Growth at any cost approach of some NBFCs poses risks: RBI Governor

Governor Das warns of action for failure to do so; directs them to review compensation practices linked to targets

Reserve Bank of India (RBI) Governor Shaktikanta Das on Wednesday flagged the “growth at any cost” approach of some non-banking financial companies (NBFCs) and warned them that the central bank would not hesitate to take action if there is no self correction.

Additionally, the RBI directed NBFCs to review their prevailing compensation practices, variable pay and incentive structures, some of which are purely target driven in certain NBFCs.

“…some NBFCs are aggressively pursuing growth without building up sustainable business practices and risk management frameworks, commensurate with the scale and complexity of their portfolio,” Das said. He added that an imprudent ‘growth at any cost’ approach would be counterproductive for their health.

 

Das highlighted that some NBFCs, including microfinance institutions (MFIs) and housing finance companies (HFCs), driven by investor pressure and significant accretion to capital, are chasing excessive returns on their equity (RoE).

While setting growth targets is in NBFC boards’ domain, concerns arise when they charge usurious interest rates, along with unreasonably high processing fees and frivolous penalties, he added.

Additionally, he said that the “push effect” of these targets may drive retail credit growth rather than actual demand, potentially leading to high indebtedness and posing financial stability risks if not addressed by NBFCs.

“It is important that NBFCs follow sustainable business goals, a ‘compliance first’ culture, a strong risk management framework, a strict adherence to fair practices code and a sincere approach to customer grievances,” Das said.

According to Avinash Singh, senior research analyst, Emkay Research, RBI’s commentary on NBFCs aligns with the governor's ongoing emphasis on the sector over the past year.

This follows the increase in risk weights for unsecured lending and bank funding to NBFCs.

RBI is urging NBFCs to strengthen their risk management frameworks and remain vigilant, he said.

He added that the governor is emphasising that NBFCs should prioritise a customer-centric approach rather than chase excessive RoE, driven by private equity (PE) or public market investors. “Overall, some tapering of growth is expected when regulators intervene.”

Not just PE-driven unlisted NBFCs, or HFCs, or MFIs, even listed entities are under pressure to grow at a certain pace that justifies high valuation in public markets. And, any calibration or dip in performance will result in shares and valuation plummeting, said an industry expert.

In FY24, the assets under management (AUM) of NBFCs grew by 18 per cent year-on-year (Y-o-Y) and stood at Rs 47 trillion, according to rating agency ICRA.

However, the growth this year will be slower owing to the slowdown in bank funding to NBFCs. This is following RBI increasing risk weights in November last year.

According to Karthik Srinivasan, group head – financial sector ratings, ICRA, despite raising risk weights for bank funding to NBFCs in November last year, the RBI probably feels that growth rates of NBFCs have not sufficiently tapered.

In FY24, the NBFC sector experienced significant expansion, with retail-focused NBFCs growing over 25 per cent Y-o-Y.

“RBI worries that excessive lending growth could lead to asset quality issues in the future. While current asset quality numbers appear benign, there are indications of rising stress. Additionally, the RBI is concerned about banks' direct and indirect exposure to NBFCs, as past failures of individual NBFCs have shown the potential for widespread sector isolation,” he said.

RBI data shows the gross non-performing asset (NPA) and net NPA ratios of the NBFC sector as of June 2024 were 2.6 per cent and 1.1 per cent, respectively. This compares with 3.2 per cent and 1.2 per cent in the same quarter of the previous year.

The RBI has raised concerns to prevent small borrowers from becoming overleveraged. The sector is currently growing at 18 per cent Y-o-Y, which is healthy. These issues are unlikely to hinder the sector's growth, as economic growth typically supports growth in this area as well, said an NBFC chief.

“… we are committed to safeguarding customer interests. The RBI’s emphasis on customer protection and compliance aligns well with our commitment to responsible credit lending practices. Muthoot Finance remains dedicated to maintaining a robust risk management framework and enhancing operational resilience to navigate complexities,” said George Alexander Muthoot, managing director (MD), Muthoot Finance.

Meanwhile, in the post-policy press conference, Swaminathan J, deputy governor, RBI, said that the particular messaging by RBI is for a set of players who are pursuing high risk, high growth strategy and to certain segments, which are likely to get into stress.

Overall, however, RBI has stressed that the health of the banking and NBFC sector continues to be strong.

Das also highlighted build-up of stress in a few unsecured loan segments like loans for consumption purposes, microfinance loans and credit card outstanding.

“The Reserve Bank is closely monitoring the incoming information and will take measures, as may be considered necessary,” he said. He added that banks and NBFCs, on their part, need to carefully assess their individual exposures in these areas, both in terms of size and quality.

“Their underwriting standards and post-sanction monitoring have to be robust. Continued attention also needs to be given to potential risks from inoperative deposit accounts, cybersecurity landscape and mule accounts, etc,” he added.