NBFCs Report: Convergence with banking and Tighter Norms – S.S.Tarapore

The Non- Banking Finance Companies ( NBFCs) sector has been one of the most difficult areas of regulation and supervision for the past fifty years. While heroic efforts have been made to bring about a semblance of order, the problems continue to remain intractable.

The Report of the Working Group on Issues and Concerns in the NBFCs Sector ( Chairman Ms. Usha Thorat) was released on August 29,2011 and the Reserve Bank of India (RBI) has called for comments by the end of September 2011.

The Report provides an excellent blueprint for chalking out the future course of the evolution of the NBFCs sector. It would be useful to recapitulate the history of the NBFCs. In the late 1950s there was a proliferation of commercial banks, many of which were not viable. Hence the RBI was empowered, through legislative amendments, to undertake a process of moratorium and amalgamation to weed out the unviable banks and accordingly there was a drastic reduction in the number of commercial banks. While this process was on, there was a mushrooming of a very large number of NBFCs which were beyond the pale of financial regulation. In 1964, the RBI Act was amended to give the RBI some limited powers to regulate the NBFCs and the legislative framework was amended from time to time to put in place a comprehensive regulatory and supervisory framework to protect the interests of the depositors, and to ensure sound functioning of the NBFCs. The NBFC sector has been litigation prone and for years the RBI has had to devote its attention to litigation which at times was fractious. In the late 1980s there were judicial pronouncements which changed the course of history of this sector. There was one segment of the NBFCs which was well run and subject to effective regulation and supervision and another which just could not meet the regulatory framework. The Court directive to the RBI was that for companies which could not meet the regulatory framework, an alternative regulatory framework should be developed. Accordingly, in the late 1980s, a new category of ` Residuary Non- Banking Finance Companies ( RNBCs)’ was introduced. These companies had a soft regulatory regime under which the companies were not subject to any regulation on the liabilities side but the asset side was tightly controlled by investments only in prescribed ` safe’ instruments. The upshot of this was that the well run NBFCs shrunk in number as well as volume of deposits while the deposits of RNBCs , which were loosely regulated, zoomed. A determined effort was made by the RBI, in 2004, to phase out the deposit taking activity of the RNBCs and they were required to develop a new business model which would not depend on resources by way of deposits. The number of NBFCs ( including RNBCs) came down from 1,429 in March 1998 to 311 in March 2010. During the same period, the deposits of all NBFCs ( including RNBCs) declined from Rs 23,770 crore, equivalent to 52.3 per cent of the total assets, to Rs 17,273 crore, equivalent to only 15.7 per cent of total assets. The Usha Thorat Report provides a viable roadmap for the future development of the NBFCs sector and the authorities would be well advised to implement most of the recommendations in the Report.

Some select recommendations are discussed below.

The Report rightly points out that the present RBI Act stipulates a a cap on the minimum entry point capital of Rs 2 crore which is totally inadequate in the current context. Prescribing a specific figure in the Act on the entry norm is not feasible as inflation and the size of overall activity soon makes a specific figure to be totally inadequate. The Usha Thorat Working Group recommends that this should be amended to prescribe a floor and the RBI should have the discretion to prescribe whatever level it deems appropriate.

While this is the ideal situation the RBI is unlikely to be given unfettered powers to prescribe a higher NOF. If there are legal constraints, the RBI can be empowered to determine the prescription of the NOF within a stipulated range; this would require that the range would need to be very wide. In any case, the legislative amendments proposed by the Working Group would need to be examined by the Financial Sector Legislative Reforms Commission ( FSLRC).

The Working Group recommends a process of ` deregistering’ with the RBI for NBFCs below a certain size. This would be fraught with problems as the process of deregistering would put a large number of NBFCs outside the pale of regulation which would be detrimental to the overall stability of the financial system. It would be best to undertake a system of ` moratorium’ and amalgamation or gradually close down NBFCs which cannot meet the stipulated NOF size. The existing limit for acceptance of deposits by Asset Finance Companies ( AFCs) is 4 times the NOF. The Working Group recommends that this limit should be reduced to 2.5 times the NOF. The AFCs are, in many ways, very different from the loan and investment companies as their lending is backed by real assets. Thus, rated AFCs should, as at present, continue to be allowed to accept public deposits up to 4 times the NOF. The Working Group provides signal service by focusing attention on regulatory arbitrage and the need for convergence in regulation. The Working Group recognizes that the NBFCs have a niche area where banks do not operate and hence it has refrained from recommending exact bank- like policies for NBFCs The Working Group, however, recommends that regulatory arbitrage between banks and NBFCs is best addressed through calibrated use of prudential measures. The Working Group rightly suggests that whenever RBI takes macro-prudential measures for banks, such measures should also be applicable to the NBFCs. There is also the wider issue whether, over time, deposit taking by NBFCs should be totally phased out. Deposit taking should be the exclusive prerogative of banks. The Working Group does well to stress that government owned NBFCs should be required to follow the regulatory framework applicable to other NBFCs and that supervision should be ownership neutral.

The Usha Thorat Working Group has provided a veritable lexicon on the NBFCs sector and the RBI and government should give pride of place to the Report when formulating policies and operations relating to the NBFC sector.

FPJ

Private banks, then and now : K Kanagasabapathy

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‘Taming inflation is India's bigger problem, not boosting growth' - Kalpana Kochhar, Chief Economist-South Asia, World Bank

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Light at the End of the Tunnel.....

LIGHT AT THE END OF THE TUNNEL ·       Friday's anticipated hike may be the last in the current rate hike cycle, on the hope that prices of fuel and metals would come down due to slowdown in developed economies ·       However, floating rate borrowers would have to wait for at least nine months before borrowing costs start coming down ·       WPI inflation for August turned out to be 9.78%, much above expectations of 9.6% ·       Inflation remains the main concern for RBI, which has hiked policy rates 11 times since March 2010 ·       There are some signs of demand moderating in the recent months along with growth moderation ·       Economists predict that the economy would moderate to below 8% in this fiscal

Business Today

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Fiscal deficit

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K. V. Rao, Bangalore (BS)

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BS

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HBL

RBI relaxes NRI bank account guidelines

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TOI

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TOI

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