Need for New 4-tier Regulations for NBFCs

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Syllabus: GS 3

Synopsis: The RBI’s plan to tighten regulations on large NBFCs is critical for financial stability.

Introduction 

The RBI has planned an important change in its regulatory approach towards India’s non-banking financial companies (NBFCs). It plans to monitor larger NBFCs almost as closely as it monitors banks.

Read – 4-tier structure for regulation of NBFCs| ForumIAS Blog

What was the need for a change in the regulatory framework?

•  The size of NBFC has increased from just about 12% of banks in 2010 to a quarter of the banking sector.
• The growth has been facilitated by the lighter regulations on sourcing funds from home loans to micro-finance and large infrastructure projects.
• However, These lighter regulations revealed a systematic risk. For instance, IL&FS’s payment defaults resulted in a large scale economic crisis in 2018. 

What is RBI’s proposed regulatory structure?

The RBI has introduced a four-tiered regulatory structure. By this, RBI is striking a balance between the need for low regulations and less systemic risks in the sector. 

• First, For smaller NBFCs, regulations are light, on the basis of a largely ‘let it go’ approach.
• Second, For the largest NBFCs, it is imposing tougher ‘bank-like’ capitalization, governance, and monitoring norms. It is with an aim to reduce a systemic risk due to the nature of their operations.

• Third, the top tier will be activated only when a certain large player poses ‘extreme risks’. NBFC categorized in this tier will face the toughest regulations.

Way forward

• The banking sector is in despair over the past two years (PMC Bank, Yes Bank, Lakshmi Vilas Bank). Thus, a complete restart of the omission tool for NBFCs is critical to keep the confidence and maintain financial stability.
• It is hoped that the plan for the regulation of NBFCs is official soon. This would ensure the new economic recovery is not hampered by funding constraints.