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RBI Body Raises Concern Over Rise in Bank Borrowing by NBFCs

Bank financing for NBFCs has resumed its upward trend after the market correction brought on by the IL&FS default and a brief pause caused by the COVID-19 pandemic.

  • 3,541 Views | Updated on: Mar 01, 2024

The Centre for Advanced Financial Research and Learning (CAFRAL), an independent research institution set up by the Reserve Bank of India (RBI), has expressed concern over the rising dependence of Non-Banking Financial Companies (NBFCs) on bank borrowings. In its India Finance Report 2023, CAFRAL warned that this trend could lead to systemic contagion and financial instability.

Key Takeaways

  • The CAFRAL Report is an annual publication that provides a comprehensive analysis of the Indian financial sector.
  • The 2023 CAFRAL Report focused on the challenges and opportunities of financial inclusion in India.
  • The report found that bank financing for NBFCs has been rising since the COVID-19 pandemic, reaching a record high in August 2023.
  • This report identified several risks associated with the rising dependence of NBFCs on bank borrowings, including systemic contagion, financial instability, and increased vulnerability to regulatory arbitrage.
  • It also recommended strengthening prudential regulations for NBFCs, enhancing supervision and monitoring, and promoting a well-diversified financial system.

The CAFRAL Report, also known as the India Finance Report, is an annual publication by the Centre for Advanced Financial Research and Learning (CAFRAL), an independent research institution set up by the Reserve Bank of India (RBI). The report provides a comprehensive analysis of the Indian financial sector, covering key trends, risks, and policy challenges.

The CAFRAL Report is widely regarded as an authoritative source of information on the Indian finance sector. It is used by policymakers, regulators, analysts, and investors to understand the finance sector’s current state and make informed decisions.

The report is typically released in September or October each year. The 2023 CAFRAL Report, titled “Connecting the Last Mile,” focused on the challenges and opportunities of financial inclusion in India.

Key Findings of the CAFRAL Report

The CAFRAL report highlighted several key points regarding the rising bank financing of NBFCs:

  • Bank financing for NBFCs has been upward since the COVID-19 pandemic, reaching a record high of ₹13.83 lakh crore in August 2023.
  • This increase in bank financing has been driven by a decline in secured borrowings and a rise in unsecured borrowings, indicating a shift towards riskier finance.
  • There has been a significant increase in lending by NBFCs to smaller NBFCs, creating an interconnected web of financial institutions.
  • NBFCs’ reserves and surplus have declined, indicating that their buffers have grown thinner.

Risks Associated with Rising Bank Financing of NBFCs

The CAFRAL report identified several risks associated with the rising dependence of NBFCs on bank borrowings:

Systemic contagion

If a large NBFC were to default, it could trigger a domino effect, leading to losses for banks and other financial institutions.

Financial instability

The interconnectedness of NBFCs could amplify the impact of a default, leading to widespread financial instability.

Increased vulnerability to regulatory arbitrage

NBFCs may engage in risky lending practices to exploit regulatory arbitrage, further exacerbating the risks.

Recommendations from the CAFRAL Report

To address the concerns raised in the report, CAFRAL has recommended the following measures:

Strengthening Prudential Regulations for NBFCs

This means making stricter RBI rules for Non-Banking Financial Companies (NBFCs) to make sure they are financially sound and can handle risks. This includes making banks lending to NBFCs keep more money in reserve in case the NBFC cannot repay its loans.

It also means requiring NBFCs to hold more capital, which is like a cushion of money that can be used to absorb losses. These measures are designed to protect the financial system as a whole from the risk of NBFC failures.

Enhancing Supervision and Monitoring

This will mean keeping a close eye on NBFCs to make sure they are operating safely and not posing a risk to the financial system. This is especially important because NBFCs have become more reliant on bank borrowings in recent years, which could lead to systemic contagion if a large NBFC were to default.

Promoting a Well-diversified Financial System

The government should encourage the development of a well-diversified financial system, reducing reliance on NBFCs for credit provision.

Imagine the economy as a large house and the financial system as the plumbing. A well-diversified financial system is like having multiple pipes carrying water from different sources (banks, NBFCs, insurance companies, etc.). This ensures that even if one pipe breaks (an NBFC defaults), the house still has access to water.

To Sum it Up

The rising dependence of NBFCs on bank borrowings poses a significant threat to the stability of the Indian financial system. The RBI and other regulatory bodies should take proactive measures to address these concerns and safeguard the financial health of the country.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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