The Hindu : Business : The non-banking sector from a regulatory prism

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Monday, Dec 20, 2004

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The non-banking sector from a regulatory prism

There is confusion in classifying non-banking finance companies. As it happens, the residuary non-banking companies that are very different from other NBFCs have been the fastest in growth but the least regulated, says C. R. L. Narasimhan.

THE RESERVE Bank of India in its recent Report on Trend and Progress of Banking in India, 2003-04, devotes an entire chapter (Chapter VI) to non-banking financial companies (NBFCs). There is nothing unusual about it: Since 1997 at least, the NBFCs, as a class, have come to be recognised by policy makers and not just in the constructive role they play in the financial sector. More likely, it is because of the challenges that the regulators face in extending their sway over them that the NBFCs have come to occupy a prominent place in all important policy statements.

It is difficult to recall any reasonably long dissertation on NBFCs in any of the bi-annual monetary and credit policy statements prior to 1998. Even as a majority of NBFCs came under regulation, policy makers have come to appreciate better the important, distinctive functions they undertake. It is no coincidence that in recent years NBFCs have considerably added to their product range and adopted the latest technology.

Yet, the picture is not all hunky dory. The chief merit in extending regulation and supervision over previously unregulated entities is that it makes possible a degree of standardisation among the regulated. Hence, among other advantages, the impact of a new regulation on NBFCs can be more meaningfully analysed. The discussion can be over comparable institutions.

Classification problem

However, there is a lacuna even at the outset in the form of a classification problem. Even now — eight years after regulation was extended to NBFCs — the RBI has identified as many as 12 categories of NBFCs. Five of them are regulated by the RBI; one — chit funds — jointly by the RBI and the Registrar of Chits and two — mutual benefit funds including nidhis and micro finance companies — by the Department of Company Affairs, Government of India. The National Housing Bank (NHB) regulates housing finance companies. The RBI has also included insurance companies, stock broking companies and merchant banking companies among NBFCs. The last two are regulated by the Securities and Exchange Board of India while insurance companies come under the Insurance Regulatory and Development Authority. Other than the fact that all these come under the category of "non-banks,'' there are not many common features. Certainly public perception of an NBFC does not include insurance companies or merchant banks. The only reason in classifying all these as NBFCs may have to do with the ongoing debate over the need for a financial super regulator. Evidently it becomes easier to conceptualise when the categories to be regulated are small in number. Thus banks and NBFCs may form two neat divisions but from a practical point of view it will be meaningless to treat either category as a homogeneous group, especially the large number of entities that undertake diverse functions and are bunched together under NBFCs. Equally important is to recognise the fact that there is already considerable regulatory overlap and consequent confusion as in the case of merchant banks.

Multiple regulation

There is also a possibility of systemic risk arising from the operations of one entity which, because of its diverse profile, comes under multiple regulators. Bankassurance, a form of selling insurance products through banks and NBFCs, is one function that comes under the RBI as well as the IRDA. More common are capital market investments by banks and NBFCs. Apart from the RBI, the SEBI too comes into the picture. The RBI report says that a comprehensive framework for reporting has been put in place for such large NBFCs having presence in more than one segment.

The RBI's report has recorded the fact that the onset of regulation (since 1997) has brought about a reduction in the number of NBFCs as a certificate of registration from the RBI has been made mandatory. Statutory norms for net owned funds were prescribed and had to be complied within a definite time period. At the end of June 2004 the RBI received 38,050 applications from NBFCs for certificate of registration. Of these only 13,671 were approved, including 584 from companies authorised to receive public deposits.

The RBI says that the NBFCs are in a consolidation phase. However, it is not clear as to what roles the remaining NBFCs will take on in the years to come. Consolidation essentially means scaling up in size and given that the regulation for NBFCs is still evolving, one wonders how even the best run NBFC will survive leave alone thrive in an environment where there will be a blurring of distinctions between banks and other financial service providers. In fact a foreign bank such as the Citigroup has a large presence in the NBFC segment.

Already, the traditional NBFCs, hire purchase finance companies and equipment leasing companies face intense competition from banks. As a rule banks, because of their access to retail deposits, have a lower cost of funds. As against this, some NBFCs have developed unmatched expertise in hire purchase financing of trucks and, to a lesser extent, cars. One is not sure whether a bank, especially in the public sector, can have access to market information and develop the skills and attitude to make a niche business such as truck financing a success. In fact previous forays by banks in such areas have been disastrous.

Two other developments having an impact on the liabilities side of an NBFC are worth noting. The RBI has liberalised bank finance to NBFCs. In practice this means that even NBFCs that finance second hand assets can seek refinance from banks. More significantly, the RBI has initiated a debate on the phasing out of public deposits mobilised by NBFCs. Pointing out that their dependence on public deposits has been declining in proportionate terms over the years, the central bank would like them to voluntarily phase out public deposits and instead raise all their resources from institutional sources, including commercial banks.

The central bank cites recent statistics to support its view. Both the number of deposit taking NBFCs and the share of deposits in their overall liabilities have been coming down. There were 996 deposit taking NBFCs in 1997. By September 2007 the number had come down to 577. In 2000-01, public deposits with NBFCs were of the order of Rs. 6,500 crores (11.2 per cent of the liabilities). By 2003-04 these had come down to Rs. 3,400 crores (12.7 per cent of total liabilities).

However, the case for phasing out public deposits even voluntarily is hardly convincing especially from an investor's perspective. Some NBFCs, which accept deposits, have an excellent track record including in customer service. Many categories of investors prefer them to banks even though they do not get tax concessions (such as 80L) or a significantly higher interest. Most certainly depositors will be deprived of a choice if and when NBFCs withdraw their deposit schemes, voluntarily or through some misguided regulation.

Which brings into focus the possible reason behind the moves to discourage NBFCs from accepting public deposits. Two points are of great relevance here. One has to go back to the classification issues mentioned earlier. The term NBFCs covers residuary non-banking companies (RNBCs) too, mainly five companies of which two are high profile ones — Sahara and Peerless.

The RBI's statistics have their own story to tell. Out of the Rs. 20,100 crores public deposits with all NBFCs as on March 31, 2003, as much as Rs. 15,065 crores (75 per cent) were with RNBCs. Further, the RNBCs were mobilising such large deposits while having a very low level of net owned funds — just Rs. 809 crores.

The contrast becomes striking when one considers that the remaining NBFCs put together had only Rs. 5,035 crores of public deposits but had considerably higher net owned funds (Rs. 4,141 crores as on March 31, 2003).

There is no doubt that in the immediate future the biggest regulatory challenge will come from the realm of RNBCs. Their first steps in that direction have been resisted. RNBCs merit a detailed story on their own.

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