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Ref. No. KLI/22-23/E-BB/492
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.
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.
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.
The CAFRAL report highlighted several key points regarding the rising bank financing of NBFCs:
The CAFRAL report identified several risks associated with the rising dependence of NBFCs on bank borrowings:
If a large NBFC were to default, it could trigger a domino effect, leading to losses for banks and other financial institutions.
The interconnectedness of NBFCs could amplify the impact of a default, leading to widespread financial instability.
NBFCs may engage in risky lending practices to exploit regulatory arbitrage, further exacerbating the risks.
To address the concerns raised in the report, CAFRAL has recommended the following measures:
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.
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.
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.
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.
Ref. No. KLI/22-23/E-BB/2435