RBI's NBFC paper silent on liquidity management, says India Ratings

The Reserve Bank of India’s (RBI’s) paper on the proposed framework for regulating non-banking financial companies (NBFCs) is silent on liquidity management and gives risk-weight benefits if they are subject to bank-like regulatory treatment.

Certain intended provisions on real estate exposure, if made into rules, may restrict land financing by finance companies, according to India Ratings.

The paper has not said whether the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) will be applicable to upper layers of NBFCs.

Also, it does not say whether they would be provided, as in the case of banks, a liquidity backstop that can place SLR securities in the repo window, and raise funds.

The regulations, if implemented, will lead to an increase in the cost of compliance for NBFCs-UL (upper layer) and may lead to greater incentives towards consolidation or the drive to convert into a bank, India Ratings said.

The paper talks about risk-weight arbitrage for NBFCs in the context of standard asset provisions, and also articulates a common equity tier 1 (CET-1) of 9 per cent for a certain category of them. But it does not deal with the industry demand on risk-weight benefit, which is applicable to banks (such as on retail assets). Banks get a certain leeway for extending retail loans without sacrificing prudential norms.

NBFCs have developed the expertise of underwriting higher risk and pricing for it. However, an unbridled increase in exposure can increase the riskiness of the business model and lead to their failure. In order to curtail this risk, the discussion paper stipulates capping exposures in the case of sensitive sectors such as real estate and the capital market, India Ratings said.

The paper proposes restricting real estate funding to only those projects where approval/ permission is in place.

It also proposes board-approved limits for exposure to commercial real estate and internal sub-limits for financing land acquisition.

This would significantly restrict land financing by NBFCs.

Better disclosure norms and a strengthened corporate governance framework would go a long way in reducing an information asymmetry within the NBFC space and instil confidence among stakeholders.

A stronger and independent board would infuse resilience into NBFCs to tide over the challenging operating environment and carry on operations, maintaining a balance between risk and return, it added.