Failure of any large NBFC may translate into a risk to its lenders: RBI Dy Governor M Rajeshwar Rao

The reputation of the non-banking financial sector has been dented in recent times by failure of certain entities due to idiosyncratic factors, said Reserve Bank of India Deputy Governor M Rajeshwar Rao.

The challenge, therefore, is to restore trust in the sector by ensuring that few entities or activities do not generate vulnerabilities which go undetected and create shocks and give rise to systemic risk through their interlinkages with the financial system.

“Forestalling and where necessary, decisively resolving such episodes becomes a key focus of our regulatory and supervisory efforts,”Rao said at the CII NBFC Summit.

There are 9651 NBFCs across twelve different categories focussed on a diverse set of products, customer segments, and geographies.

As on March 31, 2021, the non-banking finance company (NBFC) sector (including housing finance companies/ HFCs) had assets worth more than ₹54 lakh crore, equivalent to about 25 per cent of the asset size of the banking sector.

“Therefore, there can be no doubt regarding its significance and role within the financial system in meeting the credit needs of a large segment of the society,” Rao said.

Over the last five years the NBFC sector assets have grown at cumulative average growth rate of 17.91 per cent.

The Deputy Governor underscored that: “Now, the non-banking sector has grown significantly and several NBFCs match the size of the largest Urban Cooperative Bank or the largest Regional Rural bank.

“In fact, few of them are as big as some of the new generation private sector banks. Further, they have become more and more interconnected with the financial system.”

He said NBFCs are the largest net borrowers of funds from the financial system and banks provide a substantial part of the funding to NBFCs and HFCs.

Therefore, failure of any large NBFC or HFC may translate into a risk to its lenders with the potential to create a contagion.

Failure of any large and deeply interconnected NBFC can also cause disruption to the operations of the small and mid-sized NBFCs through domino effect by limiting their ability to raise funds.

Rao emphasised that liquidity stress in the sector triggered by failure of a large CIC (core investment company) broke the myth that NBFCs do not pose any systemic risk to the financial system.

SBR framework

The Deputy Governor said a scale-based regulatory (SBR) framework, proportionate to the systemic significance of NBFCs, may be optimal approach where the level of regulation and supervision will be a function of the size, activity, and riskiness of NBFCs.

As regulations would be proportional to the scale of NBFCs, it would not impose undue costs on the Regulated Entities (REs).

Rao explained that: “While certain arbitrages that could potentially have adverse impact would be minimised, the fundamental premise of allowing operational flexibility to NBFCs in conducting their business would not be diluted.

“...There has been a consistent and conscious understanding that a “one size fits all” approach is not suitable for NBFC sector, which are a diverse set of financial intermediaries, with different business models, serve heterogenous group of customers and are exposed to different risks.”

The Deputy Governor urged NBFC promoters/ managements to create a culture of responsible governance in their respective organisations where every employee feels responsible towards the customer, organisation, and society.

He felt that good governance is key to long term resilience, efficiency and survival of the entities.

Customer protection

Rao underscored that protecting customers against unfair, deceptive, or fraudulent practices has to become top priority of every entity and permeate the organisation culturally and become a part of its ethos.

“Customer service would mean, amongst many other things, that a customer has similar pre-sale and post-sale experience, she/he is not disadvantaged vis-à-vis another customer because he or she approached the financial entity through a different delivery channel, and he or she has a right to hassle-free exit from the contractual obligation.

“This issue has been deliberated often enough and it’s time to act now,” the Deputy Governor said.