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Challenge of common regulations for non-banking finance companies

In the reform era, the focus is on countering undesirable practices, whether of a bank or of any other entity

THE IMPORTANT issue of ensuring a regulatory level playing field between banks and non-banking finance companies has been addressed by a specially constituted RBI committee. Its draft report — put up on the RBI's website for comments — proceeds from the present fairly well known dichotomy between banks and NBFCs in areas of regulation even when there is a substantial overlap in their functions. As a group, banks are well regulated whereas NBFCs started getting the requisite regulatory attention only recently.

Banks and NBFCs compete in providing certain financial services while NBFCs specialise in certain products and services that receive little or much reduced emphasis from the mainline banking system.

These include hire purchase and leasing, IPO funding, small ticket loans and venture capital. Unlike banks they do not provide working capital by way of cash credits and cannot mobilise demand deposits such as savings bank and current accounts.

In the committee's view, regulatory lacuna arises in one of the following ways: NBFCs are a highly heterogeneous group. Bringing them under a common regulatory system is a stupendous task.

They exist under private, public and foreign ownership. Some of them are associates of banks; a few are subsidiaries of foreign entities and a few others are owned by foreign banks that have branches in India.

Subsidiaries of foreign banks have been allowed to undertake certain transactions from which their parent banks are barred or given limited leeway by the domestic regulators.

Non-deposit taking NBFCs (NBFCs-ND) are not supervised in any substantial manner. Hence, compared to banks that undertake similar functions they may enjoy a "regulatory arbitrage.''

While deposit taking by NBFCs has been brought under RBI supervision, there are no regulations other than those pertaining to raising of resources in the short-term through CPs and long-term funds by way of debentures and bank borrowings. Bank borrowings are determined by exposure limits set by lenders and as there is no stipulation on the end use of funds the leverage available to NBFCs-ND to gear their balance sheet is practically unlimited. That in turn raises major systemic issues.

Unequal playing field

There is an unequal playing field not only between banks and NBFCs but also between NBFCs. As of January 2006, there were 12,615 NBFCs-ND and 436 deposit taking NBFCs and residuary NBFCs (Sahara, Peerless not included). Of the deposit taking companies, 16 with asset size above Rs. 500 crore account for 48.6 per cent of the aggregate deposits of Rs. 3,777 crore.

In the non-deposit taking segment too, there is a similar skewed pattern: 104 NBFCs have assets of at least 100 crore. Citi group having five group companies heads the list in terms of aggregate asset followed by GE Capital and associates. Just 10 companies hold 43.3 per cent of the total assets of this segment. Of these, five are foreign owned and together account for the bulk of bank borrowings, CPs and debentures issued.

A major regulatory concern arises here as some NBFCs are known to mobilise substantial bank borrowings for investing in the share market. In fact it is this fear — that NBFCs are fuelling what may turn out to be another bubble — that seems to have weighed the most with the expert group while listing the deleterious consequences of uneven regulation between banks and NBFCs on the one hand and between NBFCs themselves on the other. Practically all its specific recommendations therefore aim to give the regulator the authority to supervise NBFCs more closely in their dealings with the capital market. Other, more general, recommendations seek to limit their ability to leverage their balance sheets with ease.

Greater cost efficiency

Even if most of the committee's recommendations are accepted it is highly unlikely that the fundamental character of an NBFC can be changed abruptly. These entities came into being to fill a void in mainline commercial banking.

They have greater cost efficiency than banks. The world over, NBFCs (or merchant banks/other non-banks) enjoy greater leeway on both the assets and liabilities sides of their balance sheets than the tightly regulated banks. That gives them greater flexibility in product selection and in pricing their services.

That is why it has been possible for NBFCs in India to pay more on public deposits than banks. Their contribution to developing products such as hire purchase and leasing has been well recognised. And although deposit taking NBFCs were the first to invite regulatory intervention (way back in 1998), some among those that survived the rigours of the first-time regulation continue to be the first choice for many depositors.

So the question needs to be asked: is it possible to create a level playing field between banks and NBFCs and among NBFCs themselves? Even if it is possible to move towards regulatory convergence, will it not be better to clearly spell out the goals that such uniformity in regulation will achieve? Protecting the integrity of the system and public money (wherever applicable) are of course very basic goals.

In today's context there is an understandable anxiety over NBFCs investing heavily in stock markets by leveraging their balance sheets. Indeed the committee has debated a number of action points to check this menace. But banks, already put on leash in respect of stock market investments, cannot be straitjacketed further unless of course they are seen lending to NBFCs that play the stock markets in a big way.

Foreign ownership issue

The issue of foreign ownership of the top NBFCs has naturally weighed with the committee, especially when the world's largest financial services group Citicorp and the engineering and financial services giant GE have a significant presence in the NBFC segment. It is better to view foreign ownership of financial institutions in its entirety: banks, NBFCs and even BPOs providing IT services, all under the same set of shareholders, exist side by side. The choice of a particular form of organisation — a bank versus an NBFC, for instance — is best left to the entities seeking entry.

But it is inconceivable that the tight regulatory norms including entry level ones, applicable to banks, can ever be extended to NBFCs. Nor is it likely that standards for banks will be relaxed for the sake of ushering in a level playing field. It may seem elementary but there have always been identifiable strengths and weaknesses for a bank as there are for an NBFC.

In an increasingly liberal environment it will be appropriate that markets rather than regulators decide what is best for customers.

C. R. L. NARASIMHAN

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