RBI's revised regulatory framework for NBFCs: Is it the right approach?

 NBFCs play an important role in facilitating credit to the specific sectors along with banks and thus the resilience of the sector is imperative for ensuring India's financial and economic development

Reserve Bank of India, after its discussion paper released in January 2021, has recently come up with a revised regulatory framework for Non-Bank Financial Companies (NBFCs), a ‘scale based approach’ which shall be implemented in India with effect from October 1, 2022. In this framework, NBFCs are classified inter alia into four layers based on the activity, size and risks coupled with application of varied regulations based on the former criteria. The regulatory norms and capital requirements have been made stringent for the upper layers in specific components which include inter alia non-performing asset classification norms, changes in concentration of credit/investment, sector exposures, and restrictions on loans, large exposure framework, international exposure limit, corporate governance requirements etc.

NBFCs play an important role in facilitating credit to the specific sectors along with banks and thus the resilience of the sector is imperative for ensuring India’s financial and economic development. The regulatory framework applicable to banks and NBFCs is almost different in India, similar to practices followed internationally. While banks are subject to strict capital/prudential requirements, NBFCs are loosely regulated internationally. Globally, the NBFCs are traditionally termed as shadow banks, which has assumed new name as 'non-bank financial intermediation (NBFI)' or 'market-based finance' recently. As they are loosely regulated globally, they pose a risk to the global financial system, except in India, where NBFCs are already subject to regulatory requirements almost in line with banks.

The large-sized NBFCs have the potential to amplify financial vulnerabilities due to their size being nearly the same as that of banks which are already subject to strict regulatory requirements. The interconnectedness of the banking system with NBFCs is another major factor as risk in any particular institution may have systemic risk impact on the whole financial system as they are closely dependent on one another. We have the example of IL&FS to substantiate this.