Reserve Bank of India, after its discussion paper released in January 2021, recently proposed a revised regulatory framework for non-bank financial corporations (NBFCs), a “scale-based approach” that will be implemented in India as of October 1. , 2022. In this context, the NBFCs are classified among others into four levels according to the activity, the size and the risks coupled with the application of various regulations based on the first criteria. Regulatory standards and capital requirements have been made stringent for the upper layers in specific components which include, among others, non-performing asset classification standards, changes in credit / investment concentration, exposures sectoral and loan restrictions, large exposures framework, limited international exposure, corporate governance requirements, etc.
NBFCs play an important role in facilitating credit to specific sectors with banks and therefore the resilience of the sector is imperative to ensure the financial and economic development of India. The regulatory framework applicable to banks and NBFCs is almost different in India, similar to the practices followed internationally. While banks are subject to strict capital / prudence requirements, NBFCs are poorly regulated internationally. Globally, NBFCs have traditionally been referred to as shadow banks, which have recently taken on the new name of “non-bank financial intermediation (NBFI)” or “market-based finance”. As they are loosely regulated globally, they pose a risk to the global financial system, except in India, where NBFCs are already subject to regulatory requirements almost in line with those of banks.
Large NBFCs have the potential to amplify financial vulnerabilities due to their almost identical size to banks that are already subject to strict regulatory requirements. The interconnection of the banking system with NBFCs is another major factor as the risk in a particular institution can have a systemic impact on the entire financial system as they are closely dependent on each other. We have the example of IL & FS to prove it.
As the importance of NBFCs in credit intermediation increases, the IL&FS episode shed light on the asset-liability mismatches of NBFCs, which pose not only risks to the NBFC industry, but to the system as a whole. financial. Banks and NBFCs are subjected to a stress test analysis as presented in the financial stability report published by RBI every six months, where the interconnection coupled with the analysis of credit risk, liquidity risk and many other components is analyzed and recommended actions. The IL&FS crisis opened our eyes to the fact that the exposure of NBFC / HFC to banks has increased and that lenders face a difficult combination of growing credit risk and growing credit demand with NBFCs and creditors. Smaller MFIs facing constraints and illiquidity,
Global financial sector vulnerabilities can also have a severe impact, especially on emerging economies, spillover, as financial instability anywhere can pose a threat to financial stability anywhere. Monetary policy cannot work effectively in the scenario of financial instability, as financial instability disrupts the functioning of the market and distorts bank balance sheets, resulting in constraints on the credit available to businesses and households. This can lead to a reduction in aggregate demand which puts additional strain on the weakened financial system. The only solution is to make the financial system resilient, which is only possible through strict regulatory requirements coupled with identifying systemically important financial institutions in the economy and prescribing additional standards for these institutions. .
Transforming shadow banking into resilient market finance is therefore one of the functions assigned to the Financial Stability Board (FSB), a branch of the G20, which is regularly monitored through its reviews by the peers and its progress reports. The 2020 Global Non-Bank Financial Intermediation Tracking Report presents the trends and risks of NBFI, covering 29 jurisdictions that account for 80% of global GDP, where, it is evident that the entire global NBFI industry has exploded faster than the banking sector over the past decade. This requires building the resilience of the NBFC sector to overcome any possible crisis emanating from this sector.
The 2016 FSB peer review report, submitted on India specifically on the topic “Regulation and Supervision of NBFCs and HFCs”, recommended, inter alia, to improve the timelines for data collection and their reporting. analysis, as well as improve their assessment of risks arising from NBFCs (eg liquidity and contagion). He also recommended reviewing the commercial criteria of NBFCs to strengthen the application of its regulatory scope and suggested that the RBI consider, among other things, rationalizing the number of NBFCs and harmonizing the prudential rules of NBFCs with those of banks. . He also suggested that the RBI consider revising the use of the NBFC term “systemically important” to align its meaning with that of banks. The implementation of this revised regulatory framework for NBFCs appears to be almost in line with the peer review recommendations above.
The latest financial sector assessment program of India conducted jointly by the IMF and the World Bank in 2017 also focused, inter alia, on strengthening the regulatory framework for NBFCs, considering that India is a growing financial economy. The Indian economy has slowly started its growth trajectory evolving from the clutches of COVID 19 in 2021 and it may be the right time to announce such a strategy, which will be implemented from October 2022, leaving enough time for regulated entities to adapt to the same.
The author is an agent of the Indian Economic Service (2010). The opinions expressed are personal.