Business

Fine-tuning regulatory framework for NBFCs

The NBFC sector and its linkages with banking are in for a major overhaul

COMMERCIAL BANKS and non-banking finance companies are not subject to uniform regulation although for both the principal regulator is the Reserve Bank of India.

The dichotomy has many practical implications. While the two undertake many common functions, there are also certain spheres in which they do not compete. For instance, certain typical NBFC activities such as hire purchase and leasing, IPO funding, small ticket loans and venture capital are financial services that mainline banks in India have traditionally kept away from or placed much less emphasis.

On their part, banks alone provide working capital by way of cash credits and mobilise demand deposits (savings bank and current accounts).

No level field

As a category, NBFCs are heterogeneous in their ownership patterns (such as foreign or domestic) and in the nature of activities undertaken. Hence regulation impacts unevenly even within this broad category. Hence there is no level playing field not only between banks and NBFCs but among NBFCs themselves.

Banks, by definition, are the most regulated, being subject to prudential norms, capital adequacy stipulations, CRR/SLR requirements, priority sector lending limits and so on.

Loopholes in regulation

While deposit taking NBFCs have been brought under regulation, non-deposit taking companies (NBFC-NDs) are, for all practical purposes, still out of it.

"Even in the former case, regulation is less rigorous than for banks. This gives NBFCs as a category and the minimally regulated non-deposit taking ones among them in particular an opportunity to exploit the "regulatory arbitrage.''

An outstanding example is the enormous capacity of NBFC-NDs to leverage their balance sheets to raise funds. There is practically no regulation to constrain them. As pointed out, only deposit taking NBFCs have been brought under regulation and even they have fewer norms than banks.

Banks and NBFCs complement as well as compete with one another. This should on the whole lead to a widening of the financial sector and benefit the customer. For instance, ownership of an NBFC by a bank gives the former a status and an assurance that its well-regulated owner will ensure its solvency.

At the same time the relatively easy regulatory norms have made it easier to set up NBFCs. (Many foreign banks have used the NBFC route to expand or even enter India). Naturally the cost of conducting similar businesses should be lower with NBFCs.

The RBI has laid down a number of guidelines to fine-tune the existing financial linkages between banks and NBFCs, the objective being to protect the interests of bank depositors.

In the normal course, NBFCs are more advantageously placed than banks. Likewise there are norms covering the structural linkages between the two. However, there are still several grey areas.

Key guiding principles

The RBI has identified the following key principles that should guide a revised framework for NBFCs.

(1) While as a rule any financial service provider should be regulated, as a first step all "systemically relevant entities'' should be covered. What is systemically relevant will be covered from time to time.

(2) To avoid regulatory arbitrage, regulation and supervision should be centred on activities and not be institution centric, as it is now.

(3) New norms should be made applicable to NBFCs that are less regulated now, the objective being to enhance their governance.

(4) Ownership of an NBFC should not be the criterion for deciding on the products it offers.

(5) Foreign entities now gain a foothold in the Indian financial sector by investing in an NBFC through the automatic route available for FDI. Certain checks and balances must be prescribed to monitor their movements into other fields without undergoing an authorisation process.

(6) Banks should not use an NBFC as a vehicle for creating arbitrage opportunities. Under no circumstances should the NBFC route be used for undermining existing regulations.

Limit on borrowing

Some of these have been put into practice already. For now, all NBFC-NDs with an asset size of Rs. 100 crore and more will be considered systemically important.

They cannot raise borrowings more than ten times their net owned funds. These will have to follow new capital adequacy norms. Other restrictions such as those laid down under group exposure limits will have to be complied with.

Ownership

Among the other new guidelines, the one that has received wide publicity relates to ownership and governance of NBFCs.

The RBI has laid down that banks including foreign banks operating in India shall not hold more than 10 per cent of the paid up capital of a deposit taking NBFC. Housing finance companies have been excluded from this stipulation.

Some of these new regulatory norms will have a far-reaching impact on the NBFCs.

C. R. L. NARASIMHAN

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