Reserve Bank of India action does not imply systemic risk, say NBFC chiefs

The Reserve Bank of India (RBI) recently halted the loan disbursement activities of four non-banking finance companies (NBFCs) from October 2024. Speaking at the Business Standard BFSI Insight Summit 2024, top executives of leading NBFCs – Jairam Sridharan, managing director (MD), Piramal Capital & Housing Finance; Rajiv Sabharwal, MD and chief executive officer (CEO), Tata Capital; Umesh Revankar, executive vice-chairman, Shriram Finance; Vishakha Mulye, CEO, Aditya Birla Capital; and Vivek Kumar Dewangan, chairman & managing director, REC, said the regulator's firm stance against some entities would not have an overall impact on the sector. Edited excerpts: 

The RBI’s recent actions do not show the NBFCs in a good light. Are you concerned about the image of the segment? 

  Sridharan: RBI’s punitive actions over the last year have encompassed both banks and non-banks. It's the most recent round of action, which is on two NBFCs and two MFI (microfinance institution) entities. It is kind of a little bit more. But in general, the RBI has been concerned about conduct issues of all lenders over the last year and a half, and very appropriately so. The lending industry needs to pay heed to the underlying concerns that are being raised on conduct, whether it is on interest rate regime, or on transparency to customers, or KYC (know your customer). It’s very important for us to take into account the main themes that RBI has talked about over this last year and a half. The RBI actions have been structure agnostic. 

Sabharwal: We should divide everything into two parts. One is regulations, which come as circulars that apply to everyone, and those are based on where they feel structurally anything is a challenge for the industry and needs to be corrected. The other is purely based on supervision, which is specific to individual entities and may not apply to all entities. If it is specific to certain entities, we should take it that way. Whether it is to NBFCs, banks, small finance banks, or MFIs, they have found certain challenges in those entities. They have asked those entities to make corrections. RBI never surprises you. They advise you what is right and wrong, and if within the time frame that action does not happen, that is when it leads to this. 

Have you noticed a shift in banks' approach toward the NBFC segment, are banks becoming more wary of lending to NBFCs, given that a significant portion of NBFC funding ultimately comes from them? 

Revankar: NBFCs by and large are dependent on banks for raising resources. There has been some kind of re-looking into the way banks are lending. New products or new arrangements have been coming, like co-lending is one such arrangement.

RBI is also trying to lend more responsibility by making the NBFC also be a partner in each of the loans. There is an effort to make the bank lending to NBFCs more systematic rather than having some ad hoc arrangements with some of the NBFCs... Overall, I don't see any of the banks trying to back off from the existing arrangement. 

Has RBI’s evolving perception of the NBFC sector impacted the relationship, and are banks becoming more cautious in their dealings, or have you noticed an increase in pricing for NBFCs? 

Mulye: We should not generalise the action of the RBI. It is entity-specific because they carry the supervision every year, wherever there are concerns, they probably would have taken this action. It is not that these actions were not done before. Probably, the form and the method in which it was communicated were different. 

As a banker, we never generalise and say that I am not going to lend to this particular sector. What we say is, yes, we are cautious about this sector, not necessarily because of the reasons that have been cited in the recent actions, but because of various other reasons. Then one looks at the specific companies, does a thorough due diligence, and then decides on the limits. So, I wouldn't generalise and say that the bankers will take a view that they will not lend it to all NBFCs. It will be NBFC-specific. 

Vivek, your position is unique as a state-owned entity within the sector. Would you say that the sector’s image has taken a hit? 

  Dewangan: The recent guidelines or advice issued by RBI has forced all the banks and NBFCs to go for introspection to take self-corrective action. Since REC is into infrastructure financing, let me cover one particular issue that RBI issued in May, draft guidelines for infrastructure financing. If under-construction projects are delayed, they have to make higher provisioning.

The spirit is good that we need to have closer monitoring of the infrastructure projects. We do have a history of time and cost overruns for these projects. The draft guidelines which were issued by the RBI were quite useful, but it was merely draft guidelines. They are yet to come up with the final guidelines. These guidelines apply uniformly to the banks as well as to NBFCs. 

There’s a growing view that the advantages of being an NBFC are diminishing as the regulatory arbitrage between banks and NBFCs narrows. Do you think advantages are fading or is it still business as usual for the sector? 

Sabharwal: We should not use the word arbitrage in that manner. There will be places where banks will have an advantage. They are far more regulated, they are bigger in size. NBFCs have their own model. 

You will have a lot of NBFCs which are much larger, and governed far better than a lot of small banks. So, putting all of them in one category is not right. If some NBFCs face problems, it is not an existential crisis for NBFCs. We have seen some banks face problems, that doesn't mean the banking sector is in a problem. Everything has to be looked at on its own merit and not decided by painting the whole sector in one way. 

Mulye: We are a very large country. To serve the financial requirements of the whole population, we require different models, and each model has its strengths and certain weaknesses rather than arbitrage. Banks had the ability to participate in the checking account and, therefore, traditionally had the advantage of a lower cost. That no longer is true. Barring the top three or four banks, if you look at many of us sitting on this dais today, our cost is equal to the fourth or the fifth bank… Diverse models play a vital role in India. Each organisation must carve out its niche, evaluating cost-benefit dynamics to deliver services to customers affordably. 

Revankar: NBFCs are specialised entities with a niche focus and a deep understanding of their markets. While there are around 9,000 NBFCs, each operates with a unique business model, unlike banks, which tend to be more uniform in their offerings and approach. 

NBFCs cater to specific customer segments, often operating closer to their customers geographically and tailoring their services to meet specific needs. NBFCs have the option to convert into banks if they choose. However, unless clear guidelines or a structured path for such a transition are provided, there’s no pressing need for every NBFC to become a bank. 

Sridharan: Historically, NBFCs in India have been the vanguards of innovation. They started gold loans, housing finance, car loans, and microfinance businesses. Along the risk-reward spectrum, different business models exist. Some players will play in a very low-risk, low-reward segment but it will be very large in size. Other players will want to play in a smaller market with a higher risk and return. The same player cannot do both. It requires a very different DNA to do both of those things. 

However, the question remains: Do we really need 9,350 NBFCs to serve 25 per cent of the market, when 35 banks collectively cater to the remaining 75 per cent? While diversification and specialised players are crucial, having 9,000+ entities for a quarter of the market raises valid concerns. This long tail of NBFCs has often been a challenge for regulators, leading to periodic consolidations. 

Infrastructure financing in the context of the RBI’s draft guidelines faced strong criticism from banks and NBFCs. Can you walk us through the key concerns? 

Dewangan: The RBI issued draft guidelines in May, stipulating that over the next three years, the provisioning has to be made higher for those under-construction projects that are delayed. Those banks or NBFCs that were not following India's accounting standards, their profitability would be affected. 

For those who already follow India's standards, profitability won’t be affected, but they will have to make higher provisioning over the next three years, which may go up to 5 per cent. Ultimately, it will lead to higher costs of lending for the borrowers. That was the main concern. We have given our comments to the RBI and have taken up the matter with the Department of Financial Services. We hope that a balanced view will be taken by the RBI and they'll come up with the final guidelines. The concern is that if the existing draft guideline gets converted into a final guideline, the infrastructure financing cost will increase.