Opinion
Finance is not the Wild West there is no place for cowboys here
Summary
- To maintain financial stability, RBI has imposed restrictions on four NBFCs for excessive lending practices, signalling a firm stance against reckless growth.
Regulators, especially financial sector regulators, need to bare their teeth from time to time. And, when the occasion demands, show they are capable of biting as well.
The Reserve Bank of India’s (RBI) recent action, imposing business restrictions on four non-banking finance companies (NBFCs) – Asirvad Micro Finance Ltd, Arohan Financial Services Ltd, DMI Finance Pvt Ltd and Navi Finserv Ltd - asking them to cease and desist from sanction and disbursal of loans is of a piece with this well-enshrined philosophy.
According to the RBI, its action, effective from close of business of 21 October, is based on ‘material supervisory concerns observed in the pricing policy of these companies in terms of their Weighted Average Lending Rate (WALR) and the interest spread charged over their cost of funds, which were found to be excessive.’
Further, their pricing policy was found to be ‘not in adherence with the regulations laid down in the Bank’s Master Direction (MD) relating to regulatory framework for microfinance loans and directions relating to NBFC-scale based regulation’, wherein the nature of the regulatory framework is directly a function of the size of the NBFC.
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This is not the first time the RBI has come down on recalcitrant NBFCs.
Similar action had been taken against JM Financial (since lifted in October 2024) and IIFL in March this year when the RBI had directed JMFPL to cease and desist, with immediate effect, from doing any form of financing against shares and debentures, including sanction and disbursal of loans against Initial public offering (IPO) of shares as well as against subscription to non-convertible debentures (NCDs).
Nor is it the first time that RBI has cautioned NBFCs against cavalier behaviour.
At the conclusion of the Monetary Policy Committee meeting on 9 October, RBI governor Shaktikanta Das issued a stern warning to non-banks, particularly microfinance and housing finance companies, cautioning against their aggressive pursuit of "growth at any cost," which could threaten the financial stability of the economy.
He also expressed concern about microfinance institutions (MFIs) and housing finance companies (HFCs) imposing usurious interest rates and frivolous penalties on their customers.
Castigating them for chasing business targets and growing retail credit rather than basing lending on actual demand, Das cautioned that the ‘consequent high cost and high indebtedness could pose financial stability risks if not addressed by these NBFCs.’ He warned them unequivocally that, ‘The Reserve Bank is closely monitoring these areas and will not hesitate to take appropriate action if necessary,’ adding that ‘Self-correction by the NBFCs would, however, be the desired option.’
Governor Das was quick to clarify that the RBI’s angst is not against the sector as a whole but is directed at some outliers who were putting the whole system at risk.
As deputy governor J Swaminathan said, “The messaging is targeted towards such NBFCs that are pursuing a high-risk, high-growth strategy and also to certain segments which are likely to get into stress in our estimate."
Clearly, his warning fell on deaf ears. Or so it would seem going by the RBI’s swift action within less than a fortnight after. This is as it should be. Due to the growing interlinkage between banks and NBFCs, with bank exposure to NBFCs growing from ₹3.9 trillion in February 2018 to ₹15.21 trillion in December 2023 (close to trebling), the systemic risk posed by the collapse of a major NBFC cannot be overstated.
The chaos following the collapses of IL&FS in 2018 and Dewan Housing in 2019 serves as a stark reminder of the potential fallout.
Also read: The unravelling of a financial titan: Ravi Parthasarathy and the IL&FS scandal
The financial sector stands in a league of its own, distinct from other industries. As the sub-prime crisis in the US demonstrated so vividly, the contagion effect means the collapse of any one large player has the potential to bring down many others, putting the entire financial sector and the economy at peril. The financial sector is not the Wild West. There is no place for cowboys here and if the RBI has to play sheriff, it is for the larger good.
