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Decoding RBI’s Concerns: The Fast and Furious Expansion of NBFCs

7 min read |

Non-Banking Financial Companies (NBFCs) have been a major growth engine in India’s financial sector. But with this rapid expansion, the Reserve Bank of India (RBI) is stepping in to ensure stability with stricter regulations. Let’s delve into the reasons behind this move and what it means for borrowers and lenders alike.

Rising Risk, Rising Scrutiny

One key driver of the RBI’s actions is the potential for risk. Unsecured loans, a major NBFC product, have witnessed a surge in recent years. Rise of fintech & digital lenders has played an important role in reducing friction in borrowing especially for tech savvy gen z & millennials alike. Most lenders have managed to register 20%-60% growth in their unsecured loan portfolio between FY22 and Q2 of FY24. This focus on unsecured lending by NBFCs in the face of tightened liquidity, raises concerns about potential defaults.

Why the Tightening?

The RBI's measures aim to achieve a multi-pronged effect:

  • Promoting Stability: By requiring more capital for risky loans, the RBI aims to safeguard the financial system from potential NBFC failures.
  • Protecting Borrowers: Stricter regulations can help prevent predatory lending practices and ensure borrowers are treated fairly.
  • Ensuring Transparency: Clearer guidelines can foster a more transparent financial ecosystem, benefiting both borrowers and lenders.

6 major steps to be regulated by RBI for NBFCs

Regulatory Framework and Compliance

The RBI has introduced a scale-based regulation framework categorizing NBFCs into four layers: Base, Middle, Upper, and Top. Each layer has specific regulatory requirements based on the size, complexity, and risk profile of the NBFCs. For instance, non-deposit taking NBFCs with an asset size below ₹1,000 crore fall into the Base Layer, while those with an asset size above ₹1,000 crore fall into the Middle Layer. NBFCs identified by the RBI for their systemic importance are placed in the Upper and Top Layers

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Enhanced Net Owned Funds (NOF)

To strengthen the financial base of NBFCs, the RBI has increased the minimum Net Owned Funds (NOF) requirement in a phased manner. For example, the NOF requirement for NBFC-Investment and Credit Companies (NBFC-ICC) has been raised from ₹2 crore to ₹10 crore by March 31, 2027. This step is aimed at ensuring that NBFCs have sufficient capital to absorb losses and continue their operations without significant disruptions

Stricter NPA Classification Norms

The RBI has tightened the norms for classifying non-performing assets (NPAs). The overdue period for classifying loans as NPAs will be reduced in phases from more than 150 days to more than 90 days by March 31, 2026. This change will bring NBFCs’ NPA norms in line with those of banks, promoting greater financial discipline and transparency

Co-Lending Model

The RBI’s co-lending model encourages collaboration between banks and NBFCs to enhance credit flow to the priority sectors such as agriculture, MSMEs, and housing. This model leverages the strengths of both banks and NBFCs, combining the former’s lower cost of funds with the latter’s wider reach. This collaboration is intended to make credit more accessible and affordable, particularly in rural areas

Risk Management and Governance

NBFCs are required to establish a Risk Management Committee (RMC) to oversee the overall risks faced by the company, including liquidity risk. Additionally, NBFCs within the same group must consolidate their assets to determine the appropriate regulatory layer, ensuring that systemic risks are appropriately managed. The RBI also mandates a leverage ratio cap, requiring most NBFCs to maintain a ratio of no more than seven times their capital, which helps in maintaining financial stability

The RBI’s stringent regulations on NBFCs are designed to enhance their resilience, improve governance standards, and ensure they can effectively manage risks. By raising capital requirements, tightening NPA norms, and promoting collaboration through the co-lending model, the RBI aims to create a more stable and transparent financial system. These measures are essential for maintaining the confidence of investors and consumers, ultimately contributing to the overall health of the financial sector in India.

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