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Dear RBI, don’t throw out the NBFC baby with the bathwater!

RBI should do its job of protecting the integrity of debt markets, but growth should not suffer.

, ET Bureau|
Oct 09, 2018, 08.03 AM IST
0Comments
The Reserve Bank of India’s (RBI) policy meet last Friday was noteworthy for quite a few developments. Popular attention was focused on the central bank’s decision to defy expectations not to cut rates. The rupee’s free fall, rising oil prices made many experts believe that the RBI would be ready to step up rates, but the RBI had other ideas.

While this predictably hogged much attention, a very key point about the RBI’s stance on the issue of NBFC funding got little attention, till Monday that is.

RBI deputy governor Dr Viral Acharya talked tough on Friday about the NBFCs’ funding practices. He dwelt especially on the tactics NBFCs use to get marginal funding advantage by relying on short-term borrowing. Here is his exact quote: “I would like to encourage, in fact, urge financial firms to place greater reliance on equity and other forms of long term finance for funding long term assets rather than relying excessively on short term paper… chasing lower marginal cost of funding in order to retain or acquire market share in lending is a myopic strategy.”

The deputy governor did not mince words and the NBFCs felt the pain in Monday’s trade. Fears that the RBI would clamp down on the sector with tough new regulations felled the sector’s shares again on Monday. After spending much of the past two years in the stratosphere, made possibly by surging consumption and the retreat of public sector banks from lending, the NBFCs are feeling the heat. Fears that new regulation would make them more like banks and crimp their free-wheeling ways made investors wary and cautious. Worries over lack of funding may slow down growth has already driven down most NBFC shares by more than 30% since the last week of September, and the RBI’s announcement on Friday means that NBFCs would be under intense pressure in the coming days and weeks.

This pressure, however, is not the problem. NBFC shares have fallen sharply in the past too and there is no reason why the prices can’t go up if business models are sustainable.

The problem may lie with what RBI intends to do. Deputy Governor NS Vishwanathan hinted on Friday that the central bank may do something on rules relating to asset liability mismatch. “There is an ALM guidelines and we are looking at strengthening this so that we can avoid the rollover risk,” Vishwanathan said.

Tweaking ALM guidelines or other rules to prevent a messy blow-up is quite welcome and is something that the central bank should do. Some people have also suggested that NBFCs should be regulated like banks given their asset size, growth and the too-big-to-fail status. Some NBFCs now have assets of nearly Rs 1 lakh crore or more than that and the calls to tighten regulation to prevent a Lehman-like situation is a broadly valid argument.

But how RBI goes about this job is important and the central bank would do well not to come down like a sledgehammer on a sector that has been responsible to some extent for spurring the consumption story in India. With banks unable to lend because of bad loan problems, companies like Bajaj Finance, L&T Finance, Shriram Transport and M&M Financial Services have responded by feeding the needs of individuals, entrepreneurs and small businesses across the country. HFCs are not regulated by the RBI but here again the home loan growth rates have been impressive at a time when public sector banks are struggling.

The RBI should not forget this important role. Regulation is fine and the central bank should do its job of protecting the integrity of debt markets, but growth should not suffer and that too at an important time for the economy.

The markets’ self-adjusting mechanism will take care of some of the anomalies in the treatment given to companies with different financial models, credit profiles and business practices. Already, we are seeing investors demanding higher rates for companies they believe to be risky. The stock market will also adjust to ensure that high-quality companies are valued differently from their not-so-sound brethren. Throw out the bathwater if you want, but keep the baby alive and allow it to grow!


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