• Being financial intermediaries, NBFCs are engaged in the activity of bringing the saving and the investing community together. In this role they are perceived to be playing a complimentary role to banks rather than competitors, as majority population in the country does not yet have access to mainstream financial products and services including a bank account. NBFCs especially NBFC-MFIs (Micro Finance Institutions) and Asset Finance Companies thus have a complimentary role in the financial inclusion agenda of the country.
• Further, some of the big NBFCs, namely, infrastructure finance companies or those in factoring business, give fillip to the growth and development of the important sectors, like infrastructure. NBFCs have carved niche business areas for themselves within the financial sector space and are popular for providing customised products like second hand vehicle financing, mostly at the doorstep of the customer. In short, NBFCs bring the much needed diversity to the financial sector thereby diversifying the risks, increasing liquidity in the markets thereby promoting financial stability and bringing efficiency to the financial sector.

In the wake of failure of several banks in the late 1950s and early 1960s in India, large number of ordinary depositors lost their money. At this time, the Reserve Bank did note that there were deposit taking activities undertaken by non-banking companies. Though they were not systemically as important as the banks, the Reserve Bank initiated regulating them, as they had the potential to cause pain to their depositors. These institutions have thus been under the regulatory oversight of the Reserve Bank of India since 1963. Since then regulation has generally kept pace with the dynamism displayed by the sector. Later in 1996, in the wake of the failure of a big NBFC, the Reserve Bank tightened the regulatory structure over the NBFCs, with rigorous registration requirements, enhanced reporting and supervision. The Reserve Bank also decided that no additional NBFC will be permitted to raise deposits from the public. Further, in 1999 capital requirement for fresh registration was enhanced from `25 lakh to `200 lakh. Later when the NBFCs sourced their funding heavily from the banking system, it raised systemic risk issues. At the same time, their growing size and interconnectedness also raise concerns on financial stability. Sensing this, the Reserve Bank brought asset side prudential regulations onto the NBFCs. The Reserve Bank’s endeavour has been to streamline NBFC regulation, address the risks posed by them to financial stability, address depositors’ and customers’ interests, address regulatory arbitrage and help the sector grow in a healthy and efficient manner.

Some of the regulatory measures include identifying systemically important non-deposit taking NBFCs as those with asset size of ‘100 crore and above in the year 2006 and bringing them under stricter prudential norms (CRAR and exposure norms), issuing guidelines on Fair Practices Code, aligning the guidelines on restructuring and securitisation with that of banks, permitting NBFCs-ND-SI to issue perpetual debt instruments etc. Recently, in November 2014, the entire regulatory framework was reviewed with a view to transitioning, over time, to an activity based regulation of NBFCs. As a first step in this direction, certain changes to the regulatory framework are sought to be made to a) address risks wherever they exist, b) address regulatory gaps and arbitrage arising from differential regulations, both within the sector as well as vis-a-vis other financial institutions, c) harmonise and simplify regulations to facilitate a smoother compliance culture among NBFCs, and d) strengthen governance standards. Threshold for systemic significance has been redefined as Rs. 500 crore from the extant Rs. 100 crore in assets. Systemically important NBFCs along with deposit taking NBFCs would be subject to inter alia, higher minimum Tier 1 capital, higher corporate governance standards and also stricter asset classification norms.

The challenge for the NBFC sector is to grow in a prudential manner while not stopping altogether on financial innovations. The key lies in having in place adequate risk management systems and procedures before entering into risky areas.

It is the constant endeavour of the Reserve Bank to enable prudential growth of the sector, keeping in view the multiple objectives of financial stability, consumer and depositor protection, and need for more players in the financial market, addressing regulatory arbitrage concerns while not forgetting the uniqueness of the NBFC sector.