The Centre for Advanced Financial Research and Learning (CAFRAL), a research organisation established by the Reserve Bank of India (RBI), has shed light on an increasing risk in bank financing for Non-Banking Finance Companies (NBFCs). It also points out potential threats within the digital lending sphere. Moreover, CAFRAL has issued a cautionary note about counterfeit/illegitimate lending apps, which are gathering personal data and presenting possible risks to user safety.
Major Concerns Highlighted by CAFRAL
CAFRAL expressed concern over interdependency risks within the NBFC sector. Banks often lend primarily to larger NBFCs, fostering a trend of increased lending within the NBFC sector. This breeds a network of mutual dependencies that can amplify shocks and propagate them across the entire system.
Effects of Contractionary Monetary Policy on NBFCs
According to CAFRAL, contractionary monetary policy results in risk accumulation within NBFC portfolios. With RBI increasing the policy rate, NBFCs confront heightened borrowing expenses and reduced profitability. To sustain their margins, they tend to reallocate their lending towards riskier segments, thereby exposing themselves to considerable credit, market, and liquidity risk factors.
The Peril of Illicit Lending Apps and Impact of Fintech
CAFRAL also highlighted the issue of false/illegal digital lending apps which pose as legitimate platforms while gathering user data for possible misuse. These apps often ask for extensive personal information, potentially endangering consumer safety and privacy. As the link between online lending and traditional banking strengthens, the potential losses from this sector could affect traditional banking.
Understanding NBFCs
Non-Banking Finance Companies (NBFCs) are institutions primarily involved in financial activities like granting loans and investing in securities. About 50% of a company’s assets must be financial assets, and over 50% of its income must come from these financial assets to qualify as an NBFC under the RBI.
However, companies primarily engaged in sectors like agriculture, industry, goods trading, services, or real estate would not come under RBI regulation even if they conduct some financial activities.
Exemptions From Registration with RBI
Certain categories of NBFCs, such as SEBI-registered Venture Capital Funds, Merchant Banking, and Stock broking companies, are exempt from this registration requirement.
Difference between NBFCs and Banks
Key differences exist between NBFCs and banks. NBFCs are restricted from accepting demand deposits, do not form part of the payment and settlement system, and cannot offer deposit insurance to their depositors like banks can. Unlike banks, NBFCs primarily finance their operations through market borrowings and bank loans.
Actions Needed Moving Forward
To secure financial stability, the RBI and other regulators should enhance their monitoring of interlinkages and spillovers between NBFCs and banks, as well as within the NBFC sector. It is also crucial to improve risk management procedures, governance norms, and regulatory oversight to ensure sound decision-making and transparency. Moreover, regulatory scrutiny needs tightening over digital lending applications to ensure they comply with consumer protection laws and data privacy regulations.