Why has RBI again cautioned NBFCs not to cross regulatory redlines

The focus is on unsecured retail lending by shadow banks, according to experts

Just 205 words from Shaktikanta Das on non-banking financial companies (NBFCs) is all that has taken for many in the business – and the wider world of stakeholders – to take a hard look at the way they transact. The Reserve Bank of India (RBI) governor’s statement last fortnight (following the monetary policy committee meeting) may lead to banks looking at their exposures to NBFCs afresh, especially those with significant non-secured credit on their books. There have already been calls among private equity investors since and rating agencies are set to review shadow banks they rate. 
 

Mint Road though was not being alarmist.
 

Read footnote 49 in Das’s address: Gross non-performing assets (GNPA) ratio of banks stood at 2.7 per cent at end-June 2024 – the lowest since end-March 2011. And even as he highlighted other sound financials of banks, he pointed to NBFCs’ key health parameters which are moving in tandem with banking. GNPA and net-NPA ratios of NBFCs (excluding those under resolution) in June 2024 were 2.6 per cent and 1.1 per cent, respectively (it was 3.2 per cent and 1.2 per cent in the same quarter of the previous financial year). Clearly, only a few NBFCs, or shadow banks, were crossing regulatory redlines.
 

Mind the outliers
 

As Mahesh Thakkar views it, legacy NBFCs are by and large into secured assets – be it loans to small and medium businesses, vehicle financing or mortgages. Assets are well assigned; (but) this is not the case with unsecured retail lending. For Thakkar, director-general of the Finance Industry Development Council, the issue is straightforward – giving out loans is the easier part, recoveries are tough. “It’s not like selling toothpaste. I feel more effort should be placed on recoveries and this should be incentivised by NBFCs. Also, read the Governor’s statement carefully: It refers to outliers.”
 

The “outliers”, according to Das, were the approaches adopted by some NBFCs: Growth at any cost; usurious interest rates along with unreasonably high processing fees, and frivolous penalties. Then there is the ‘push effect’: Business targets-driven retail credit growth rather than on actual demand. Plus, compensation practices, variable pay and incentive structures – some of which seem to be purely target driven in certain NBFCs.
 

That the RBI would crack the whip was evident in September when it sought granular details on the loan books of select NBFCs: On the outstanding product-wise portfolio and annualised interest charged on them. The annualised interest-slabs being: Less than 10 per cent, 10-20 per cent, 20-30 per cent, 30-40 per cent, 40-50 per cent, and above 50 per cent. That data being looked on the last three slabs was an indicator that “usurious rates” were on the radar.
 

And earlier in June, Mint Road got cracking on the payouts to NBFCs’ key management personnel. It was a follow-through on its circular of April 29, 2022 which asked firms in the “middle” and “upper” layers of its four-tiered scale-based regulatory (SBR) framework to put in place a board-approved compensation policy. These included the setting up of remuneration committees, principles for fixed-variable pay structures, and claw-back provisions effective April 1, 2023. This circular placed NBFCs in the “middle” and “upper” layers of the SBR framework on par with private banks’ senior management.
 

“It will be interesting to watch changes, especially in deposit mobilisation, demand of funds in the upcoming capex cycle, the listing of two large NBFCs, credit demand by small businesses and the role-play among banks, NBFCs and small finance banks,” says Vimal Bhandari, executive vice-chairman and chief executive officer, Arka Fincap.
 

These are inter-linked aspects: Bank credit-deposit ratio is in the high 70s (though it is showing signs of tapering of late); and when a fresh capex cycle kicks in, is there to be another revisit of NBFC exposures? “The funding environment is a key monitorable and how it evolves for the lower-rated NBFCs since they do not benefit from a very diversified resource profile,” says Pankaj Naik, director, India Ratings & Research.
 

The initial public offerings of HDB Financial Services (a subsidiary of HDFC Bank) with fresh equity issuance of Rs 2,500 crore and offer-for-sale; and of Tata Capital (issue size to be decided) will give a sense of what investors feel of NBFCs. More so, given Das’ observation that “driven by the significant accretion to their capital from both domestic and overseas sources, and sometimes under pressure from their investors, some NBFCs,  including microfinance institutions and housing finance companies, are chasing excessive returns on their equity.” A few NBFC corner-room occupants told Business Standard (off record) that this is a signal from the central bank that playing the valuation game is not desirable.
 

Focus on fintechs
 

“Corporate governance and compliance with regulatory requirements were always key aspects of the rating exercise.
Interaction with the audit committee of the boards (of NBFCs) and request for interaction with the statutory auditor further help in gaining a better perspective on governance and compliance. Due diligence of business operations by all stakeholders, including lenders and rating agencies, has become finer and finer,” adds Naik.
 

The broad sweep of RBI’s observations notwithstanding, a particular class of NBFCs will be under closer scrutiny: Fintechs. As Rohan Lakhaiyar, partner, financial services (risk advisory), Grant Thornton Bharat, puts it there are no entry barriers for this ecosystem. Regulated entities are increasingly engaging with them to digitalise and automate several business operation processes. “While there are no explicit regulatory instructions issued to fintechs by RBI, there are implicit expectations from the former on matters of market conduct, governance, risk management, cybersecurity, among others.” His stance: How do these implicit expectations get communicated to fintechs and, more importantly, who ensures ongoing adherence? And that, in turn, puts the spotlight on self-regulated organisations in which Mint Road has invested time and effort.