (non-performing assets) is a separate issue altogether and has nothing to do with the efficacy of regulations. The story of NBFCs is also evolving on the same lines as banks. There are large, medium and small NBFCs as also several financiers in the unorganised sector. Just like the MSME sector, the smaller players are bearing the brunt of excessive regulations, thereby hampering growth opportunities.

NBFCs are essentially divided under three categories — nature of activity, size, and whether they are deposit-taking or not. They are classified as systemically and non-systemically important. The regulations prescribed by the RBI — in the form of capital adequacy norms, prudential norms, fair practices code, KYC norms and other corporate governance norms — are to be complied with by all NBFCs accepting public deposits (irrespective of the value of total assets held) and the non-deposit taking systemically important NBFCs.

Moreover, in the aftermath of IL&FS crisis, the RBI, in November 2019, came out with a framework to revise the existing guidelines on liquidity risk management making it applicable for all NBFCs with an asset size of ₹100 crore and above and all deposit-taking NBFCs irrespective of the asset size. With most regulations relating to banks and NBFCs converging it is time to seriously consider large NBFCs over ₹10,000 crore to be part of Banking Regulations Act rather than NBFC regulations, with the necessary changes in their business model.

The protection of the Banking Regulation Act will ensure that all large NBFCs get the required benefits of a bank which are not currently available to them. They are systemically important, and investors and depositors will be well-protected if they are under the supervisory system of Banking Regulations Act.

In effect, large NBFCs should be converted into a separate category of banks. Smaller NBFCs should conduct business with minimum burden of regulations and this should be applicable for NBFCs with asset size of less than ₹500 crore provided they do not accept public deposits.

For this category, prudential norms, income recognition standards, etc., should be dispensed with. Further, the 90-day NPA norm should not apply to such smaller NBFCs. The present stimulus package should consider providing long-term equity to smaller NBFCs that are starved of long-term funding. In other words, for NBFCs with asset size between ₹500 crore and ₹10,000 crores, all the NBFC regulations should apply.

Way forward

As we start from virtually a clean slate post-Covid, we should reorient our approach to regulations based on size and not on activity alone. Small players have a significant role to play in the new phase of growth. By design or otherwise we are now forced to bucket the MSME sector with the smaller NBFCs, since the latter has to provide the much-needed loans to the former.

The Fund of Fund equity scheme announced recently should have a dedicated window for small NBFCs also, since it will anyway find its way to the MSME sector. The idea propounded above is not to fragment businesses based on size but only to advocate flexibility in regulations so that the smaller players bestow all energy for doing business. It should not be a case of saying: ‘We are complying with all laws and regulations and time permitting we also manufacture, sell and also provide finance.’

The writer is a chartered accountant

Published on June 30, 2020
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