Based on the brilliant lecture on the above subject by Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India – November 6, 2020 – at the ‘National E-Summit on Non-Banking Finance Companies’ organized by ASSOCHAM, the following article traces its origin. It has been drawn from the RBI web site as under:

https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1101

Though an attempt has been made to keep the pace of his coverage of the speech, necessary modification has been made to understand its deeper direction and resultant facts in near future.

The speech adorns the following subjects to lead us through a vast canvas of NBFC.

  • Growth of the NBFC sector and the need for prudence
  • Pandemic effect
  • The regulatory approach
  • The future – principle of proportionality, regulatory FinTech, ensuing transparency and governance, consumer protection and fair conduct
  • Conclusion

NBFC

Growth of the NBFC sector and the need for prudence

Let us look at the growth of NBFC during the pandemic from the statistical information provided by RBI Dy. Governor.

Following direct quotations from the speech is quite revealing of the inherent weakness of the smaller NBFCs.

“In the aftermath of liquidity stress post-IL&FS and DHFL events, the market funding conditions turned difficult for NBFCs. While NBFCs with better governance standards and better operating practices did well, others bore the brunt of the market forces. Smaller NBFCs and Microfinance Institutions (MFIs), who were contributing significantly to the last mile credit delivery, also got impacted as their funding sources got further squeezed.”

Some financial information produced below further reinforces the above observation.

  The profitability of the NBFC Sector (Deposit Taking and NDSI)

Profitability Parameters March 2017 March 2020 
Net profit (Rs. In Crore)

 

31,923 41257 
Annualized ROA (%)   1.5 1.2 
Annualized ROE (%)   6.3 5.1

The glorious induction of NBFC as the main financial entity approach with a massive growth of this sector giving competitive edge often eclipsing even conventional banks with its speed, vast reach of customers and astonishing speed to deliver the sanction of financial products made RBI, its regulators to take immediate regulatory steps like protecting the depositors in case of deposit-accepting companies, and consequently protect the financial stability of the NBFC itself.

What are the most important and significant regulatory changes that can be explained?

  • First and foremost, in line with RBI’s emphasis on ownership-neutral regulations, Government-owned NBFCs were brought under the purview of prudential regulation since May 2018. Considering the fact that Government-owned NBFCs account for more than one-third of this vibrant sector, with particular mention under infrastructure lending, this was one of the most wanted acts of RBI.
  • Alarmed by the liquidity crisis in NBFCs, the introduction of the liquidity risk management framework for NBFCs with asset size above Rs.100 crores was introduced. The guidelines follow the ‘Principles of Sound Liquidity Risk Management and Supervision’ published by the Basel Committee on Banking Supervision. The framework insists on the Boards of NBFCs to take an active role in the management of liquidity risk and deploy internal monitoring tools suitable to their business profile. Introduction of Liquidity Coverage Ratio (LCR) meant for large NBFCs would get prepared to effectively meet cash outflows even under severe liquidity stress scenarios over a 30-day horizon. These NBFCs have been instructed to mitigate the risks associated with maturity/liquidity transformation they are engaging in operations.
  • Compelled by organic growth based on Fin Tech-based product delivery systems, RBI introduced guidelines for P2P lending platforms. Further, the deputy governor recalled the ecosystem created under the Account Aggregator (AA) framework as another example of proactive regulation in the technology-intense activities. Particular mention was his information that these AA framework does not store the data passing through it.
  • The failure of a large NBFC, a large Core Investment Company with a total lack of financial stability prompted the regulator to introduce stringent regulations for these holding companies.
  • Introduction of a significant regulatory framework for Housing Finance Corporations for treating them as NBFC was a milestone instilling a sense of responsibility for this sector.
  • He also emphasized that mere stringent regulations should not impede their flexibility and ability to compete with banks in serving their clients.

Pandemic effect

The Pandemic Effect

In the aftermath of liquidity stress post-IL&FS and DHFL events, the market funding conditions got strained for NBFCs. While NBFCs with better governance standards and better operating practices managed well, others bore the brunt of the market forces, smaller NBFCs, and Microfinance Institutions (MFIs), who were contributing effectively to the last mile credit delivery, also got the worst impact as their funding sources got further squeezed. The Reserve Bank acted in a swift and proactive manner to improve access to funding and liquidity by its monetary policy and liquidity measures and resultantly, the cost of funds for NBFCs and HFCs got reduced facilitating better functioning.

