Non-Banking Financial Companies (NBFCs) have for long been complaining how regulations similar to those in force for full-fledged banks are eroding the advantage they have of being NBFCs.
In their latest pre-budget memorandum, too, the industry has lobbied with the government on this issue.
“If NBFCs are to be regulated like banks, then the typical NBFC model of lending shall suffer,” the Finance Industry Development Council (FIDC), an industry lobby, said in a memorandum it submitted to the government on November 22.
Such a situation could impact lending to the unbanked and underbanked segments of society, the Council said.
The context here is the regulatory approach of the Reserve Bank of India (RBI) towards the shadow lenders. Traditionally, NBFCs have enjoyed a lighter touch from RBI; this has changed in recent years.
RBI, learning from the past mistakes, has been tightening rules for NBFCs. In October 2021, RBI introduced a scale-based regulatory framework for NBFCs effective October 1, 2022.
The framework includes different facets of regulation of NBFCs pertaining to capital requirements, governance standards, and prudential regulation, among others.
Under this regime, NBFCs are divided into four layers on the basis of their size, activity and perceived risk. The new rules mean a tougher life for NBFCs, the most rigorous among them being changes in asset classification.
The asset norms applicable to NBFCs are similar to those for banks. An RBI circular on November 12 said an NBFC loan will be tagged a Non-Performing Asset (NPA) if an overdue amount is not paid by the 90th day, just like it is for banks.
NBFCs aren’t happy with such strict rules. “This shall lead to the small borrowers getting an NPA tag strictly at the end of 90th day of delay and further prolong the tag for a longer duration, till he/she repays the entire overdue amount. And this may happen for reasons that are totally beyond his or her control,” said the industry body.
Reasons for concern
Why is the RBI worried? The reason isn’t hard to understand. The regulator is extra-cautious after the scams at Infrastructure Leasing & Financial Services (IL&FS) and Dewan Housing Finance and doesn’t want to take chances.
After all, many large NBFCs have systemic interconnectedness. Any failures can have catastrophic effects on the rest of the system. Banks, which deal with public money, have significant exposure to NBFCs. To be precise, Rs 11.7 lakh crore as of 23 September, 2022, up 31 percent from the previous year, per RBI data. That’s a massive jump.
So what do NBFCs want from the government?
Industry leaders expect the government to prod RBI to relax regulations for the sector. But it is not just about regulations. The industry also wants the government to harmonize provisions related to taxation and recovery, too.
NBFCs have demanded that the threshold to allow recovery proceedings under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, should be reduced from Rs 20 lakh to Rs 1 lakh in order to bring them on par with housing financiers, banks, small finance banks and other financial institutions.
Also, the industry wants flexibility in upgrading loans of up to Rs 2 crore from NPAs to the standard category on partial repayment of arrears.
There is a demand for tax relief in the form of exemption of NBFCs from tax deducted on source on income from securitisation.
“It is both imprudent and harsh to expect NBFCs to comply without giving them commensurate recovery tools and tax reliefs,” said the FIDC memo.
Case for a light touch
Should the RBI and government have lighter regulation for the shadow banks?
Clearly, the trigger for the new scale-based approach for NBFCs was to disincentivise non-banks from growing too big after the IL&FS and Dewan Housing episodes. The regulator doesn’t want a parallel set of financial institutions growing in the financial system on par with banks but enjoying lighter regulation. Also, RBI wants to bring down the number of NBFCs in the banking system.
India currently has over 9,000 NBFCs (approximately) operating across different categories. It is important to remember that earlier an RBI working group had suggested allowing larger NBFCs to convert to banks.
At a broader level, the message is clear to NBFCs—either stay below a threshold and enjoy looser regulations or convert to banks and comply with the same set of regulations as banks to grow without an upper limit.
What do you want NBFCs to be?
This isn’t the first time the RBI is tightening rules for NBFCs. In the past, a report by a committee headed by former RBI deputy governor Usha Thorat had come up with recommendations for tighter rules for NBFCs that would minimise arbitrage between banks and NBFCs.
RBI subsequently pursued a light-touch approach towards NBFCs without tightening rules to push more credit in housing and other productive sectors. But, the developments in 2018 where two large NBFCs collapsed, triggering a liquidity shock in the banking system, changed the scenario.
NBFCs have a valid argument. It is pertinent to note that while on the one hand, the RBI is tightening rules for NBFCs, on the other, it is not giving them any incentives. In terms of recovery and taxation, NBFCs continue to be at a disadvantage vis-à-vis banks.
The key question to ask is this: How does the RBI want to position NBFCs in the financial system? With more bank permits being issued, perhaps the central bank wants to gradually reduce the number of NBFCs to the minimum to eliminate small NBFCs with a weak capital base, reduce the number of mid-sized and large NBFCs to a few to cut the systemic risks (and encourage them to become banks).But, if the idea is to retain NBFCs as a critical layer in formal finance, it makes sense to offer them a level playing field on par with full-fledged banks in some areas. All eyes are now on Finance Minister Nirmala Sitharaman.