Independent Research and Policy Advocacy

CCFS Recommendations on Credit Delivery – Part 2

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The CCFS recommendations pertaining to national full-service banks and regional banks have been covered in our previous post. Unlike these deposit-taking institutions, the third category of institutions, namely, RBI-regulated Non-Banking Financial Companies are not involved in taking public retail deposits and are primarily focussed on credit delivery and therefore supplement the bank-led channels for credit delivery. It is well-established that NBFCs have been providing credit in an effective manner to segments that have been traditionally underserved by commercial banks. These NBFCs are essentially lenders that borrow from the banking system as well as from capital markets, and are overseen actively by their creditors with respect to the quality of portfolio they originate. However, the NBFC sector has traditionally remained limited in size in relation to the banking system and has faced many challenges such as difficulties in accessing funding, and confusion in regulatory jurisdictions. The CCFS Report makes significant recommendations with regard to NBFCs and these are discussed below.

NBFCs be permitted to convert to Wholesale Banks: The CCFS Report recommends that a new category of banks called ‘Wholesale Banks’ be created and NBFCs be given the choice to be converted into these – Wholesale Banks are institutions that rely on wholesale deposits (more than Rs.5 crore) to fund their retail credit operations. The creation of this category would remove a lot of the regulatory uncertainty faced by NBFCs, give them recognition for their role in credit intermediation and thereby ease funding constraints arising due to political and regulatory risks. Since retail deposits are not involved, wholesale banks can be permitted to be set up with minimal entry capital requirements of Rs.50 crore, instead of the Rs.500 crore needed for commercial banks. While not all such wholesale banks would be engaged in retail credit, those with less than 20 branches will not be required to meet the 25% branching requirement and can be referred to as Wholesale Investment banks whereas the rest can be Wholesale Consumer banks. Wholesale banks would be subjected to RBI rules and regulations of Scheduled Commercial Banks in all other respects.

NBFCs be permitted to become Business Correspondents: Those NBFCs with retail lending operations (such as those that qualify for becoming Wholesale Consumer Banks) can be allowed to become BCs to full service banks as was initially permitted. The motivation for withdrawing this permission by RBI has been prompted by concerns of commingling of funds and the worry that permission to carry out credit intermediation for the parent bank would result in the BC essentially managing two loan books with concomitant conflicting incentives. These worries can be effectively handled through the use of technology-based solutions to make all transactions authenticated and transparent and thereby minimising chances for fraud. Such operational criteria are best left to banks to be laid down and overseen with the BC, and in an environment where a Suitability regime for consumer protection is put in place, there is all the incentive for the originating BC to ensure that underwriting standards are adhered to irrespective of which loan book the assets are originated for. The current restriction of a 30 km limit for distance between the bank and its rural BC needs to be removed in this regard.

Improving access to wholesale funding for NBFCs: Funding for NBFCs can come in the form of bank borrowings, refinance from Apex institutions, External Commercial Borrowings (ECB), sale of securitised assets, and issuance of bonds. While banks are currently the chief funders for NBFCs, access to capital markets is yet to be developed adequately. In this regard, the CCFS Report places emphasis on laying out a RBI/SEBI framework for Qualified Institutional buyers and Accredited Individual Investors to participate in debt issuances of NBFCs. Several of the ECB guidelines also need to be harmonised across institutions, such as permitting ECB in Rupees for all institutions, and making foreign currency ECBs permissible not based on NBFC category but based on size and capacity to absorb foreign exchange risk.

To aid securitisation markets, tax-free status for pass-through SPVs must be restored and the restriction that the all-inclusive interest charged to the ultimate borrower should not be more than 8% p.a above the Base rate must be removed. The capitalisation slabs for bringing in foreign equity (at USD 0.5 million, 5 million and 50 million for foreign capital below 51%, below 76% and above 75% respectively) are quite steep and in a scenario of scarce domestic equity can be relaxed. Refinance and credit guarantee facilities by Apex institutions must be given based on the nature of activity and must not preclude certain types of institutions by virtue of their legal type. Requiring NBFC-MFIs to disclose to RBI or MFIN the operating costs of their mature branches would further ensure that the more efficient institutions have easier access to funding.

Role for NBFCs in meeting Banks’ Priority Sector lending obligations: While the Committee has made recommendations in the form of an Adjusted PSL mechanism for improving efficiency of PSL credit delivery, the Committee also envisages that the mandate is not to be achieved only by direct origination of PSL Assets by banks but by enhancing the tradability of PSL assets between various originators. Creating an active market for PSL assets will be critical to ensuring that the policy objective of credit delivery to Priority Sectors at a national level is actually achieved. In a similar vein, equity investments by banks in NBFCs in low financial depth districts, among others, can be made eligible for contribution to overall PSL targets. Such instances should be permitted with a multiplier of four to reflect higher risk and the illiquid nature of these investments.

Regulatory Convergence between banks and NBFCs with respect to certain aspects: The Committee calls for convergence in rules applicable to banks and NBFCs, specifically with regard to uniform applicability of SARFAESI Act, and NPA recognition and standard asset provisioning norms (and to make them at the level of underlying riskiness of each asset-class instead of at the level of each institution-type involved in originating the assets). Regulatory convergence would also be in the form of greater accountability for NBFCs, in term of disclosing their stress-test results annually as well as placing a requirement on them to mandatorily adopt Core-Banking Systems for aiding off-site supervision by the regulator.

Remove policy biases that inadvertently disfavour NBFCs: Any restrictions on the total indebtedness of a small borrower cannot be applied only to certain institutions while exempting other institutions from it. The Committee recommends that the total borrowal limit be set at Rs.100,000 across all lenders and this be implemented through mandatory reporting to credit bureaus by all lenders and not just by NBFC-MFIs. This will remove the need for limiting the number of loans or the number of institutions a borrower can take exposure to and would help bring down prices through competition.

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