Regulatory frameworks are set just right for scaling up well-managed NBFCs – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/view-regulatory-frameworks-are-set-just-right-for-scaling-up-well-managed-nbfcs/articleshow/84325357.cmsSynopsis

Over the last couple of decades, NBFCs have seen significant increase in terms of size, reach and advancements. As financial intermediaries, they primarily serve the needs of MSMEs as well as individuals, including some sections of society for whom banks are inaccessible. Also, apart from the traditional brick-and-mortar models, some of the new-age fintechs have significantly leveraged technology and found innovative ways to reach and serve the ultimate customers.

Nirmal Jain

Nirmal Jain

The writer is chairman, IIFL FinanceIn January, RBI released its discussion paper on the revised regulatory framework for non-banking financial companies (NBFCs) on a scale-based approach. This aims for a regulatory framework commensurate with the NBFCs’ scale of operations, complexity of transactions and interconnectedness with the financial system. Rather than using a ‘one-size-fits-all’ approach, this is a welcome move taken by RBI as it provides a balanced approach between limiting exposure to systemic risk and allowing for continued growth in the segment.

Over the last couple of decades, NBFCs have seen significant increase in terms of size, reach and advancements. As financial intermediaries, they primarily serve the needs of MSMEs as well as individuals, including some sections of society for whom banks are inaccessible. Also, apart from the traditional brick-and-mortar models, some of the new-age fintechs have significantly leveraged technology and found innovative ways to reach and serve the ultimate customers.

From being around 12% of the balance sheet size of banks, NBFCs have now reached about 25%. NBFCs have increasingly played a vital role in the economy as they support real economic activity by widening access to financial services, and by providing last-mile funding. RBI and GoI understand the need to have a robust network of NBFCs to deliver credit to the underserved segments of society. They have, therefore, been providing the required reforms impetus, along with an appropriate regulatory framework to mitigate risk.

Increased size and complexity of NBFCs have also meant increased spillover and systemic risk for the financial system. Especially after the IL&FS crisis, the risk perception of NBFCs has taken a significant hit. RBI and GoI have continued to maintain the fundamental premise of ‘less rigorous’ regulations for relatively smaller NBFCs. With more than 97% of NBFCs having an asset size of less than ₹10 billion, taking a stringent view on smaller-scale NBFCs could dampen future growth of the sector. Thankfully, RBI has taken a balanced approach between limiting exposure to systemic risk and allowing for continued growth.

With the increasing systemic risk owing to the rising scale of NBFC operations in India, introduction of relatively more stringent regulations for systemically important NBFCs was long overdue. For inclusion in the upper layer, a total of 30 NBFCs will be selected from a sample set of 50 large ones based on various parameters like size, inter-connectedness, complexity and supervisory limits including segmental penetration, liability mix and group structure.

This top layer (TL) will be kept empty, but can get populated in case RBI takes a view that there has been unsustainable increase in the systemic risk, and is spilling over from a specific NBFC-Upper Layer (UL). Most of the regulations introduced in the discussion paper will be instrumental in bringing about structural changes to NBFC operations – particularly in the UL and TL.

Introduction of differential standard asset provisioning, compulsory implementation of core banking solution (CBS) and application, the large exposure framework norms will aid large and systemically important NBFCs to become future-ready for conversion into banks at a later stage. It will also improve transparency in the system.

Banks have already seen the benefit of the introduction of CBS, which has brought about a significant reduction in the fraudulent transactions in the system. Regulations of limiting exposure to individual groups and higher standard provisioning requirement will also be instrumental in strengthening the balance sheet quality, and providing much required resilience in the system.

With this discussion paper, RBI and GoI have provided a regulatory framework that is futuristic without hampering the growth prospects of the industry. Contrary to many industry observers’ suspicion about NBFCs’ growth in the face of rising competition from private banks, the stage is set for scaling up of well-managed NBFCs.

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