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Failure of any major NBFC can translate into risk for its lenders: RBI Dy Governor M Rajeshwar Rao

By on October 22, 2021 0

The reputation of the non-bank financial sector has been tarnished in recent times by the failure of certain entities due to idiosyncratic factors, said Deputy Governor of the Reserve Bank of India, Mr. Rajeshwar Rao.

The challenge is therefore to restore confidence in the sector by ensuring that few entities or activities do not generate vulnerabilities that go unnoticed and create shocks and generate systemic risk through their interconnections with the financial system.

“The prevention and, if necessary, the decisive resolution of such episodes becomes a key objective of our regulatory and supervisory efforts,” Rao said at the NBFC CII Summit.

There are 9651 NBFCs in twelve different categories focused on a diverse set of products, customer segments and geographies.

As of March 31, 2021, the non-bank finance companies (NBFC) sector (including housing finance companies / HFCs) had assets worth over 54 lakh crore, which is the equivalent of approximately 25 % of the size of banking sector assets.

“Therefore, there is no doubt about its importance and role within the financial system in meeting the credit needs of a large part of society,” Rao said.

Over the past five years, the NBFC’s sector assets have grown at a cumulative average growth rate of 17.91 percent.

The Deputy Governor pointed out that: “Now the non-banking sector has grown considerably and several NBFCs are the size of the largest urban cooperative bank or the largest rural regional bank.

“In fact, few of them are as important as some of the new generation private sector banks. In addition, they have become increasingly interconnected with the financial system.

He said that NBFCs are the largest net borrowers of funds from the financial system and that banks provide a substantial part of the funding to NBFCs and HFCs.

Therefore, the failure of any major NBFC or HFC can translate into risk for its lenders with the potential to create contagion.

The failure of any large and deeply interconnected NBFCs can also disrupt the operations of small and medium-sized NBFCs through a domino effect by limiting their ability to raise funds.

Rao pointed out that the liquidity stress in the industry triggered by the failure of a large CIC (core investment firm) has shattered the myth that NBFCs pose no systemic risk to the financial system.

SBR framework

The deputy governor said that a scale-based regulatory framework (SBR) commensurate with the systemic importance of NBFCs may be an optimal approach where the level of regulation and supervision will be a function of size, NBFC activity and risk.

Since regulation would be proportional to the scale of NBFCs, it would not impose undue costs on regulated entities (REs).

Rao explained that, “Although some trade-offs that could have a negative impact are minimized, the fundamental principle of allowing operational flexibility to NBFCs in the conduct of their business would not be diluted.

“… There has been a consistent and conscious understanding that a ‘one size fits all’ approach is not suitable for the NBFC industry, which is a diverse set of financial intermediaries, with different business models, serving a heterogeneous group. customers and is exposed to various risks.

The Deputy Governor urged the promoters / leaderships of the NBFC to create a culture of responsible governance in their respective organizations where every employee feels responsible to the customer, the organization and the company.

He believed that good governance is the key to the resilience, efficiency and long-term survival of entities.

Client protection

Rao stressed that protecting customers from unfair, deceptive or fraudulent practices must become the top priority of every entity and permeate the organization culturally and be part of its philosophy.

“Customer service would mean, among other things, that a customer has a similar pre and post-sales experience, they are not at a disadvantage compared to another customer because they approached the financial entity through a different delivery channel,” and he or she has the right to withdraw from the contractual obligation without any hassle.

“This issue has been debated quite often and it is time to act now,” said the Deputy Governor.