Making NBFCs Bankable!

Published on Tue, Sep 13, 2011 at 18:29 |  Source : Moneycontrol.com
By: Viren H Mehta, Director of Ernst & Young
In August 2011, the Report and Recommendations made by Working Group Committee on Issues and Concerns in the Non-banking financial companies (NBFC) Sector proposed far-reaching changes to the existing regulatory and supervisory framework for NBFC. If adopted by Reserve Bank of India (RBI), these recommendations would significantly shape the future evolution of India's NBFC sector. Overall, the recommendations attempt convergence of the regulatory framework for banks and NBFCs in order to reduce systemic risk. The above argument is premised on the hypothesis that the business of NBFC and banks is similar at least on the asset side, but the current regulatory environment is lighter for NBFCs and stringent for banks.

The Committee's recommendations to increase Tier 1 capital ratio and risk weights for NBFCs not sponsored by banks may improve the stability of the sector, but it should also be viewed from the context that NBFC do not have access to inexpensive public deposits as the banks do. Additional capital requirements for NBFCs, even as bank's lending to NBFCs was deemed non-priority sector lending recently by RBI, will not necessarily help in creating a level playing field for banks and NBFCs even as their regulatory frameworks converge. Tighter NPA norms may help make the sector more stable, though.
Proposed relief to NBFCs in the form of benefits offered by the tax treatment of provisions for credit losses and by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act would ease pressure on profitability and capital (due to faster recovery of bad loans). However, these would require legal changes that are in jurisdiction of other regulators.

Tightening of regulations may alleviate the risk of contagion to banks or other financial institutions from deposit taking NBFCs, but only to a certain extent. Public deposits form a very small percentage of funding for NBFCs, considerably lesser contribution made by them through equity. Also, banks contribution to the funding of NBFCs is less than the equity of NBFCs. The significant contribution of equity in NBFC's funding structure acts as a safety net in case of defaults by lenders.

A prior regulatory approval for any change in ownership or sale of more than 25% stake in registered NBFCs may fundamentally modify the structure of the sector.

For an NBFC to be eligible for registration and supervision, total assets of all NBFCs in a group should meet the cut off limit of INR100 crore. Out of 280 deposit taking NBFCs as on March 2010, very few have assets of over INR100 crore. Moreover, about vast majority of the reporting NBFC that accept deposits have assets less than INR50 crore, which would make them fit for deregistration if the Committee's recommendations are accepted.

In a diversified economy like ours, NBFCs play a critical complementary role in furthering financial inclusion and ensuring last mile delivery of credit, which is important for sustainable economic growth. The proposed registration norms may impact RBI's efforts towards financial inclusion, an area that the regulator has stressed on while working on the guidelines for licensing of new banks in India. Decline in number of NBFCs may leave vast unbanked regions in India without access to credit, in turn impacting the overall economic growth.

From a systemic risk perspective, stringent capital regulations coupled with other recommended regulatory measures would help improve the functioning of the NBFC sector in the long-term, but the what needs to be reconsidered is the level of risk that NBFC bring into the financial system visvis the risk generated by banks and accordingly, implement the prudential and liquidity norms in a phased manner.

Disclaimer: Views expressed in this article are personal