The future

The principle of proportionality

It is not unusual to expect a greater sense of regulation for a large NBFC capable of contributing a large impact on financial stability. There is also another irrefutable argument that why not convert a large NBFC as a commercial bank which would automatically entitle itself to a higher degree of regulation. So, the option left with a bigger NBFC would be to convert itself as a commercial bank for effective functioning. Or, it will enable other smaller NBFCs to function at a lower scale of functioning with regulation-free structure.

The Deputy Governor further dealt with the current situation of the microfinance sector where NBFC-MFIs have come down to 30% of the microfinance sector.  He further felt that there would be regulations based on activity-based principles than entity-based principles. It was his opinion that there would be a correlation between the degree of regulation and the need for flexibility so that more regulation would contain more systematic risk.

Regulating FinTech

NBFCs have adopted the latest FinTech products like Peer to peer (P2P) lending, Account Aggregator (AA), and credit intermediation over “only digital platform” where the regulations have helped the industry to grow in a systematic and robust manner. While making regulation for the future in the FinTech area, orderly growth and customer protection and data security will remain the guiding principles for the RBI. The current failure in loss of data in Big Basket as announced recently would invite the attention of all stakeholders of the company. Even I got a note from google indicating the urgency to change immediately the password of my account with them. Sad but true that while customer satisfaction has reached the highest level of satisfaction and availability of the best products to the customer, the necessity to have the best safeguard for data safety has become an urgent matter inviting the regulatory authorities to act proportionately.

Ensuring transparency and good governance

Good governance has become the ultimate success in any NBFC with the active implementation of all regulatory requirements. During the latter part of his speech, the deputy governor touched good governance as a natural progression if the promotors/owners and senior management are fundamentally ‘fit and proper”.

His following observation merits deeper thinking among the investors who have recently moved in a greater measure to invest in NBFCs. Yes, the simple message that the better the management, more appropriate would be good governance offering security and safety to funds invested in their companies.

“It is extremely critical that appropriate filtering mechanisms are in place to allow only the genuine and able promoters to start the business of NBFCs. After all, by issuing a Certificate of Registration to new NBFCs, we provide them with the regulatory mandate to access public funds multiple times their net worth. Besides, it is necessary that NBFCs do not become conduits in money laundering and terrorist financing in any manner. While the current mechanism within RBI focuses on the above objective for companies seeking registration, there is a need to extend similar rigor of due diligence whenever there is a change in ownership/ control in an existing NBFC.” Investor from all strata of the society needs security and safety of their investments but with the best finance tech products used to produce the best financial results.

What about consumer protection and fair treatment?

The above statement adorned the RBI senior officer in his later part of the speech. He echoed the thought that a consumer of financial services from either a bank or NBFC would expect fair treatment and an effective grievance redressal system embedded in the institutions. He visualized the establishment of an Ombudsman as corrective machinery to deal with the expectations of emerging customers who have got used to avail the best finance tech products offered by new NBFCs.

The Global Financial Crisis was primarily attributed to the feather-touch regulatory approach, ignoring of the liquidity risks by financial intermediaries and unabated financial innovation. Abundant Liquidity, light-touch regulation, and financial innovation have also aided the growth of the NBFCs. The financial system today is significantly different from what it was at the outset of the financial crisis more than a decade ago. He attributed that feather touch regulation, latest finance tech products, and ever-expanding expectations of investors contributed towards the widening financial risk of the investor in the absence of the best regulatory approach of the authorities ably assisted by the best technical input for their functioning. The regulator would be forced to have a calibrated approach towards all NBFCs with the objective of consumer protection and financial stability at all financial institutions.

In the eyes of the Deputy Governor, clarity of purpose with the latest technology would meet the needs of the time in regulatory measure.

Our observations

The mere thought of a Deputy Governor touching the challenges of any NBFC either from an expanding business point of view or the emerging and current risks of security and safety of the investing public in a speech clearly spells the priorities of the Central bank of India, namely, the Reserve Bank of India. Instead of shying away from the engulfing risk perspective of the financial institutions, the most admired regulatory authority has expanded its area of operations with the best technical inputs in the financial world. The breadth and width of the thinking of the Deputy Governor give the best glimmer of hope for the small investing public both as an investor or as a depositor. Incidentally, the small borrowing public has got the best of easy availability of credit with the security and safety of an able regulator who has been keeping a tight vigil over the financial institutions, irrespective of the size of their operations.

This dynamic approach of the Reserve Bank of India has earned itself as one of the best-managed central banks in the world. Its timely action during the pandemic with the flexibility of approach and easy availability of its expert guidance has earned the admiration of the world. It never shied away from meeting the financial requirements of the nation without much ado.

*****

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