The proposed changes to India’s regulatory framework for non-bank financial institutions (NBFIs) recently unveiled in the Reserve Bank of India’s (RBI) discussion paper are likely to enhance the sector’s stability, according to Fitch Ratings.
The credit rating agency believes that the reforms would preserve NBFIs’ niche business models, and could improve the funding environment for some entities by strengthening investor confidence in the sector.
”For the sector as a whole, the proposed measures should strengthen governance and risk management, although we do not view these areas as major credit weaknesses for Fitch-rated Indian NBFIs. The longer-term impact of such reform would also depend on its implementation, and robust regulatory and market scrutiny will be key in holding entities to higher standards,” the agency said in a note.
Scale-based regulations
ICRA observed that larger entities face enhanced disclosure requirements, and tighter risk and capital management requirements, which would likely be credit positive, it added.
It opined that the scale-based regulations reflect calls for closer supervision of large NBFIs that have grown more systemically significant.
“We believe the moves to strengthen risk controls and frameworks should be manageable for Fitch-rated NBFIs. For example, they should already comfortably meet the suggested requirement for “Upper Layer” NBFIs, expected to include 25-30 of the largest entities including Fitch-rated names, to maintain a minimum common equity Tier 1 ratio of 9 per cent,” the agency said.
Fitch views proposals to appoint auditors by rotation, as well as requirements to disclose information such as the incidence of covenant breaches and asset quality divergence as credit positive.
Unlike banks, many NBFIs have appointed the same auditors for many years. In addition, lending to directors and senior employees would be restricted, reducing governance risks.
Core banking solution
Requirements to implement a core banking solution (credited for improving efficiency and reducing operational risks in banks) and introduce an internal capital adequacy assessment process (ICAAP) could further strengthen the framework for monitoring and managing risks.
Most large NBFIs’ systems are already integrated with banks and payment portals, and Fitch believes additional costs to meet the core banking solution requirement would be manageable. However, the measure could pose a more significant expense for mid-sized NBFIs.
For NBFIs in the Upper Layer, listing may be made mandatory. The agency opined that this would affect only a few corporate-backed NBFIs, and should not present a challenge given their parents’ experience in capital markets.
Real estate lending
In general, business models should not be significantly affected, but some lending activities could be curtailed by the suggested changes, especially in real estate, ICRA said.
The agency observed that the RBI is looking to restrain lending to early-stage development projects that have not yet received regulatory approval, and has proposed added internal controls for lending against land acquisition.
“Some entities have built up exposures to these risky areas in recent years, which have become a point of vulnerability for the sector. The suggested new rules could curb a further run-up in such exposures in the longer term,” the agency said.
Provisioning
Fitch is of the view that the suggested reform would also raise NBFIs’ standard provisioning requirements on commercial real estate lending, to be in line with those for banks.
Fitch-rated Indian NBFIs do not engage in real estate lending, other than IIFL Finance. However, if IIFL is placed in the Upper Layer, any added provisioning from this proposal is unlikely to be significant relative to the firm’s broader provisioning needs in light of the pandemic, the agency said.
Fitch noted that NBFIs with assets below ₹1,000 crore (around $130 million) would continue to operate under current frameworks, but additional rules aligning non-performing loan recognition and a new leverage cap of seven times would add to regulatory robustness.
The central bank further highlighted the need for a resolution framework for failing NBFIs. This would be another important element in the regulator’s financial stability toolkit.