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Regulatory Actions on NBFCs Raise Business Volatility, says Fitch


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According to ratings agency Fitch, a spate of regulatory actions on non-banking finance companies (NBFCs) could lead to increased business volatility for some entities in the near term. The Reserve Bank of India (RBI) has been taking steps to strengthen corporate governance and risk management in the sector, which may reduce industry risks. However, the interpretation and implementation of regulations can vary among firms, leading to compliance and governance lapses. The evolving nature of the sector and the challenging regulatory environment can contribute to these issues.

Recent Enforcement Actions and Regulatory Event Risk

Fitch highlights a series of enforcement actions on both banks and NBFCs, which has raised regulatory event risk for the sector compared to the past two years. For example, in March, the RBI directed IIFL Finance Ltd to cease new gold-backed lending and associated off-balance sheet funding transactions. The regulators found several deficiencies in the company’s business, including cash disbursal of gold-backed loans exceeding Rs 20,000. Fitch considers some of these deficiencies to be more severe.

Compliance with Regulatory Caps on Loan Disbursal

The RBI has recently emphasized that NBFCs should comply with existing regulatory caps on the disbursal of loans in cash, setting the limit at below Rs 20,000 per outstanding facility. This is in contrast to a higher cap of Rs 200,000 on general cash transactions, which some lenders had adopted. These measures aim to ensure better oversight and control of cash transactions in the sector.

Risk Profile of NBFCs

Fitch notes that many NBFCs have historically demonstrated a high risk tolerance, with an appetite for rapid growth, elevated leverage, and slim liquidity buffers. This risk-taking behavior contributed to the failures of several NBFCs in 2018-2019. However, after those incidents, many finance companies took steps to address their vulnerabilities by reducing short-term funding, strengthening capital positions, and disposing of risky assets. This resulted in an improvement in the debt-to-equity ratio for large Fitch-monitored NBFCs, which decreased from 5.9x in FY18 to 4.3x in FY22. However, Fitch also highlights that risk appetites have started to increase again as the economic backdrop has become more favorable.

Overall, the regulatory actions and efforts by the RBI to enhance corporate governance and risk management in the NBFC sector aim to mitigate industry risks and promote stability. However, the varying interpretations and implementation of regulations, as well as the evolving nature of the sector, continue to pose challenges for financial supervision and compliance.

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