Government has to walk the thin line between regulation and growth

Back in 1997, there were around 40,000 NBFCs operating in India. Then in 1998, the RBI came up with stringent capital adequacy and asset classification norms for NBFCs to reduce the systemic risk after the CRB fiasco. By 2002 there were just about 10 NBFCs that were still functional. The one thing that the 1998 exercise highlighted was the need to strike that fine balance between better regulation and greater freedom to function in the market. The debate is back all over again on NBFCs.

The first step on NBFC regulation

During the last few days, there have been two diverse incidents pointing at more stringent regulation of NBFCs. Firstly, the RBI has asked all NBFCs with more than Rs.5000 crore in AUM to appoint a chief risk officer (CRO) who would manage, regulate and modulate the risk of the NBFC on a real-time basis. The CRO would be appointed with a fixed term and would report directly into the board of directors. This was intended to create a sounding board to avoid cases like IL&FS and Dewan Housing, where obvious lapses were never brought to light. The second announcement was the decision to hold the independent directors of IL&FS accountable for lapses in highlighting the lapses. This puts a much greater operational onus on the independent directors and could be especially relevant to NBFCs where such risks are most rampant. What does it mean?

Regulation is the right step

There is no gainsaying that NBFCs need to be regulated better for a variety of reasons. NBFCs have moved in a big way to fill the gap left by struggling PSU banks. A lot of semi-urban and rural lending is happening through NBFCs, HFCs, and MFIs. The PSU banks have found this useful in two ways. The NBFCs work as the last mile credit delivery channels for the PSU banks and banks can also buy out portfolios of such loans from NBFCs to meet their priority sector commitments. But, that also calls for better regulation in terms of capital adequacy, NPA recognition, evaluating asset-liability mismatch etc. The cases of IL&FS and Dewan Housing have highlighted that NBFCs can also pose a very big systemic risk to the Indian economy.

Strike the delicate balance

NBFCs in India have reached a stage where they also need the freedom to operate. Unlike in 1998, the problem with NBFCs is not about the regulatory framework. The issue is about monitoring and making it work. That is where risk management is a lot more critical. That is why sounding boards like independent directors and CROs become a key instrument for regulating the NBFCs. Unlike in 1998, banks are a lot more willing to give low-cost credit to NBFCs and that has reduced the cost of funds. Now it is time for the balance!