No More a Shadow (of a) Bank (Remarks delivered by Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India – February 09, 2024 - at the NBFC Summit organised by Confederation of Indian Industry at Mumbai) - ربی - Reserve Bank of India
No More a Shadow (of a) Bank (Remarks delivered by Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India – February 09, 2024 - at the NBFC Summit organised by Confederation of Indian Industry at Mumbai)
Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India
delivered-on فروری 09, 2024
Ladies and Gentlemen! It’s a pleasure to be here at CII NBFC Summit 2024. At the outset, let me thank Mr. Abhimanyu Munjal, Chairman, CII National Committee on Non-Banking Finance Companies (NBFCs) for extending the invitation to me for delivering this inaugural talk at the 6th edition of the NBFC summit organised by CII. I recall that it was at this forum, in earlier speech2 at CII NBFC Summit held in October 2021, I had dwelt upon the introduction of Scale Based Regulatory (SBR) approach in the NBFC Sector. Much water has flown under the bridge since then. SBR framework has since been rolled out for the NBFC sector and NBFCs have seamlessly transitioned to the revised regulations. While I had previously discussed the detailed contours of the SBR framework, today I propose to discuss the broad regulatory approaches behind NBFC regulations, including SBR framework and then focus on few specific issues pertaining to NBFC sector. Role of NBFCs in the Financial Sector In December 2023, Financial Stability Board (FSB) released its annual publication ‘Global Monitoring Report on Non-Bank Financial Intermediation3’. It has noted that globally, the size of the non-bank financial intermediation (NBFI) sector has decreased by 3 per cent in 2022, which is the first notable decrease since 2009. However, Economic Function 2 (EF2) entities i.e., entities undertaking lending activities, which are akin to NBFCs in India, have exhibited a growth of around 10 per cent which is the highest among all five economic categories of the NBFI sector monitored by the FSB. The report also notes that India accounts for third largest share of EF2 assets after the United States and the UK. At individual country level, India has the highest contribution coming from lending entities in its total financial assets of NBFI sector. This report also mentions that over a five-year period between 2017 and 2022, the share of total financial assets held by the NBFI sector in half of the emerging market economies has come down. India is, however, amongst very few countries which have shown a growth in the share of total financial assets held by NBFIs. In essence, the data indicates that NBFC Sector in India remains a critical cog in the wheels of economic growth. As of March 2023, NBFCs credit to GDP ratio stood at 12.6 per cent and the sector has grown to become 18.7 per cent of banking sector assets as on March 2023 as compared to 13 per cent ten years ago (March 2013). A very notable feature of Indian NBFI sector is the predominance of lending companies. While globally, collective investment vehicles such as Money Market Funds (MMFs), fixed income funds, mixed funds, credit hedge funds, real estate funds, etc. contribute to around 74 per cent of the NBFI sector assets, the Indian case is quite different. This feature, combined with the fact that NBFCs have assumed certain significance and criticality over last few years, makes it imperative that the regulations of the NBFC sector keep pace with the changing landscape and move from a light touch regulatory approach to a more calibrated and nuanced approach to address the growing interlinkages and emerging risks in order to safeguard financial stability. It may perhaps be worthwhile to first take stock of the state of the affairs in the NBFC sector. The SBR framework for NBFCs was issued on October 22, 2021 and it became effective from October 1, 2022. Usually, the impact of such a reform can only be assessed in medium to long term. However, the initial assessment suggests that the NBFC sector has become stronger and resilient post introduction of the SBR framework. Our interaction with industry also suggests that the framework has achieved the intended effect of proportionate regulatory burden on the entities based on the parameters of size, complexity and interconnectedness, among others. As on September 30, 2023, NBFCs in the base, middle and upper layers constituted 6 per cent, 71 per cent and 23per cent of the total assets of NBFCs, respectively. The latest edition of the Financial Stability Report (FSR)4 notes that aggregate lending by NBFCs rose by 20.8 per cent (y-o-y) in September 2023 from 10.8 per cent a year ago, primarily led by personal loans and loans to industry. The GNPA ratio of NBFCs continued on its downward trajectory with improvement across sectors with overall GNPA ratio in