Non-Banking Finance Companies (NBFCs) must convert themselves into tightly regulated banks or scale down operations, according to Rajeshwar Rao, deputy governor in charge of banking regulation and risk monitoring at Reserve Bank of India (RBI).
Speaking at an Assocham event, Rao said that there could not be a “one-size-fits-all” prescription in the regulatory approach for NBFCs. Systemically important NBFCs must be identified and subjected to a higher degree of regulation, he said.
“Such non-banking finance companies should have incentives either to convert into a commercial bank or scale down their network externalities within the financial system. This would make the financial sector sound and resilient while allowing a majority of NBFCs to continue under the regulation-light structure,” Rao said.
Rao prescribed also a calibrated and graded regulatory framework, proportionate to the systemic significance of entities. NBFCs with significant externalities that contribute substantially to systemic risks must be identified and subjected to a higher degree of regulation, the RBI deputy governor said.
Over the years, the flexibility that accompanied loose regulation has enabled NBFCs to serve the last-mile customers. Between 31 March 2009 and 31 March 2019, the total assets of NBFCs grew at a compounded annual growth rate (CAGR) of 18.6%, while the balance sheets of banks grew at 10.7%.
Banks and shadow lenders are now increasingly linked. As of end-March 2020, NBFCs were the largest net borrowers of funds from the financial system, of which, more than half of the funds were from banks.
The collapse of an infrastructure financier in 2018, the government seizure of a mortgage lender in 2019 and the resulting cash crunch in the system revealed flaws intrinsic to such finance companies. Many of them found themselves in trouble due to cash crunch due to skewed asset-liability management practices with short-term borrowing funding long-term assets, imprudent lending practices, and lack of due diligence coupled with ambitious growth targets.
“It is imperative to strike a balance between regulating the NBFCs more tightly and the need to provide them with the required flexibility. This will remain the cornerstone while we imagine the future of regulation for NBFCs,” Rao said.
There are 9,601 shadow banks, of which the top 50 comprise 80% of market share by loans.