RBI’s issues with non-banks stem from less control

Context

• NBFCs, part of India’s shadow banking system have become very big over the last decade. This has created systemic risks which need to be taken more seriously. 

What are NBFCs?

• A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956.
• It is engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities.
• NBFCs lend and make investments and hence their activities are akin to that of banks.

How are they different from banks?

• NBFC cannot accept demand deposits
• NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself
• Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

How ‘big’ have NBFCs have become?

• NBFCs have been the largest net borrowers of funds from the financial system, of which, more than half of the funds were from banks, followed by mutual funds and insurance companies
• Between 31 March 2008 and 31 March 2020, banks’ lending to NBFCs jumped from Rs78,938 crore to over Rs 07 trillion, growing at 21.4% per year.

Reasons

• NBFCs borrow for the short-term, and lend for the long-term. This asset-liability mismatch gets them into trouble when their finances dry up.
• A lot of this money has been lent by NBFCs to the real estate sector, thereby increasing systemic risks.

Suggestions

• NBFC should have incentives either to convert into a commercial bank or scale down.
• It requires more regulation for NBFCs, which are used to a regulation-light structure.