NBFCs with substantial systemic risks must be subjected to higher degree of regulation: RBI DG Rajeshwar Rao

Asserting the need to recalibrate regulations for the shadow banking sector, Reserve Bank Deputy Governor M Rajeshwar Rao on Friday said NBFCs with significant externalities and which contribute substantially to systemic risks must be identified and subjected to a higher degree of regulation.

"One can also argue that the design of a prudential regulatory framework for such NBFCs can be comparable with banks so that beyond a point of criticality to systemic risks, such NBFCs should have incentives either to convert into a commercial bank or scale down their network externalities within the financial system," he said.

This would make the financial sector sound and resilient while allowing a majority of non-banking financial companies (NBFCs) to continue under the regulation-light structure, Rao said while addressing a virtual conference organised by Assocham.

Within the proportionality paradigm, he said, one must deal with entities which neither belong to the critical ones in terms of systemic risk nor are they too small in scale and complexity.

Observing that NBFCs currently enjoy a great degree of regulatory arbitrage vis-a-vis banks, he said, these entities can contribute to the build-up of systemic risks because of the regulatory arbitrage enjoyed by them and hence there is a need to recalibrate the regulations.

"We could perhaps consider a graded regulatory framework for NBFCs, calibrated in relation to their contribution to systemic significance," he said.

Talking about microfinance sector, Rao said, the share of NBFCs-MFIs (microfinance institutions) in the overall microfinance sector has come down to a little over 30 per cent as several large MFIs have converted into Small Finance Banks.

"Today we are in a situation where the regulatory rigour is applicable only to a small part of the microfinance sector. There is a need to re-prioritise the regulatory tools in the microfinance sector so that our regulations are activity-based rather than entity-based," he said.

Noting that fintech focused NBFCs keep throwing up new challenges, Rao emphasised that while making regulations for the future for the fintech sector, orderly growth, customer protection and data security will remain the guiding principles for the RBI.

On consumer protection and fair conduction, the Deputy Governor said a transparent and self-disciplining mechanism has to be imagined for the future where the changing business models and newer credit delivery mechanisms do not deviate from the objective of fair treatment of the customer.

Observing that the Global Financial Crisis was primarily attributed to feather-touch regulatory approach, ignoring of liquidity risks by financial intermediaries and unabated financial innovation, he said, abundant liquidity, light-touch regulations and financial innovation have also aided the growth of the NBFCs.

Between March 31, 2009, to March 31, 2019, the total assets of NBFCs grew at a compounded annual growth rate (CAGR) of 18.6 per cent, while the balance sheets of scheduled commercial banks (SCBs) grew at a CAGR of 10.7 per cent, he said.

Consequently, the aggregate balance sheet size of NBFCs increased from 9.3 per cent to 18.6 per cent of the aggregate balance sheet size of SCBs during the corresponding period. In absolute terms, the asset size of the NBFC sector (including HFCs) as on March 31, 2020, stood at Rs 51.47 lakh crore.

At the end of March 2020, NBFCs were the largest net borrowers of funds from the financial system, of which more than half of the funds were from SCBs, followed by asset management companies, mutual funds and insurance companies, he said.