A nation is on a successful trajectory when its finance system is robust and resilient. For India one cannot vouch for its credible financial system. The rueful NPA crisis of the banking system is often a monotonous repetitive story
But the Indian government does not seem to pay its imperative undivided attention to the large looming crisis in making. Its reluctant attitude towards handling the crisis by mere recapitalization is a step that is not only faulty and ineffective but also detestable altogether.
Well, this looming NPA crisis seems to have reached the NBFC sector too in India. The RBI has recently proposed a significant shift from the liberal regulation of the NBFC sector to a more stringent regulations and monitoring. The newer regulations will now allow NBFCs to be monitored as closely as the banks. If implemented, this could be the overhaul of the biggest regulatory framework for such financial sectors, also known as the shadow banks.
There will be suggested four-layer pyramid structure, with progressive levels of regulations.
Due to the recent stress in the system, the RBI plans to embark on the path of a scale-based regulation. In its paper namely “Revised Regulatory Framework for NBFCs – a Scale Based Approach” RBI recommends the NBFC sector to be visualized as a pyramid, with it being grouped in four layers namely – base layer (BL), Middle layer (ML), Upper Layer (UP) and a possible Top layer (TL).
NBFC four tier policy pyramid.
The least regulated layer, as it can be discerned, will be the base layer and most regulated will be the top most layer. The non-systematically important NBFCs which amount to 9,209 will be included in the base layer. RBI has proposed base layer’s NPA (non-performing Assets) classification norm from 180 days to 90 days. The upper layer includes systematically significant NBFCS, also known as the NBFCs which have the greatest potential of systematic spillover of risks.
What all has been recommended by RBI on the paper? Let’s have a sneak peek. The paper recommends a functionally independent Chief Compliance Officer, free from political and bureaucratic influence and high on efficiency and regulation. As previously noted, politically influenced high post executives can lead to financing of bogus schemes and ill-omened projects. This in turn leads to bailing out on the system by such fraudulent companies, leading to financial instability and liquidity problems in the system.
Guidelines on the line of stressed assets, NBFCs will be regulated on similar lines as banks. As for the top layer, which has the highest risk of financial spillover, they will be regulated on the lines of the private banks. It will be mandatory for them to list requirement and follow the consequent Listing obligations and Disclosure Requirements.
After CRB group firms reneged on high interest fixed deposit in 1997, parliament had restored greater scrutiny and powers over these firms to the central bank. Similarly, when largest infrastructure investment, ILFS, unraveled in 2018, it sent a shock wave throughout the system.
How did these fallouts come to be? Dating back since 1990 to 2015, NBFC’s balance sheets have more than doubled from Rs 20.7 lakh crore in 2015 to Rs 49.2 lakh crore in 2020. This is mainly due to softer approach and regulations that had given them more flexibility to finance small enterprises, MSMEs (micro finance) and large investment projects on huge scales. This greater flexibility coupled with flexible norms has led to liquidity shock waves that now NBFC faces.
What RBI proposes is mainly a lazier faire approach for smaller NBFCs, plugging some of the arbitrages available to mid -sized NBCs and imposing tougher ‘bank like’ capitalization norms. But RBI also states that such norms will come into force only when a large player could pose ‘extreme risk’.
Given banking sectors own woes, NBFC sector’s regulation comes across as crucial and mandatory. It is only when big player like Dewan Housing Finance Corporation (DHFC) entered the market, RBI decided for stricter regulations and monitoring. This could have come sooner, as India already faces banking sector bad loan crisis leading to liquidity and solvency problem. Its frequent recapitalization renders it unprofitable and lagging.
This proves NBFC a sole poignant alternative for corporate and infrastructure financing. If rectified and regulated with caution, NBFCs can play a crucial role in financing India’s ‘ATMANIRBHAR’ schemes, which can prove big for India in the long run.