RBI’s misdirected regulatory approach

RBI Governor Shaktikanta Das

In October the Reserve Bank of India barred four small lenders from making fresh loans. RBI’s main grouse was that they were charging usurious rates. In 2022, interest rate caps on small loans were removed. This was a good thing. For small borrowers, access to credit is way more important than the cost of capital.

Access to credit matters more than its cost

For a pushcart vendor, who borrows in the morning to buy the day’s stock, and repays the loan along with interest in the evening, the notion that 30 percent or 35 percent per year is criminally high is a joke.

Suppose the amount sought is Rs 5,000. The lender would disburse Rs 4,500, telling the borrower that the interest due has been deducted upfront. The casual observer might put the rate at10 percent. In reality, the interest amount of Rs 500 is against an advance of Rs 4,500 and works out to 11.11percent per day and 4,056 percent per year. If we factor in the actual duration of the loan, of half a day, the rate of interest is double that much.

If this borrower is able to access funds from a greedy, heartless, profiteering non-banking finance company (NBFC) at 40 percent year, his heart would leap up, like a poet’s at the sight of a rainbow. To cut off his access to NBFC credit and force him back into the arms of the moneylender is heartless.

Instead of shutting off access to credit for a variety of small borrowers, the RBI should, instead, try better regulation.

A way to tackle evergreening

Another, and a more valid concern of the RBI is NBFCs not exercising vigilance against evergreening of loans – a client could borrow from Peter to pay off Paul, and proceed to borrow, based on this solid credit history, from Tom, Dick and Harry. If NBFCs get no whiff of this, the cumulative loan default this would make possible could have larger consequences. The NBFCs would default on their loans to banks, and that would affect the banks’ ability to lend freely even to perfectly solid borrowers.

But if such repeated lending to the same borrowers happens, blame poor regulation, specifically, the RBI’s reluctance to make creative use of the account aggregator framework.

Operationalising the consent layer of India Stack has empowered an individual to collate all his financial transactions, including the payment of Goods and Services Tax, and present the compilation to potential lenders, as testament to his creditworthiness. An account aggregator needs the consent of the data subject (the potential borrower) to collate the data on the subject’s financial activity, scraped from bank transactions, sales, purchases, GST payments, input tax credit claims, mutual fund investments, insurance payments, etc.

In the case of small loans, the RBI should mandate procurement of the borrower’s consent a precondition for giving out a loan. The borrowers could give consent to one or more account aggregators, who should make these borrowers’ financial data available to all microlenders, whether self-help groups or NBFCs. This would bring out multiple loans, repayment of loans with borrowed funds and put an end to the practice of evergreening.

There is much more that the RBI can do to improve regulation even within the existing framework. Dispense with bilateral meetings and one-to-one mentoring/cautioning of NBFCs. Have transparent policy articulated in detail. Publish the regulatory strictures and directives issued for one errant NBFC, so that others could proactively avoid the same pitfalls.

Case for a unified regulator

Apart from transparency of norms, even the ones made on the fly, there are deeper reforms which the RBI alone can perform. At a recent policy conference of central banks of the Global South, RBI deputy governor Rajeshwar Rao spoke of the interconnectedness of diverse entities in the financial sector and the need for different regulators to work in coordination.

The sentiment is sound in the direction of reform it urges. But the reform required is not coordination of different regulators but creation of a single, unified regulator for financial conduct, with the RBI restricting its role to macroprudential regulation.

In most parts of the world, a bond is a bond is a bond, unless, of course, it is James. But in India, a government bond is not allowed to mix with the common herd of corporate bonds. The RBI sits in control of government bonds and their trading. Sebi is deigned to be fit to supervise corporate bonds. This segmentation of regulation stifles mitigation of risk arising from interconnectedness.

A bond carries different kinds of risk, of shifts in yield and exchange rates, and of credit default. These have to be mitigated by appropriate derivatives. Now, credit default swaps are insurance, even if they are issued and traded like securities. Should the bond regulator regulate them or the insurance regulator? Why not merge the insurance regulator into a single financial conduct regulator, as one of its divisions. Commodity trading used to have a separate regulator, but is comfortable being regulated by Sebi these days. If insurance were no longer a separate regulator, what rationale could there be for a separate pensions regulator?

The biggest obstacle to a unified regulator is the RBI itself, which behaves like a brooding mother hen sitting over its eggs, bristling at anyone coming near its beloved government bonds, and ready to flare its hackles at the slightest provocation.

Instead of depriving the pushcart vendor of cheap loans, the RBI would do well to spend its energies on unifying the regulation of the financial sector.