NBFCs adding to systemic risk need stricter regulation: RBI

Non-banking financial companies (NBFCs), which contribute significantly to systemic risks must be subjected to greater regulation, Reserve Bank of India (RBI) deputy governor M Rajeshwar Rao said on Friday. The prudential guidelines for such NBFCs should be comparable with those for banks so that they either scale up into a bank or scale down their network externalities, he said.

“One can also argue that the design of prudential regulatory framework for such NBFCs can be comparable with banks so that beyond a point of criticality to systemic risks, such NBFC should have incentives either to convert into a commercial bank or scale down their network externalities within the financial system. This would make the financial sector sound and resilient while allowing a majority of NBFCs to continue under the regulation-light structure,” Rao said at an industry event.

With the growth in size and interconnectedness, NBFCs have increasingly become systemically significant and the prudential regulations for them have evolved to give greater focus to the theme of financial stability. “However, let’s not forget that regulation-light structure of NBFCs has enabled the flexibility enjoyed by them,” Rao said, adding that this flexibility is the primary advantage NBFCs enjoy over banks, enabling them to serve the last mile of financial intermediation. Hence, it is imperative to strike a balance between regulating NBFCs more tightly and the need to provide them the required flexibility.

Rao also spoke of the need to re-prioritise regulatory tools in the microfinance (MFI) sector so that regulations are activity-based rather than entity-based. He said since the regulatory framework for NBFC-MFIs was framed, much has changed, with several large MFIs converting into small finance banks. As a result, the share of NBFC-MFIs in the overall microfinance sector has come down to a little over 30%. “Today we are in a situation, where the regulatory rigour is applicable only to a small part of the microfinance sector,” he said, adding that regulation should be activity-based because after all, the core of microfinance regulation lies in customer/consumer protection.