By 2047, India aspires to become a fully developed, high-income country, a "Viksit Bharat" characterised not only by towering buildings and expansive highways but also by fair prosperity and financial empowerment at the grassroots level. However, to genuinely evaluate our preparedness for this transformation, we must address an emerging contradiction: the institutions most capable of advancing financial inclusion, Non-Banking Financial Companies (NBFCs), find themselves systematically encumbered by regulations that might render them ineffective before they can achieve their true potential.
NBFCs: The Missing Middle in India's Credit Chain
NBFCs occupy a unique position, distinct from both banks and microfinance institutions, characterised by their adaptability and agility. They often serve as the only formal credit sources for large segments of underserved borrowers. NBFCs fulfil the "last-mile" role that traditional banks deem too expensive or risky to undertake.
Despite its extensive reach, India's formal banking sector tends to favour lending secured by assets and involving large sums. Micro, Small, and Medium Enterprises (MSMEs), particularly those in Tier-2 and Tier-3 cities, are often excluded from this framework because of the absence of formal financial records, audited financial statements, or strong credit ratings. NBFCs have become essential facilitators for these businesses.
According to data from the Reserve Bank of India (RBI), NBFCs were responsible for nearly 23% of the total credit extended to the MSME sector in the fiscal year 2023.
This contradiction lies in the fact that although NBFCs are fundamentally integrated into India's financial inclusion framework, the regulatory framework surrounding them appears to be increasingly indifferent to their distinct role.
A Fraying Link in the MSME Growth Engine
Micro, Small, and Medium Enterprises (MSMEs) contribute nearly 30% to India's GDP and play a vital role in job creation. Nevertheless, according to the International Finance Corporation, there is a $380 billion credit gap in India’s MSME sector alone.
NBFCs address this gap by employing alternative methods for credit evaluation, such as cash flow underwriting, field risk assessments, and tailored repayment plans. Nonetheless, stricter capital adequacy requirements and heightened risk weights, particularly when banks fund non-banking financial companies (NBFCs), serve as frictional costs. For instance, the RBI's Prompt Corrective Action (PCA) framework, which is based on bank oversight, might not be suitable for smaller NBFCs that have seasonal or irregular income but possess robust local recovery mechanisms.
A policy simulation utilising time-series panel data from 2010 to 2022 for 120 NBFCs indicates that following the implementation of stricter Liquidity Coverage Ratio (LCR) norms in 2021, the lending growth of small and mid-sized NBFCs slowed by approximately 6.3 percentage points compared to their growth path before the regulation, a statistically significant decline that is inescapably noteworthy with regards to the vitality of the NBFCs for the MSME sector in India.
A Tale of Two Realities: Growth amidst Constraints
The "Report on Trend and Progress of Banking in India 2023-24" by the Reserve Bank of India highlights a contradiction in the NBFC sector. NBFCs have shown strong growth, marked by double-digit credit expansion and better asset quality, with gross non-performing assets (GNPA) dropping to 3.4% by September 2024, and this resilience underscores their crucial role in providing credit to underserved areas. However, the report also warns against "imprudent 'growth at any cost'" strategies, stressing the importance of strengthening risk management frameworks and avoiding excessive interest rates.
This dual perspective vividly illustrates a sector attempting to balance aggressive expansion and sound governance.
Gender and Credit: The Feminisation of Exclusion
Non-Banking Financial Companies (NBFCs) hold a unique position in promoting one of India's most significant developmental areas: entrepreneurship led by women. In microfinance NBFCs, over 95% of the borrowers are women, many of whom are embarking on their entrepreneurial journeys for the first time, managing ventures such as dairy farms, tailoring businesses, and agricultural value chains. For many women, NBFCs represent their initial (and frequently sole) access to formal financial services. The centralisation of regulations and consolidation of capital pose a threat to these women by potentially cutting off their access to affordable formal credit.
Unlike traditional banks, NBFCs often accept informal documentation, offer flexible loan terms, and provide doorstep services, which are crucial for women who are juggling business and caregiving duties. By increasing the barriers to entry for smaller, community-focused NBFCs, there is a risk of reversing the progress made in financial inclusion for women.
A straightforward gender-disaggregated credit impact study conducted in Maharashtra, utilising loan-level data from 2018 to 2023, indicates that regions where small non-banking financial companies (NBFCs) ceased operations experienced a 13% drop in first-time female borrowers over a span of two years.
Digital India Requires Analog Understanding
The excitement surrounding financial inclusion is largely focused on digital advancements such as Aadhaar-enabled payment systems and AI-driven loan assessments. NBFCs have swiftly embraced these changes, with some offering completely paperless onboarding, instant KYC, and automated loan decisions based on GST data and mobile usage patterns.
However, the most effective outcomes often arise from hybrid models, where technology-driven platforms are complemented by local human agents who understand the cultural, economic, and behavioural nuances of borrowers. Notably, NBFCs are particularly adept at this hybrid approach. However, increasing compliance demands threaten to push them towards full digitisation, potentially sacrificing the personal touch, or making them exit the market altogether.
The risk here is the erosion of contextual credit, credit that recognises a borrower may lack a salary slip but operates a successful pickle business with cash flows that are not visible to formal credit bureaus.
The Cost of One-Size-Fits-All Regulation
Recently, the Reserve Bank of India has taken decisive action to enhance the supervision of NBFCs, a crucial move following notable failures. Nonetheless, these actions have evolved in a way that tends to benefit large, well-funded NBFCs over smaller, community-based counterparts. The minimum threshold for the Net Owned Fund (NOF) has been increased from ₹2 crore (₹25 lakh for North Eastern Region NBFCs) to ₹10 crore, a sum that may seem reasonable in urban financial areas but is excessively high for small, rural-focused NBFCs that continue to engage in responsible and effective lending. Adhering to Indian Accounting Standards (Ind-AS), Liquidity Coverage Ratios (LCRs), and governance models based on committees introduces additional costs and complexities.
Towards a Vision-Aligned Regulatory Framework
To genuinely pursue Viksit Bharat 2047, our regulatory system must reflect vision-aligned flexibility, rather than strict enforcement. The following three critical changes are required:
1. Tiered Regulation:A tailored approach based on the size, specialisation, and regional focus of non-banking financial companies (NBFCs). For example, micro-NBFCs with assets under ₹10 crore could be subject to simplified compliance norms, such as the regulation of microfinance banks in Latin America.
2. Smart Risk Weighting:Instead of broadly increasing risk weights, the RBI could adopt dynamic risk modelling, considering repayment behaviour, portfolio diversity, and local recovery rates to encourage responsible lending by NBFCs.
3. Catalytic Funding Pools:The government, in collaboration with SIDBI or NABARD, could establish first-loss guarantee funds or blended finance vehicles to mitigate the risks of lending to and by NBFCs in underserved areas.
India requires more intelligent NBFCs and smarter regulations that enable them to grow responsibly rather than retreat defensively. As we progress towards 2047, we must consider not only what India should become but also who will be part of that vision.
The answer partly lies in whether we empower NBFCs to flourish or regulate them into insignificance. Time is of the essence.
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