Non-banks have sought clarity from the Reserve Bank of India (RBI) on the definition of revolving credit and exemptions for certain micro, small, and medium enterprise (MSME)-focused products, including supply-chain finance and invoice discounting, after the central bank proposed barring them from issuing such facilities.
Some have pleaded with the regulator to allow revolving credit facilities, albeit with tighter underwriting and disclosures to address any concerns, or issue a new framework for such loan products.
“RBI’s issue may not be with the product itself but probably a visibility concern,” said Jatinder Handoo, chief executive of industry body Unified Fintech Forum (UFF). “We need to find a way to work closely with the regulator to resolve or address those concerns because it doesn't appear to be a quantum issue, but about a lack of visibility around what is happening when you disburse a credit line,” he said.
“It's a transaction-based product, hence, controls and checks and balances could be put in place to address any concerns,” Handoo said, suggesting more transparency through new technologies like blockchain and artificial intelligence, where all stock stakeholders, including at the merchant level, have visibility around what is happening in the system.
Other suggestions include adopting tools such as utilization pattern monitoring, mandatory re-underwriting on repeated drawdowns, reassessment of repayment capacity on persistent utilization, and supervisory testing of whether fresh drawings are servicing old obligations.
“Those (help) distinguish a healthy revolver from a cosmetic one. A blanket prohibition doesn’t,” said Vivek Bimbrahw, former banker and consulting head-stakeholder relations, at think tank National Council of Applied Economic Research (NCAER).
The UFF, formerly known as the Digital Lenders’ Association of India (DLAI), and the Finance Industry Development Council (FIDC), the apex representative body and self-regulatory organisation for non-banking financial companies (NBFCs), have submitted their suggestions to RBI.
The central bank had sought feedback on the 6 August draft circular by 28 August.
Survival vs regulation
The draft raised concerns among non-banks about its impact on business, particularly certain credit facilities extended to MSMEs and small businesses, as well as their access to capital.
In a 10 August note, Kotak Institutional Equities said that the norms will increase operational nuances, lower interest returns for lenders, and lead to higher operational expenses for borrowers, flagging that NBFCs such as Aditya Birla Finance, Bajaj Finance, and Tata Capital may take a hit.
NBFCs offer flexi/revolving credit facilities, mostly to MSME loan customers, including secured loans against property, unsecured loans, supply-chain loans, and working capital loans, and, in some cases, personal and professional loans.
The FIDC, in its submission, said that many small and medium NBFCs, including captive NBFCs, deal exclusively in such products. “Consequent to such prohibition, the economic rationale for their continued existence shall be severely dented, leading to loss of investor/public funds and employment to personnel working in such NBFCs.”
RBI’s concerns, on the other hand, seem to stem from credit line-like products, wherein lenders typically sanction an overarching credit line to borrowers, who then have the option to withdraw only the amount they need. However, in certain cases where borrowers are under financial stress or unable to repay, they tend to withdraw more from the sanctioned line, or lenders extend more credit to avoid declaring the account as stressed or delinquent.
“That is evergreening wearing a product label. With household leverage climbing, it’s a fair thing to worry about,” said Bimbrahw. “The regulator’s concern is legitimate: A revolving facility can quietly mask deterioration,” he said.
But NBFCs typically serve borrowers who don’t meet banks’ credit filters. “Take revolving credit away from NBFCs, and that customer does not migrate to a bank overdraft. He simply loses the product,” Bimbrahw said, adding that in such a scenario, micro-entrepreneurs with lumpy, seasonal cash flows end up running multiple term loans and paying interest on even idle money.
What has caught the industry off guard is that the ban proposal comes at a time when the government has been pushing for MSME lending and easier access to credit.
“The question is whether, under the revolving credit facility for supply-chain finance, each drawdown should be treated as a term loan, because underwriting or an appraisal process each time creates friction,” Handoo said.
For service providers or fintechs, such norms will require product-level adjustments, which take time both internally and externally, as new products, such as those with bullet repayments, are developed and lenders approach customers to explain them.
Revolving credit market
“We are of the view that a firm, equivocal regulatory position on such products is required to allow NBFCs to freely operate and confidently serve the credit needs of various classes of borrowers,” the FIDC said.
The industry body said that ‘revolving credit’ is currently defined only as a product that is not a ‘term loan’, even though NBFCs offer a variety of products that fall under neither category and are similar to credit cards or overdraft facilities offered by banks.
It added that, according to preliminary industry estimates, products representing “substantial credit outstanding" may potentially be impacted.
The argument is also that if there were an issue with the product itself, RBI would have barred all lenders, rather than just NBFCs, from offering it. As such, restricting access to such products will push customers either towards informal credit or term loans, the latter of which will only increase leverage.
“There is a need in the market that's why NBFCs are giving such loans and if RBI finds a risk in that, the solution would be to counter that risk,” said Sundeep Mohindru, founder and promoter of Trade Receivables electronic Discounting System (TReDS) platform M1xchange, adding that banning products such as channel or dealer finance and invoice discounting could have a very large impact as MSMEs rely heavily on them for their supply-chain management.
“The chances of default are higher, so therefore better controls have to be put in,” he said, adding that installing controls or defining a new framework of controls is a better solution than completely stopping such products.