September 2023 being 4.6 per cent vs. 5.9 per cent in Sep 2022 and NNPA ratio was 1.5 per cent vs. 3.2 per cent in Sep 2022. Capital adequacy of NBFCs has also improved to 27.6 per cent from 27.4 per cent during this period. The profitability of NBFCs has also improved as evident from increase in RoA to 2.9 per cent from 2.5 per cent. In terms of the outlook, stress tests conducted by the Reserve Bank shows that the overall sector will be able to withstand future shocks. For credit risk, under the baseline scenario, the one-year ahead GNPA ratio of the sector is estimated to be 3.8 per cent and CRAR at 22.0 per cent while under a medium shock, the CRAR may drop by around 70 bps relative to the baseline and in the event of severe shock, the capital adequacy ratio of the sector may decline by 101 bps relative to the baseline, to 21.0 per cent. Similarly, for liquidity risk, the stress test results indicate that the number of NBFCs which would face negative cumulative mismatch in liquidity over the next one year in the baseline, medium and high-risk scenarios stood at 6 (representing 1.3 per cent of asset size of the sample), 17 (10.4 per cent) and 34 (15.0 per cent), respectively. Overall the NBFC sector remains healthy, stable and resilient to future shocks. However, the FSR also notes that during the last four years, the compound annual growth rate (CAGR) for personal loans (nearly 33 per cent) has far exceeded that for overall credit growth (nearly 15 per cent) for the NBFC sector. Our recent increase in risk weights of select retail loan categories may have to be seen in this context. Regulatory approaches for NBFC sector Coming to the regulatory approach for the NBFC sector - While framing the regulations for the financial sector, Reserve Bank has always been conscious of the fact that the degree of regulation of a financial entity should be commensurate with the perception of risks posed by the entity and the scale of its operations on the financial system. Our regulatory approach towards NBFC sector has been guided by a combination of activity-based and entity-based regulations to safeguard financial stability and protect customers. We have tried to leverage the strengths of both these approaches to achieve a more comprehensive and flexible regulatory framework. We find this hybrid approach particularly valuable for an ever-evolving NBFC Sector, where innovations and new business models seem to be constantly emerging. Entity based regulations have the advantage of providing a comprehensive view of overall risk exposure of a specific financial institution and is better placed to address the systemic risks arising from the interplay of various activities within a single entity to minimise negative externalities. From regulator’s perspective, entity-based regulations are generally easier to implement and enforce, as regulations are applied uniformly to a set of entities. However, the flip side is that entity-based regulations may be less precise in targeting specific activities, slower to adapt to changing landscape, and, at times, may potentially impose extra burden on low-risk activities. On the other hand, activity-based regulations allow for more precise targeting of potentially risky financial activities by enabling the regulators to focus on high-risk activities regardless of the type of institution involved. Potential down-side is that such an approach could result in a fragmented regulatory landscape, with different rules for various activities, potentially making oversight more complex. At times, systemic risks arising from the combination of multiple activities may remain undetected. It has been advocated that ideally, the principle of same risk, same activity, same regulation should apply, i.e, there should be similar regulation for entities undertaking similar activity to avoid regulatory arbitrage. As the saying goes - if it looks like a duck, quacks like a duck, and acts like a duck, then it probably is a duck- and should be regulated as a duck. However, this approach needs to be calibrated suitably for effective yet non-stifling regulations. Instead of following a narrow approach of putting in place the same set of regulations for all financial institutions irrespective of their scale of operations, a nuanced approach may be more suitable for achieving the desired objectives. We have been cognizant of the fact that the NBFCs engage in specialised activities, each carrying its unique risks, and the flexibility inherent in the hybrid model has enabled us to adapt swiftly to the changes in the sector without sacrificing the overarching systemic risk management inherent in the entity-based regulations. Keeping this balance in mind, our regulatory approach has evolved into two broad categories – prudential regulations and conduct of business regulations. While the prudential regulation focusses on solvency, safety and soundness of the financial entities and overall financial system, the conduct of business regulation focusses on how the financial entities deal with their customers and fair business practices. The current regulatory landscape is a combination of entity and activity-based approaches under the pillars of prudential and conduct regulations. Let me cite some recent regulations in the NBFC sector wherein we have tried to maintain the balance between different regulatory approaches:
