The Reserve Bank of India (RBI) has warned non-banking financial companies (NBFC) to exercise caution regarding over-reliance on algorithm-based credit models and avoid excessive lending in specific segments.
Deputy governor Swaminathan Janakiraman highlighted potential inaccuracies in rule-based credit-assessment models, in a speech published on the central bank’s website on Thursday.
He was addressing the heads of assurance functions, such as chief compliance and risk officers, and heads of internal audit of select non-bank lenders. The conference was attended by around 280 representatives of more than 100 non-bank lenders.
“…NBFCs must maintain a clear-eyed perspective on their capabilities and limitations, supplemented by continuous monitoring and validation of credit scoring models,” Swaminathan said. It is essential, he said, that the NBFCs validate these models on a periodic basis to ensure the models stay relevant at all times.
Swaminathan advised against setting high-risk limits for segments like unsecured loans. He urged risk managers to make a professional assessment of risks that may be building up in their books.
“There appears to be a fancy among most NBFCs to do more of the same thing, such as retail unsecured lending, top up loans or capital market funding,” he said, adding that over-reliance on such products may bring “grief” at some point in time later.
Additionally, he urged NBFCs to take prudent liquidity management practices. Diversification of funding sources, maintaining adequate liquidity buffers, monitoring maturity profiles and putting contingency lines in place are essential to mitigate liquidity risks and ensure uninterrupted operations, the deputy governor said.
“Reliance on a limited number of funding sources can amplify liquidity vulnerabilities, especially during periods of market stress or disruptions in funding channels.” Maturity mismatches between assets and liabilities can exacerbate liquidity risk, and make NBFCs susceptible to funding squeezes or rollover difficulties, he said. Stress testing and scenario analysis can help NBFCs assess their resilience to adverse liquidity shocks and proactively manage liquidity risks.
Separately, he re-emphasised that the central bank will not hesitate to initiate appropriate supervisory action in instances when there is a circumvention of regulations.
“When individuals or regulated entities start interpreting regulations to their advantage or for their gain, it undermines the effectiveness of regulatory frameworks and compromises the stability and fairness of the market,” he said. Such practices erode trust and confidence in the financial sector, potentially exposing consumers, investors and the broader economy to risks and vulnerabilities.
