NBFCs take lead in banking licence race

While many NBFCs have welcomed the panel’s recommendations, experts believe that the conversion into a full service bank will depend on the incentives the move may finally bring and whether this will address the risks around financial stability.

With the Reserve Bank of India ( RBI) mulling granting new banking licenses, prominent non-banking finance companies may fare better than corporates in winning a universal banking licence, experts said. On Friday an internal working group of RBI recommended that large non-bank lenders with asset sizes of more than Rs 50,000 crore, including those owned by corporates, should be considered for conversion into banks, provided they have completed 10 years of operation. The proposal is based on the committee’s view that these entities can be better regulated upon conversion into a bank and can therefore reduce chances of regulatory arbitrage.

While many NBFCs have welcomed the panel’s recommendations, experts believe that the conversion into a full service bank will depend on the incentives the move may finally bring and whether this will address the risks around financial stability. “I don’t see universal bank licence as the answer to everything. We don’t want entities called NBFC becoming too large because from a liability perspective they are dependent on wholesale liability, and one disaster like DHFL could make people nervous, said Raman Agarwal, co-chairman, Finance Industry Development Council (FIDC).

“My argument is that if you can still have a failure like a Lakshmi Vilas bank ( LVB) a highly regulated entity.despite all the necessary checks and balances how does converting NBFCs into banks help? So I don’t think there are easy fixes,” said the head of an NBFC. “There will be many NBFCs who will want to continue the way they are because most banks are aiming for the same retail liabilities to shore up cheaper capital” he added.

Experts point out that the other option before RBI is to bring the large systematically NBFCs at par with banks with regard to regulatory framework. Earlier this month, RBI deputy Governor M Rajeshwar Rao had also hinted that NBFCs with high systemic risks should be subject to tighter regulation and the spillover risks from these NBFCs should be dealt with in a proportionate manner. He said,” One can also argue that the design of prudential regulatory framework for such NBFCs can be comparable with banks so that beyond a point of criticality to systemic risks, such NBFC should have incentives either to convert into a commercial bank or scale down their network externalities within the financial system.” Industry experts also feel that if RBI may be indeed looking at bringing large NBFCs under stricter regulation while allowing them to allow greater perks like banks do . “It is very important that while regulation of large NBFCs is brought at par with banks, some of the benefits that banks currently enjoy and NBFCs don’t, are also given and this should be an automatic process. As a system, such parity must be a holistic process and not piecemeal,” Agarwal added.

Granting banking licences to corporates meanwhile could pose a vexed problem for regulation. In its report the Mohanty panel observed that a majority of the members are of the view that large corporate/industrial houses should not be allowed to promote a bank. This could particularly be worrisome for the majority of large NBFCs which are backed and promoted by corporates. “The main reason being the prevailing corporate governance culture in corporate houses is not up to the international standard and it will be difficult to ring fence the non-financial activities of the promoters with that of the bank. Stress in non-financial activity may spill over to the bank. The corporate houses may either provide undue credit to their own businesses or may favour lending to their close business associates,” the committee said in the report.