The Reserve Bank of India’s (RBI) recent discussion paper proposing tighter regulations for non-bank finance companies (NBFCs), if implemented, would result in the companies becoming more resilient to credit shocks.
However, the proposals do not address NBFCs’ funding and liquidity, the key credit weakness of the sector, Moody’s Investors Service said in a report.
It said the proposal would commit the largest 25-30 NBFCs to regulations similar to banks in terms of capital, credit concentration and governance.
“The proposed new regulations would result in largely harmonised rules between banks and NBFCs on capital and leverage, which would reduce the regulatory arbitrage opportunities for NBFCs against the banks in their lending decisions,” Moody’s said.
“However, no changes are proposed to the NBFCs’ current lighter liquidity rules,” it added.
Stating that banks are subject to strict regulations on maintaining a minimum cash reserve ratio and statutory liquidity reserve, the Moody’s Investors Service report said that these conditions had not been imposed on NBFCs.
“This means the proposal does not address the key weakness of the NBFCs; the sector will continue to pose risks to banks’ asset quality because banks are the largest lenders to the NBFCs,” Moody’s added.
Moody’s said the new norms did not provide much incentive for NBFCs to convert into banks, which the regulator had envisaged via the proposed changes to bank ownership regulations in November 2020.
“The RBI is proposing to initially keep the NBFC-Top Layer empty, but will move companies into this category if it sees elevated credit risk in those companies. Those NBFCs will be subject to tighter supervision similar to the prompt corrective action framework for banks,” it added.