Nbfcs: Picking Up The Pieces

Ever since the James Raj Committee Report in the 1970s, there has been talk of the need for legislative strengthening. In the post-1992 period, the RBI has vigorously pleaded for a strengthened legislative authority and the due processes took an inordinately long time. It is to the credit of the present Finance Minister that he introduced an ordinance to put through a major piece of legislation which in early 1997 gave unequivocal powers to the RBI to undertake regulatory/supervisory intervention. While it is sometimes argued by purists that an ordinance is not the best way to through a fundamental change in the legislative framework, a pragmatic approach recognising the urgency for legislative amendment is far better than no action.

 

Unusual problems need unusual remedies and, in the present situation, the authorities should not hesitate to quickly put through certain policy changes without fear of criticism of a knee jerk reaction or locking the stable door after the horse has bolted. It is important to avoid a domino effect and, therefore, measures should be implemented forthwith as part of a damage containment policy. While such measures may reflect a policy which uses generalised measures when some companies play truant, it is necessary that self-regulatory association would need to know that a single truant member can invite harsh measures for all and as such peer group pressure should be intense.

At the present time, the fund-raising limits for hire purchase (HP) and equipment leasing (EL) companies is substantially larger than for loan and investment companies. Since some units which are essentially loan and investment companies try to masquerade as HP/EL companies, it is necessary that the present norms relating to assets and income from HP/EL should be substantially tightened. It should be stipulated that two-thirds of the assets and one half of the income should come from HP/EL as against one half of the assets and one third of the income at the present time.

The July 1996 measures gave time to companies to adjust to the regulatory framework. At present, HP/EL companies which meet both prudential norms and rating are free from the ceilings on deposits as well as the rate of interest. It must be made a condition that such companies should be required to obtain the minimum rating from two rating agencies to be able to continue to enjoy their present status. The HP/EL companies meeting prudential norms and one rating should be allowed to raise up to 10 times the NOF but be subject to the interest rate control. Registered companies meeting only one of the two stipulated norms should be allowed to raise up to five times the NOF and unregistered HP/EL companies should be allowed to raise only an amount equal to the NOF. Corresponding tightening could be undertaken in the case of loan and investment companies.

More importantly, the NBFCs capital adequacy requirements should be stepped up immediately to 12 per cent by March 1998. I am aware that such an increase of the capital adequacy requirement would be considered a punitive measure but it needs to be stressed that this is necessary if a series of failures are to be avoided. It is pertinent to maintain that in the UK, Indian banks face capital adequacy requirements of 16 per cent. When danger signals emerge the regulators must not flinch from unpopular measures.

Furthermore, the Statutory Liquidity Ratio (SLR) investments in government securities should be raised in two quarterly steps from 10 per cent to 15 per cent. When there is talk of a level playing field, it cannot be that the level playing field is always tilted against banks. When a regulatory framework is substantially lighter for one sub-sector of the financial system, the riskier operations veer around to this segment.

Nowhere in the world is there such a permissive system of non-bank financial intermediaries which undertake large deposit taking activity without operating as banks. If the Indian financial system is to mature and face up to international competition, a drastic reform of the NBFC sector would be necessary. Such NBFCs which have total liabilities above a specified threshold, say Rs 100 crore, should be required to restructure their operations within three years and transform themselves into banks.

There is one pertinent issue which is under discussion viz. the question of deposit insurance. At the outset let me stress that there should be no question of the Deposit Insurance and Credit Guarantee Corporation (DICGC) being asked to take on deposit insurance for NBFCs. Furthermore, any deposit insurance by NBFCs, themselves if undertaken on a voluntary basis would be a total failure as the good companies would not wish to participate while the reckless companies would be able to lure gullible depositors with the ruse that there is deposit insurance. I would, therefore, caution against setting up a deposit insurance scheme. If, however, such a deposit insurance scheme is still set up it should be compulsory and run by the NBFCs themselves. While issues like deposit insurance are academic as far as the CRB depositors are concerned, I have a rather unorthodox suggestion derived from the traditions of freemasonry. All NBFCs with net owned funds of Rs 25 lakh and above should contribute say one per of their

balance sheet total to a CRB depositors fund which should be used to meet the claims of depositors up to Rs 1 lakh; while the levy and the size of deposit are illustrative they should be so modulated that depositors up to Rs 1 lakh receive, say, a two-thirds compensation. These contributions could be made an eligible item of expenditure while working out the taxable profits of the NBFCs.

Finally, there is a need for a mindset change in the NBFCs. Recently a scrupulously honest senior official of a leading NBFC told me, You see, I have skills beyond the understanding of the regulators/supervisors and the auditors so I can do any thing. Besides what do they earn and what do I earn? This epitomises the regulatory/supervisory challenge.