New order for NBFCs

RBI's timely action on Srei shows willingness to use its powers

The Reserve Bank of India (RBI), as the regulator of banks and non-banking financial companies (NBFCs), on Monday announced it was superseding the boards of Srei Infrastructure Finance and Srei Equipment Finance. The RBI also said a former chief general manager of the Bank of Baroda would be appointed administrator of the NBFCs as they were shifted towards the process outlined in the Insolvency and Bankruptcy Code. After this, the central bank will apply to the National Company Law Tribunal, which oversees the bankruptcy process, to appoint the administrator as the resolution professional for the companies.

The RBI’s action is timely, and is a reflection of faith in the insolvency process. Srei’s problems began with the NBFC crisis, which was sparked by the default of Infrastructure Leasing and Financial Services (IL&FS). Troubles were intensified by the pandemic, when the spread of Covid-19 and the associated public health lockdowns delayed infrastructure projects. Since it, being an NBFC, was not eligible for the moratorium scheme, Srei sought to delay some payments to its creditors — but not all of them agreed. The companies began to have trouble paying salaries after the banks that had lent it around Rs 18,000 crore seized control of a portion of its cash flow. The last straw came when an RBI-appointed audit suggested in June this year that over Rs 8,500 crore of lending from the Srei companies may have been to related parties.
 

One important lesson of the IL&FS affair is that it is not wise to delay action on troubled NBFCs because of the possibility of contagion. This is not to say that the Srei group does not have a case that its problems have been made worse by the intransigent attitude of its creditors, including the difficulty it has faced in paying salaries. And, indeed, some in the Srei group may be upset that the central bank has seized control even while private equity investors were expressing an interest in capital infusion into the NBFCs. But the fact is that the RBI will have had to take the larger interest of the sector into consideration. It appears that the central bank, which had long argued for powers to properly regulate NBFCs, is willing to take strong action following the amendment in 2019 to the RBI Act to grant it the authority it had sought. 

There are broader lessons for the NBFC sector that Srei’s peers would be well advised to internalise. It is clear that NBFCs will have to keep their house in order because the central bank is not of a mind to allow them too much time to recover ground once problems have come out into the open. Certainly, if the issues faced by IL&FS had been uncovered and responded to earlier than they were, the chaos that followed could have been avoided. The larger fallout of that chaos was a slowdown in lending and then growth, from which the economy has not recovered since the pandemic hit. It is vital therefore that the NBFC sector, which provides crucial services that regular scheduled commercial banks are unable to provide, needs to grow accustomed to less relaxed regulation.