As many as 779 licences were cancelled in October and November, just after the crisis in the shadow banking sector unfolded with Infrastructure Leasing and Financial Services Ltd (IL&FS) defaulting on debt repayments. The defaults led to drying up of liquidity for other non-banks, triggering a crisis in the sector. In comparison, RBI had cancelled the licences of 26 NBFCs in FY18.
While NBFCs historically were loosely regulated, the situation is now changing, with the central bank proposing new rules to monitor the asset-liability and risk management framework of these entities.
While NBFCs can still exist even after they lose their licences, they gradually die being unable to raise money either from banks or the markets.
Once these NBFCs lose their licences, neither do banks buy portfolios from them nor do they lend to these NBFCs, according to Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services Llp. He expects more licences to be cancelled by the central bank in the days ahead.
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“These entities are not rated enough to borrow from the markets and therefore they cannot raise funds. They are allowed to lend, but will have to do it from their own pockets," said Parekh.
In an amendment to the RBI Act in 1997, non-banks were mandated to have net owned funds (NOF) of at least ₹25 lakh. In 1999, the central bank raised the requirement to ₹2 crore for new registrations, while existing NBFCs were allowed to operate and were given time to increase their NOF in a gradual manner. Net owned funds consist of paid-up equity capital, free reserves, balance in share premium account and capital reserves representing surplus arising out of sale proceeds of assets but not reserves created by revaluation of assets.
“The last date for complying was 31 March 2017 and the recent spate of licence cancellations is because of their inability to meet this criterion," said Raman Aggarwal, chairman of NBFC industry body Finance Industry Development Council (FIDC).
According to Aggarwal, RBI has the powers to raise the NOF of NBFCs to up to ₹100 crore and this will certainly happen in a phased manner if the central bank chooses to implement it.
“These cancellations should not be linked to the narrative about the alleged misgovernance in small non-banks," he said.
The Union budget on Friday proposed to amend the RBI Act, 1934, empowering the regulator to supersede the board of NBFCs (other than those owned by the government). This also enables RBI to consider resolution of financially-troubled NBFCs through a merger or by splitting them into viable and non-viable units called bridge institutions. RBI can also remove auditors, call for an audit of any group company of an NBFC, and have a say in the compensation of senior management. NBFCs were till now governed by the Companies Act even as they were regulated by RBI.
The central bank said in its financial stability report issued last month that NBFCs depend largely on public funds, which account for 70% of the total liabilities of the sector. Bank borrowings, debentures and commercial papers are the major sources of funding for NBFCs. Bank loans to total borrowings increased from 21.2% in March 2017 to 23.6% in March 2018 and further to 29.2% in March 2019.
There were 9,659 NBFCs registered with RBI as on 31 March, of which 88 were deposit accepting and 263 systemically important non-deposit accepting NBFCs.
The consolidated balance sheet size of the NBFC sector grew 20.6% to ₹28.8 trillion in FY19 as against an increase of 17.9% to ₹24.5 trillion in FY18. Data from RBI showed that gross bad loans of the NBFC sector as a percentage of total advances increased from 5.8% in FY18 to 6.6% in FY19. However, the net non-performing asset ratio declined marginally from 3.8% in 2017-18 to 3.7% in 2018-19.
On the other hand, the capital adequacy of the sector declined 350 basis points year-on-year to 19.3% in FY19. The central bank mandated non-banks to maintain a minimum capital adequacy ratio of 15%.
Mint reported in August last year that RBI cancelled licences of 368 NBFCs in the six months ended June 2018 for failing to meet regulatory norms.