More clarity on shadow banking

New regulations for stressed NBFCs harmonise with those for banks

On Tuesday, the Reserve Bank of India (RBI) outlined a new framework for shadow banking in India that was meant to ensure that non-banking financial companies or NBFCs are subject to stringent supervision when their key financial ratios decline. Essentially, deposit-taking NBFCs and those with systemic impact will now be subject to a prompt corrective action (PCA) framework similar to that for scheduled commercial banks, which will allow various controls to be imposed. These controls will, in a graded manner, prevent NBFCs from taking on more risk and control their promoters’ behaviour. The RBI has previously moved to streamline the norms governing non-performing assets in the shadow banking sector. The banking regulator deserves credit for promptly extending a sensible regulatory regime over the NBFC component of the financial sector after the RBI Act was amended to give it the appropriate powers.

The central principle behind the extension of such regulations to NBFCs is that, if a shadow bank is the same as a regular bank in terms of how it takes deposits and the risk its collapse poses to the overall system, then the regulatory regime should be similar as well. This is a sensible principle. The counter-argument offered by some NBFCs is that they are being encouraged to lend by the government to aid in the recovery. But that is hardly a powerful point, given that prior to the pandemic, lending was in any case in crisis due to the collapsing of trust in prominent NBFCs. The motivation for the RBI may well be to prevent a repetition of the crisis brought on by the default of Infrastructure Leasing and Financial Services Limited (IL&FS). Certainly, had IL&FS been subject to the current regulatory regime, there is every reason to hope that its troubles would have been caught earlier on, and greater supervision enforced.
 

One question is whether the timeline granted by the regulator for compliance with this new framework is sufficient. The regulations are due to come into force in October 2022. It is reasonable to ask whether the pandemic is really the right time to introduce new and more stringent regulations to govern already stressed institutions. After all, some assets might be non-performing because of the pandemic, and thus force entry into the PCA system for the associated institution in a way they would not in more normal times. But the fact is that the overall recovery, while modest, appears to be sufficient to ensure that there is no immediate crisis facing NBFCs in general. The RBI should, however, be on guard that, if for some reason the pandemic conditions worsen, the timeline can be extended without compromising on the overall direction of reform.

The RBI’s determination to ensure that the NBFC sector is regulated properly and in harmony with the banking sector deserves credit. It should not be forgotten that the role that NBFCs perform in the economy is, however, different from that of banks. They are supposed to be more innovative in their methods of inclusion, and reach out to segments that are underserved by commercial banks — particularly the unorganised sector. This does not mean that they can be greater sources of systemic risk. The RBI should be careful that, while it continues to take due precautions about the risks posed by the sector, it does not stifle the innovative and inclusive quality that sets NBFCs apart from banks.