NBFCs: Tighter regulations, cost of funds to determine future path

RBI has proposed scale-based regulatory approach as the way forward for non-bank lenders

Investors of non-banking finance company (NBFC) stocks should brace themselves for volatility in the coming months, as the Reserve Bank of India (RBI) has set the stage for further narrowing of regulatory arbitrage they enjoy vis-à-vis banks.

In a first of its kind proposal, the RBI governor spelt out the need for a dividend distribution policy for NBFCs, given the increasing significance of NBFCs and their interlinkages with different segments. A draft paper is likely soon. Not just that, a fortnight after the RBI’s internal working committee (IWC) spelt out the need for large NBFCs with assets upwards of Rs 50,000 crore to convert to banks, the governor also reiterated the need for some regulatory changes.

From the present regime governing built on the principle of proportionality, he built a case for scale-based regulatory approach linked to the systemic risk as the way forward for the sector. These changes are proposed considering the rapid developments in the recent years, which have led to significant increase in size and interconnectedness of the NBFC sector.

“Every time when the sector has seen unprecedented growth, there has always been regulatory interventions,” Siddhart Purohit of SMC Capital explained and hence a change in NBFCs landscape may be unavoidable. He points out that in the housing finance segment, the rapid growth in asset financiers, also reflected in their market capitalisation may have prompted the regulator to turn cautious.

But the question is whether NBFCs will rethink their business strategies if some of key regulatory requirements on capital adequacy or asset-liabilities management reporting become as stringent as in banks? Possibly so. While cost of funds is back at 2018 levels, the scar of sudden spike which NBFCs battled for most of 2019 is still fresh in their minds. “Compliance costs have already increased in the last two years, and if the noose tightens further, NBFCs may be weighing the options more cautiously,” said an analyst from a domestic brokerage.

Though it doesn’t mean that the idea of converting into a bank for larger NBFCs as proposed by the IWC would find immediate acceptance, co-lending and co-origination of loans may gather momentum. For instance, in about a year, Indiabulls Housing and Edelweiss Financial Services have aligned their business models towards working along with banks, rather than competing them. Therefore, while the pandemic itself has forced NBFCs to thread cautiously on growth, tighter regulations may further trim their balance sheets to mitigate systemic risks.