Are Upper Layer NBFCs regulated at par with banks? Now, coming to specific issues pertaining to NBFC sector, let me discuss two pertinent issues- First, there have been some reports and discussions that the regulations for NBFCs, especially for NBFCs in the Upper Layer, have been made at par with banks. I would like to take this opportunity to set the record straight in this matter. While it is agreed that the regulations between banks and NBFCs have been harmonised in some areas and regulations for certain NBFCs especially upper layer NBFCs have been strengthened under SBR, framework significant differences continue to exist between the regulations applicable to banks and NBFCs. I would like to highlight just a few of them to emphasize this-
In a nutshell, I would like to emphasize that the regulations for NBFCs (especially in the upper layer) are much more calibrated and are certainly not on par with the regulations applicable to banks. Should NBFCs be allowed to accept deposits? The second issue which I would like to discuss is regarding the deposit taking activity of NBFCs. With the perception that SBR framework has made regulations of NBFCs more bank-like, there have also been intermittent demands that NBFCs should be allowed to accept public deposits. Having clarified the first issue, let me emphasize that it is indeed the non-acceptance of public deposits by the NBFCs which provides the regulatory comfort to the Reserve Bank to have lower entry barriers for NBFCs, allow them to specialise in any specific sector of their choice and have lower exit barriers to wind up their businesses. Acceptance of deposit, in whatever manner and form, necessitates existence of a macro financial safety net including deposit insurance and central bank liquidity backstop. These safety nets come with increased regulatory rigour and intense supervisory oversight. The NBFCs have evolved as a niche companies serving specific economic function and it is uncharacteristic for them to demand becoming like a bank. Considering this, Reserve Bank has not issued any certificate of registration to new NBFCs for acceptance of public deposits since 1997. On the contrary, Reserve Bank’s approach has been to disincentivise deposit-taking activities of NBFCs as evident from decrease in the number of deposit-taking NBFCs over last decade from 241 in March 2014 to 26 in September 2023. Concerns and Expectations NBFC sector has come a long way since its initial days and the regulatory framework for the NBFC sector has aided its development of by providing the operational flexibility and proportionate regulations. However, there are certain risks on the horizon and I would like to use this forum to urge the NBFCs to monitor these risks in their business models or balance sheets and initiate necessary action as and when required:
Concluding thoughts We have recently come out with a draft omnibus framework for the Self-Regulatory Organisations (SROs). The SROs are expected to play an important role in improving the compliance culture as well as promote ethical business practices, customer protection, better governance standards, sound risk management measures and contribute positively to the orderly development of the financial sector, including NBFCs. The NBFC sector is an important stakeholder of the Indian financial sector. Strengthened regulation and enhanced oversight of the NBFC sector is the best testimony of the importance of the NBFCs in not only the financial system but overall economy. It’s time that NBFC sector comes out of its own shadow as well as that of the banking sector. I am sure that NBFCs will play a significant role in achieving the dream of a $5 trillion economy going forward. Thank you. [1] Inputs provided by Pradeep Kumar and Anuj Sharma are gratefully acknowledged. [2] Chasing the Horizon (Remarks delivered by Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India – October 22, 2021 - at the CII NBFC Summit on Role of NBFCs in Achieving $5 trillion Economy) available at https://www.rbi.org.in/web/rbi/-/speeches-interview/chasing-the-horizon-1135 [3] https://www.fsb.org/2023/12/global-monitoring-report-on-non-bank-financial-intermediation-2023/ [4] https://www.rbi.org.in/web/rbi/-/publications/reports/chapter-ii-financial-institutions-soundness-and-resilience-dec-23 [5] NBFC-Infrastructure Finance Companies (NBFC-IFCs) and NBFC-Investment and Credit Companies (NBFC-ICCs). |