RBI’s new norms on promoter loans, NPA divergence to increase governance standards in NBFCs: Experts

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The Reserve Bank of India’s (RBI) April 19 move to introduce norms on loans to directors along with non-performing asset (NPA) divergence reporting will increase the corporate governance standards of non-banking finance companies (NBFCs) and lead to increased investor confidence in the NBFC sector, experts said.

As per the new norms, NBFCs classified under the upper and middle layer will need to tighten their credit policy on loans to directors and entities in which their directors, shareholders, or other stakeholders have interest, rating agency ICRA said in a note dated April 21. Unless sanctioned by the Board, NBFCs shall not grant loans and advances aggregating Rs 5 crore to these officials and investors.

Similarly, all loans less than Rs 5 crore extended to directors and other senior employees will also have to be reported to the Board and adequately disclosed in annual financial statements.

“For the overall NBFC sector, these are structural changes which would strengthen the governance framework ensuring healthy growth for the sector,” Pankaj Naik, director of financial institutions at India Ratings & Research told Moneycontrol.

The RBI has also mandated NBFCs in the upper- and middle-layer categories to make divergence reporting in case the additional provisioning requirements assessed by RBI or National Housing Bank (NHB) exceed 5 percent of the reported profits before tax and impairment loss on financial instruments for the assessed period.

NBFCs will also have to make divergence reporting if the additional gross NPAs identified by the regulator exceed 5 percent of the reported gross NPAs for the period.

As per A M Karthik, vice president & sector head of financial sector ratings at ICRA, these limits are tighter than those of banks where the thresholds are 10 percent and 15 percent, respectively, on additional provision and additional GNPA assessed by the RBI for the reference period.

“The increased disclosure requirements (which come in force from March 2023 onwards), are positive from a transparency perspective and can help improve lender/investor confidence,” he said.

A major reason why analysts hold a positive view on these norms is that the NBFC sector has seen several challenges that have affected broader markets.

In what can be called India’s Lehman movement, Infrastructure Leasing & Financial Services Group companies defaulted on debt repayment in 2018, triggering a slew of liquidity problems for all non-banks.

Banks, which are the major source of funds for NBFCs, became risk-averse toward lending to non-banks. This led to NBFCs, especially the mid and small-sized ones, shutting down their shop or limiting their growth ambitions.

Consolidation became the buzzword in the NBFC sector between 2018-19 and NBFCs including Dewan Housing Finance Corp, Reliance Capital, and more recently SREI Group of companies saw their businesses getting severely affected and being taken over by other entities.

NBFC officials say that the RBI’s April 19 norms on large exposures and regulatory capital requirements can easily be met by upper layer NBFCs.

As per the rules, the upper layer of NBFCs will have to limit single counterparty and group exposures at 25 percent of its capital base. For Group exposures, an additional 10 percent exposure can be allowed if the loans are being extended toward the infrastructure sector.

For infrastructure finance companies in the upper layer category, the single and Group exposures are capped at 25 percent and 35 percent, respectively.

As per Pankaj Naik, director of financial institutions at India Ratings & Research, these large exposure norms are unlikely to affect most upper layer NBFCs as they have a retail focus and single party exposure is very small. Larger NBFCs like M&M Finance, Cholamandalam, Shriram, and Bajaj Finance are all in the retail segment.

Thus, the large exposure cap is more meaningful for wholesale NBFCs which lend to real estate and infrastructure financing. However, wholesale lending has seen a slowdown in disbursements due to headwinds faced by the sector, Naik told Moneycontrol.

Shriram City Union Managing Director and Chief Executive Officer YS Chakravarti shared similar views.

“The cap on single counterparty/group exposure is linked as a percentage to the NBFCs’ Tier I capital, which translates into a fairly large outlay. Retail NBFCs have no such large exposures, so we do not think this will have an impact on them,” Chakravarti said.

“Wholesale NBFCs will have to reassess their lending if they have high exposures and take a more cautious approach, which leads to de-risking of their book and in the long term be beneficial for the industry,” he added.

When asked whether the new minimum capital requirement norms will force non-banks to raise capital or go slow on growth, Jugal Mantri, executive director, and CEO at Anand Rathi Global Finance said he does not believe these rules alone will force NBFCs to raise funds.

“There will definitely be capital raising efforts by NBFC who would need to replace the benefit of Perpetual instruments. However, this has been an integral part of NBFCs business as the balance sheet growth was always linked to capital requirements and I do not think capital raising will trigger on account of proposed changes,” Mantri told Moneycontrol.

The participation of NBFCs has significantly increased in the Indian financial system and therefore RBI is trying to bring its regulations on par with banks, Mantri said.

"However, these have been tough business times due to the COVID-19 pandemic and thus there could be more time given for business stabilisation,” the executive director at Anand Rathi Global Finance said further.