– By Nand Gopal Anand, Vrindesh Patel and Aanand Kishore
The banking landscape in India is fast progressing with the emergence of innovative financial products, which require a robust credit pipeline. With the increasing demand for credit, non-banking financial institutions (NBFCs) have stepped in to play their part in the development. While NBFCs have been playing a key role, however, certain untoward instances have time and again surfaced in the market which has made the Reserve Bank of India (RBI) wary and vigilant of the practices being followed. Such practices are usually an offshoot of the “push effect”, where ever-increasing business targets push NBFCs towards aggressive credit expansion. The situation is fuelled by growing competition in the market and grand expectations of the stakeholders, compelling NBFCs to extend credit on riskier terms. Higher disbursements at an elevated risk have also legitimised sanctioning of loans which are nearly usurious in nature, escalating the general borrowing costs of customers. Such loans aid in compensating for the non-performing accounts and swelled-up outstanding receivables.
The RBI has maintained its outlook that NBFCs are a vital catalyst for development of the Indian economy. However, it can be observed that various NBFCs have mushroomed in the market which aim to benefit from the growing demand in the retail sector where the consumers are gullible, allowing the said NBFCs to gain maximum benefits. On October 17, 2024, the RBI took decisive action against four NBFCs instructing them to temporarily cease extending loans in view of various supervisory concerns. The focal concerns identified by the RBI were excessive Weighted Average Lending Rates and Interest Spreads. These actions also follow the statements of Mr. Shaktikanta Das, Governor, RBI, delivered on October 9, 2024, where he expressed concerns about the aggressive growth strategies of certain NBFCs. The Governor underscored that while growth is essential, an unrestrained “growth at any cost” mindset can potentially undermine overall financial health and stability of NBFCs.
To curb the market deviations, the RBI has actively engaged with NBFCs through notifications and advisories, reinforcing the “fair practices code” to promote a responsible market, particularly for small-value loans.
The key regulatory measures include:
- Notification on ‘regulatory measures towards consumer credit and bank credit to NBFCs’ dated November 16, 2023, which implemented a hike in risk weights attributed to exposure of banks to NBFCs (excluding core investment companies and priority sector lending) by 25% where the extant risk weight as per external credit assessment institutions was below 100%. This has added to the challenges faced by NBFCs to secure input financing from banks.
- Notification on ‘fair practices code for lenders – charging of interest’ dated April 29, 2024, wherein RBI remarked that onsite examination of regulated entities (REs) (including NBFCs) uncovered instances of unfair practices in charging of interest. Accordingly, RBI directed REs to review such practices and take corrective action.
RBI representatives have also expressed concerns at various media interactions cautioning NBFCs against oversimplified underwriting, and risks associated with excessive reliance on bank borrowings and unsustainable microfinance interest rates. Additionally, NBFCs have been asked to avoid over-reliance on algorithm-based credit models, highlighting the need for regular validation to ensure their accuracy and relevance. The RBI Governor at one of its speeches expressed concern over certain NBFCs extending usurious loans, i.e., charging high interest rates on small loans, urging these entities to exercise their discretion responsibly.
Navigating Responsible Growth
A considerable portion of India’s population is unaccustomed to the formal credit system and opts for unsecured personal loans due to their ease of access and minimal compliances. This gap in financial literacy highlights the importance for NBFCs to endeavour meeting compliance standards as sacrosanct, non-negotiable, and free from interpretation for convenience. The RBI on March 14, 2022, lifted pricing caps for microfinance loans authorising REs to determine interest rates and repayment terms according to their board approved policies. Nonetheless, it has repeatedly underscored that such rates must not be “usurious” and would remain under its scrutiny.
For building the foundation of sustainable and healthy growth, the following business practices may be considered for adoption by NBFCs, precluding RBI from undertaking further regulatory measures:
- Deployment of regulatory freedom: To ensure that the board of directors of NBFCs functions as envisioned by the RBI, it should be ensured that the board comprise diverse and independent members such as market leaders, industry experts and former regulators who possess an in-depth understanding of ground realities and are committed towards financial health of customers while ensuring long term viability.
- Risk management frameworks: In line with their operational complexity, NBFCs should enhance risk management by establishing robust underwriting standards that duly assess borrower financial health, repayment capacity, and credit history. Regular post-sanction monitoring may also be implemented to flag early signs of risk based on borrower conditions, economic factors, and predictive analytics.
- Transparency of Key Facts Statement: NBFCs must provide precise and standardized information regarding loan terms and associated costs. This transparency is crucial in eliminating hidden costs and ensuring that customers fully comprehend their commitments. Such practice can build trust with clients and promote informed borrowing decisions.
- Compliance-first culture: A paradigm transition towards “compliance-first” culture is vital, emphasizing adherence to fair lending and effective grievance redressal. NBFCs may reassess their incentive structures to avoid fostering reckless lending driven solely by performance metrics. Establishing effective channels for customer feedback can help identify areas for improvement. A balanced approach will elevate customer service as well as employee morale, creating an ethical workplace environment.
In aspirational economies like India, regulatory bans seldom serve the long-term interests of customers or the broader market. NBFCs, well-positioned to drive financial inclusion, can achieve sustainable growth by embracing self-regulation that aligns innovation with operational integrity promoting a balanced and resilient market ecosystem.
(Nand Gopal Anand is Partner, Vrindesh Patel is Senior Associate and Aanand Kishore is Associate at JSA Advocates & Solicitors.)
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