NBFCs: Learning to adjust with the new reality
– Vinod Kothari | vinod@vinodkothari.com
The increase of risk weights for consumer lending by the RBI, coupled with increase in risk weights for lending to NBFCs, has affected capital adequacy of several regulated financial entities, particularly NBFCs focused on consumer lending. It has also created a situation of risk aversion. While the full rigour of this very significant regulatory provision is still being absorbed, the Finance Minister also added her bit of garbed caution – “enthusiasm is good but take only how much you can digest”. Suddenly, the situation is now forcing NBFCs to review their product structure, resource mobilisation, capital plans, and above all, risk management.
Shadow banking is financial system’s banana skin
Just a few days ago, on 7th November, 2023, the chairman of Swiss banking giant UBS, addressing a banking conference in Hong Kong, made what he realised was likely to upset half the audience. He said: “a large share of global financial assets are now in non-bank financial intermediaries, the shadow sector….I think the next crisis when it happens will be in that sector. It will be fiduciary crisis.”
The Financial Stability Forum publishes a report on non-banking intermediation, usually in December every year, and hence, the 2022 Report shows NBFIs holding over 49% of the financial assets of the world, to reach a whopping USD 240 trillion. This number, of course, is not lending institutions or credit intermediaries, which are called “narrow measure financial intermediaries” in the report. The latter number is about USD 68 trillion, and the former number includes insurance companies, pension funds, and the like.
Concerns about these “shadow banks” is that institutions look like a duck, quack like a duck, and move like a duck, but aren’t ducks still. In essence, they are not regulated as banks, though the perform credit intermediation function similar to banks.
Chinese trust companies holding huge investments in real estate are already reeling under problems.
In September this year, EU regulators also adopted a rule requiring banks to report exposure to shadow banks.
India’s NBFCs are not shadow banks
These regulatory moves and concerns elsewhere in the world need not cause any impact on India’s NBFC sector. NBFCs in India are not unregulated: in after the introduction of the scale-based regulatory system, NBFC regulations are at par with those applicable to banks. In fact, in many respects, NBFC regulations are stricter than those in case of banks. NBFCs need 15% capital adequacy, as opposed to 11.5% in case of banks. Most NBFCs are non-depository, while banks are, by definition, deposit-taking.
Therefore, it will be wrong to be carried away by these global concerns.
Bank-NBFC alliance is here to stay
The partnering between banks and NBFCs – NBFCs that take the funds to the last mile, and the banks that get the liabilities – is here to stay. The partners make best use of their capabilities. NBFCs have geographical outreach, technological competencies, better customer interface, and so on. Banks have always been strong in liability management. Therefore, the partnering is the best way to make use of their differential capabilities.
Hence, the only question that will arch over the growth of the NBFCs in future will be – can NBFCs continue to push unsecured consumer lending, or do they have to find ways to fund economic activity of a country with a strong aspiration and growth potential. If lending aligns with growth in incomes, it pays for itself. If lending latches on pure consumption, a loan just results into another loan. This is where NBFCs have to learn to re-strategise their business.
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RBI has clearly said that increase in risk weights is applicable for Consumer credit, however there is still confusions around NBFC which lend to other sectors. Whether this increase in risk weights would affect other nbfcs. There will be increase in cost of lending for bank loan to nbfcs, whether nbfc would be forced to adopt increase in risk weight to pass on the cost to end consumer, irrespective of whether they are lending consumer credit or not
The point in last para stating that if loan generate incomes is less risky is crucial one. But most of the consumer lending is towards consumerism. It is high time these NBFCs move towards equipment finance to small units leading to increase of incomes at lower starta of the society and making the economy more sustainable. We hardly receive calls for installing a big washing machine and iron table to open a laundry or a refrigeration system to shopkeepers and market places.