Level field, finally

The Reserve Bank of India's new guidelines to rein in the mushrooming growth of non-banking finance companies (NBFCs) will stop the huge regulatory arbitrage that the foreign players have been enjoying. Ever since the regulator announced the roadmap for opening up the banking sector in 2005, foreign banks have been aggressively using the NBFC route for expansion. As the banking sector will not be opened up before April 2009, foreign banks wanted to add more muscle to their balance sheet by intensifying their non-banking activities. This could be done easily because of the glaring gaps in the NBFC regulations. Under the foreign direct investment norms, any foreign player could set up an NBFC once it is cleared by the Foreign Investment Promotion Board. The RBI nod in this case was a mere formality. There are several NBFCs which have been set up as subsidiaries of foreign entities as well as of foreign banks having branches in India. They could undertake transactions which were barred for banks. Since non-deposit taking NBFCs have not been supervised adequately, the foreign players enjoyed an unfair advantage.

The RBI has capped borrowings by systemically important NBFCs not taking public deposits, introduced a capital adequacy requirement and applied exposure norms. Systemically important non-deposit taking NBFCs are those with asset size of Rs 100 crore. The central bank will also regulate the NBFCs promoted by parents of foreign banks operating in India on a consolidated basis. Besides, it has barred all banks""domestic as well as foreign""from holding more than 10 per cent of the paid-up equity capital of a deposit-taking NBFC. There are 436 such NBFCs, of which 16 have asset size above Rs 500 crore and account for 48.6 per cent of the Rs 3,777 crore aggregate deposits of the sector. Of the 2,615 non-deposit taking NBFCs, 104 have assets worth at least Rs 100 crore each.

With five NBFCs, the Citigroup heads the segment of non-deposit taking companies, followed by GE Capital and its associates. Out of the 104 companies, 10 companies account for 43.3 per cent of the total assets of this segment. Five of the 10 companies are foreign-owned with huge exposure to bank borrowings, commercial papers (CPs) and debentures. The leverage available in gearing up the balance sheet by a non-deposit-taking NBFC is unlimited and in the absence of any restriction on the end use of funds, there can always be issues that have implications for the entire financial system.

The RBI had in 1963 first formulated a scheme to provide an indirect protection to the depositors of NBFCs. After that it had to wait for 34 years to acquire more powers to regulate the sector. In 1997 the RBI Act was amended to stipulate the minimum entry point norm and compulsory registration for the NBFCs. The very next year, the banking regulator introduced prudential norms for NBFCs and stipulated the minimum net-owned fund requirement. However, while prudential norms of asset classification, income recognition and provisioning had been applicable to the NBFCs, certain other critical norms like capital adequacy ratio and cap on exposures to borrowers were not there. The new guidelines have addressed these gaps.