Bank-NBFC interconnectedness poses systemic risks: RBI ED Lakshmi Kanth Rao

"Sector needs strong regulatory standards to ensure no gaps"

The interconnectedness of the Non-Banking Financial Company (NBFC) sector with banks poses systemic risks, said the Reserve Bank of India (RBI) Executive Director, Lakshmi Kanth Rao.

Speaking at the industry body Assocham event on Friday, Rao said that the NBFC sector accounts for nearly 30 per cent of the total bank credit in India and plays a key role in credit intermediation.

“They (NBFCs) are more interconnected with the banks, so anything that happens in the NBFC sector has a way of spreading through the banking sector and leading to overall financial stability issues. But, at the same time, they also contribute to the diversification of the overall financial system,” Rao said.

While acknowledging NBFCs’ contribution to financial diversification and stability, which are invaluable, Rao said, “yet their interconnectedness with banks also poses systemic risks. A balanced regulatory approach is essential to support NBFC growth while ensuring overall financial stability.”

Speaking on the NBFCs' demand for a level playing field between them and banks, Rao said that it is a complex issue due to the distinct roles and regulatory requirements of the two segments.

Rao said, “Banks and NBFCs differ fundamentally in their operations and risk profiles, necessitating different regulatory approaches.”

He cited the increased dependence of NBFCs on banks for their funding. Rao said that entities need to diversify instead of concentrating their sources of funding.

He also outlined the areas that NBFCs must increase their focus on, such as compliance, customer protection and experience, liquidity management, cybersecurity, and Self-Regulatory Organizations (SROs).

Rao said that as the importance of NBFCs in the system increases, they must also focus on these aspects. He stated that entities must have a proper compliance system and adhere to the guidelines given by the regulator.

“We have called for applications for Self-Regulatory Organizations (SROs). This is a developmental aspect where NBFCs can play a strong role in regulating themselves. The sector itself needs to have strong regulatory standards to ensure there are no regulatory gaps.”

The RBI on Wednesday invited applications for the recognition of self-regulatory organisations (SROs) and said a maximum of two such entities will get approval for the sector.

While speaking on infrastructure financing, Rao noted that due to the key risks associated with infrastructure financing, collaboration among all stakeholders, including banks, NBFCs, and the government, is essential.