New NBFC rules likely to avert credit risks
Premium- Rules will insulate lenders from shocks, help avoid concentration of risk
MUMBAI : The Reserve Bank of India’s (RBI) latest move to stem systemic risks and make shadow banks more accountable by extending the large exposure framework to upper-layer non-banking financial companies will not only reduce credit risks, but may also lead to consolidation, experts said.
On Tuesday, RBI said the exposure of a non-banking financial company (NBFC) to a single entity must not cross 20% of its available capital base and, subject to board approval, an additional 5% exposure will be allowed. For a group of connected entities, the aggregate exposure will be limited to 25% of the non-bank’s capital base. The rules, however, provide more headroom for infrastructure finance companies.
With the announcement, the central bank has now harmonized regulations for upper-layer non-banks, commercial banks and co-operative banks, leaving little room for arbitrage. The large exposure framework was first introduced for banks in 2016, and subsequently revised in 2019. In 2020, the guidelines were extended to urban cooperative banks, following the collapse of the Punjab and Maharashtra Cooperative Bank in 2019.
According to experts, if the large exposure norms were not harmonized for commercial banks, cooperative banks, as well as NBFCs, the gaps could be exploited by borrowers. “When others have such caps and NBFCs do not, it poses a risk to the credit system," said R. Gandhi, former deputy governor, RBI.
Besides, the move to bring NBFCs on par with banks on large exposures, and a string of other measures by the central bank, have also led to speculation that the sector may enter a phase of consolidation, especially after HDFC Bank’s merger announcement with Housing Development Finance Corp. earlier this month.
In October 2021, RBI released a set of rules to classify NBFCs based on their size and perceived risks. RBI had said the upper layer of NBFCs could have group exposure of up to 40% of the capital base. While it has now reduced the exposure for group entities, the single borrower exposure limit has been retained.
The rules will help avoid concentration of risk and insulate lenders from shocks owing to failure of any large borrower account.
Before it decided to bring regulated entities on par, RBI followed entity-based regulations, or a category the lender belonged to. In 2013, under former governor Raghuram Rajan, RBI made a conscious shift towards activity-based regulation. “Changes started then are being visible now after years of work," said Gandhi.
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By creating a large exposure framework, RBI is also prodding large borrowers to tap funds from the markets instead of solely relying on bank loans, experts said, adding that since market exposures will be in the form of tradeable securities, the price discovery of an asset is better, as markets react faster than the banking sector on fresh information about a company.
RBI has initiated a series of measures to strengthen the supervisory framework for scheduled commercial banks, urban cooperative banks as well as non-banks, governor Das had said on 16 January 2021. “The possibility of working in silos has been eliminated."
According to the Bank for International Settlements (BIS), risk of large losses associated with the failure of a single counterparty or a borrower is not captured by the risk-based capital standards of the Basel Committee on Banking Supervision.