Tough RBI Actions Spook NBFCs Over Bank Lending

The Reserve Bank of India (RBI) has taken a series of tough actions against non-banking financial companies (NBFCs) in recent months, raising concerns about their liquidity and growth prospects. The RBI has imposed restrictions on some NBFCs’ business activities, such as gold loans and securities financing, citing material supervisory concerns and deficiencies in their loan processes. These actions have also made banks wary of lending to NBFCs, which rely on bank borrowings for their funding needs.

RBI curbs on gold loans and securities financing

In March 2024, the RBI directed IIFL Finance Ltd. to stop sanctioning or disbursing gold loans or assigning/securitising/selling any of its gold loans with immediate effect. The RBI also restricted JM Financial Products Ltd. from undertaking financing of bonds and stocks, after observing major deficiencies in the company’s loan process. These restrictions came after the RBI barred Paytm Payments Bank from accepting fresh deposits and credit transactions in January 2024, limiting its banking operations.

Gold loans and securities financing are high-margin but potentially risky business lines for NBFCs, as they involve lending against volatile assets that may lose value in case of market fluctuations. The RBI’s actions are aimed at curbing unethical practices and systemic risks in the financial sector, although they may temporarily impact credit expansion.

Impact on NBFCs’ liquidity and growth

The RBI’s actions have put NBFCs on guard, as they fear more regulatory scrutiny and intervention in their business activities. NBFCs are expected to moderate their loan disbursals and focus on improving their internal control systems and governance standards. They may also face challenges in raising funds from the market, as investors may become more cautious of their risk profiles.

NBFCs have been growing faster than banks in recent years, driven by their niche segments, product innovation, and customer reach. They have also benefited from the liquidity support provided by the RBI and the government during the COVID-19 pandemic. However, the RBI’s actions may slow down their growth momentum and affect their profitability.

Banks turn cautious of lending to NBFCs

The RBI’s actions have also made banks more conservative in lending to NBFCs, which account for a significant share of their exposure. According to the RBI data, bank lending to NBFCs increased by 35% year-on-year to Rs 9.9 lakh crore as of December 2023. This growth was partly driven by the RBI’s liquidity measures, such as targeted long-term repo operations (TLTRO) and partial credit guarantee scheme (PCGS), which encouraged banks to lend to NBFCs.

However, banks may now reassess their risk appetite and lending criteria for NBFCs, especially those engaged in unsecured retail loans, gold loans, and securities financing. Banks may also demand higher collateral or interest rates from NBFCs, or reduce their exposure to them. This may affect the availability and cost of funds for NBFCs, which may hamper their ability to lend to their end-customers.

RBI’s rationale behind the actions

The RBI’s actions are part of its broader efforts to maintain financial stability and foster responsible lending practices in the system. The RBI has been tightening its regulatory oversight and supervision of NBFCs since the collapse of IL&FS in 2018, which triggered a liquidity crisis in the sector. The RBI has also introduced a new framework for NBFC classification and regulation in August 2023, based on their size, complexity, interconnectedness, and systemic importance.

The RBI has also expressed its concern over the rapid growth in unsecured loans, which accounted for 32% of total bank credit as of September 2023. Unsecured loans are typically given without any collateral or guarantee, and are based on the borrower’s income and credit score. They include personal loans, credit card loans, consumer durable loans, education loans, etc. The RBI has increased the risk-weights on unsecured credit and bank loans to NBFCs from November 2023 onwards, to reflect the higher credit risk involved.

The RBI’s actions are intended to ensure that NBFCs follow prudent lending norms and do not expose themselves or the system to undue risks. The RBI has also urged NBFCs to diversify their funding sources and reduce their reliance on bank borrowings. The RBI has also advised NBFCs to strengthen their capital adequacy, liquidity, and asset quality, and comply with the regulatory norms and reporting requirements.

The RBI’s actions may have some short-term implications for NBFCs’ liquidity and growth, but they are expected to improve their long-term resilience and sustainability. They may also encourage NBFCs to adopt better governance and risk management practices, and enhance their transparency and accountability. The RBI’s actions may also benefit the banking sector, as they may reduce the credit risk and contagion risk from NBFCs.

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