Relevance: GS Paper III (Economy)
Why has this issue cropped up?
The RBI recently spoke about working towards harmonisation of the various categories of NBFCs involved in credit intermediation. This is a welcome step.
Categories of NBFCs in India
- Of the more than 10,000 NBFCs operating in India, 95 per cent are non-deposit taking.
- The others include asset financing, micro-finance, and core investment companies.
Problem with categorisation of NBFCs
Too many categories increase compliance cost for the industry and monitoring cost for the regulator.
- When the RBI releases the guidelines for harmonised entities later this month, it will recognise only two categories, NBFCs and CICs.
- The effects of the harmonised regulations could have far-reaching implications for the future growth and business direction of NBFCs.
The issues that need to be addressed
The key questions that the RBI should address are:
- Should we have the same set of regulations for all NBFCs even as they vary widely in their business focus and sources of funding?
- How do you enforce prudential risk measures for each asset class, while preventing distortionary anomalies from arising post implementation of ‘activity based’ regulations?
- And, should banks and NBFCs engaged in similar activities operate under equitable, non-discriminatory regulations?
- Separate regulations for each activity that an entity is involved in would increase compliance cost, which will hit smaller players more.
- On activity-based regulations, there is a need to differentiate between assets based on inherent risks. Risk weights could then be prescribed based on the quality of asset and tenure.
- A risk weight mechanism based on the expected losses considering the probability of default, the loss given default, duration and exposure at default is the need of the hour.
- The RBI must allow the poor to monetise their meagre gold assets better by doing away with the cap.
- Gold loans given to farmers by banks are classified as priority sector lending whereas gold loans by NBFCs do not get the benefit. Ideally, the RBI can bring all such lending into the priority sector ambit, whether the exposure is by banks directly, or indirectly through NBFCs.
- There is also a case for considering small ticket gold loans as micro-credit and, therefore, priority sector lending.
- Lastly, while the RBI is the lender of last resort for banks, the NBFCs currently do not have any such institutional mechanism. To protect the interests of the marginalised borrowers, the RBI should open a direct source of funds for NBFCs, even as a short-term measure till the debt market returns to normalcy.