RBI Hints At Graded Regulatory Framework For NBFCs
A security guard walks through the RBI regional headquarters in New Delhi. (Photographer: T. Narayan/Bloomberg)

RBI Hints At Graded Regulatory Framework For NBFCs

A graded regulatory framework may be needed for India’s growing and diverse non-bank lending segment to strike a balance between the need to ensure financial stability while leaving enough flexibility for innovation. That’s according to Rajeshwar Rao, who has recently taken over as deputy governor at the Reserve Bank of India.

Speaking at an event organised by Assocham, Rao said there’s a view that any regulatory framework would ideally be designed according to the principle of proportionality. By extension, it can be argued that the spill-over risks from a large systematically important NBFC must be dealt with in a proportionate manner and these entities should be subjected to a higher degree of regulation.

One can also argue that the design of prudential regulatory framework for such NBFCs can be comparable with banks so that beyond a point of criticality to systemic risks, such NBFC should have incentives either to convert into a commercial bank or scale down their network externalities within the financial system.
Rajeshwar Rao, Deputy Governor, RBI

This would make the financial sector sound and resilient while allowing a majority of NBFCs to continue under the regulation-light structure, Rao added.

The comments come after a two-year period of volatility for India’s non-bank lenders. The collapse of IL&FS in 2018 exposed fragilities in the funding profile of these lenders and forced the RBI to tighten liquidity rules among others. At the time, a small subset of large NBFCs had argued that tougher regulations could be imposed on them while allowing them more open access to public deposits.

The RBI is yet to accept the suggestion of carving out a new category from within NBFCs already designated as systemically important.

Rao also highlighted the need to deal with entities which neither belong to the critical ones in terms of systemic risk nor are they too small in their scale and complexity. “These NBFCs currently enjoy great degree of regulatory arbitrage vis-à-vis banks. As a group, these entities can contribute to build-up of systemic risks because of the regulatory arbitrage enjoyed by them; hence there is a need to recalibrate the regulations,” he said.

Commenting on microfinance entities, which have seen a number of ups and downs over the years, Rao noted that the share of non-banks in the business has come down to a little over 30%. As such, tougher rules imposed on NBFC-MFIs may not be enough to ensure the appropriate functioning of that business, Rao suggested, alluding to the different rules that exist for banks and non-banks in the MFI segment.

Today we’re in a situation, where the regulatory rigour is applicable only to a small part of the microfinance sector. There is a need to re-prioritise the regulatory tools in the microfinance sector so that our regulations are activity-based rather than entity-based. After all, the core of microfinance regulation lies in customer/consumer protection.
Rajeshwar Rao, Deputy Governor, RBI

On the RBI’s approach towards the fintech segment, Rao said that the regulator will continue to try and enable growth of digital technology for new financial products and services.

He cited rules laid down for peer-to-peer lenders, account aggregators and digital only platforms. “While making regulation for the future in FinTech area, orderly growth and customer protection and data security will remain the guiding principles for the RBI,” Rao said.

Given the diverse regulatory needs for different segments of non-bank lenders, Rao said that there may be no no “one-size-fits-all” prescription in the regulatory approach for NBFCs.

Perhaps a calibrated and graded regulatory framework, proportionate to the systemic significance of entities concerned is the way forward.
Rajeshwar Rao, Deputy Governor, RBI
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