(Photo: Reuters)
(Photo: Reuters)

Opinion | The case for a unified supervision regime for NBFCs

The IL&FS crisis and Cobrapost episode are warning signs to get our act together on systemic risk

Early last week, Cobrapost, an investigative blog, promised a “sting". Notice of the sting was sent to regulators, officials, market participants, and the mainstream media. The delivered sting, an exposé of 31,000 crore of dubious loans allegedly given out by Dewan Housing Finance Ltd (DHFL), turned out to be less poisonous than the market expected. While the DHFL stock slithered nearly 40% over five days, the general market shrugged off the news.

Coming as it did on the back of the Infrastructure Leasing & Financial Services (IL&FS) crisis of last October, it added some concern to the overall non-banking financial company (NBFC) sector. In journalistic jargon, these entities are pejoratively called “shadow banks". In reality, NBFCs in India do a lot of the heavy lifting, connecting the large savings pool to consumers and small firms that need the capital.

India has 10,000 active NBFCs that are regulated by the Reserve Bank of India (RBI), of which some 275 are systemically important (SI). Non-deposit taking systemically important entities, tagged with the alphabet soup acronym NBFC ND-SI, are those with a threshold asset size greater than 500 crore—asset finance companies, asset reconstruction companies, infrastructure finance companies, and microfinance companies are among the various types that make up the broad group of NBFCs. Peer-to-peer (P2P) lending companies are the newest set to join this group. Strange as it may seem, DHFL, which is a housing finance company, is not regulated by RBI but by the National Housing Bank (NHB).

Worldwide, regulation of non-banks is a hot topic. In China, the most significant source of instability in recent times came with a dramatic surge in P2P lending from 2013 to 2016. At its peak, nearly 20% of all marginal credit in the economy was being handled by P2P firms. These firms were unregulated for that period, and both the supply of capital and the interest rates for lending were not prudentially supervised. To mitigate a huge crisis and to protect consumers, China dramatically tightened its regulation related to P2P firms beginning in 2016. The number of P2P firms will likely decline from more than 1,500 to under 50 by the time the process is completed.

Among developed markets, the US has a decentralized and multi-organization way of regulating its financial institutions, in part determined by the regulatory charter under which the institution is registered. The UK is regulated more centrally by a prudential authority and a conduct authority. The power to intervene in the case of a distressed bank lies with the Bank of England. Australia follows the “twin peak model" with the Reserve Bank of Australia as the lender of last resort coordinating stability measures with the Australian Prudential Regulation Authority, which supervises banks, building societies, credit unions, life and general insurance companies, reinsurance companies, private health insurers and superannuation funds.

Each model has its pros and cons. It may not be right for India to adopt one or the other model without giving it considerable thought. That said, the time has indeed come to give the matter of systemic stability a lot of thought. Indian non-banks are governed by a regulatory hodgepodge of RBI, the Securities and Exchange Board of India (Sebi), the Insurance Regulatory and Development Authority (Irda), NHB, the ministry of corporate affairs (for nidhi companies) and state governments (for chit funds). Cooperation is on an ad hoc basis and often post-event.

The Financial Sector Legislative Reforms Commission (FSLRC) took up this task and submitted its report in 2013. The commission chaired by former justice B.N. Srikrishna recommended that Sebi, Irda, the Pension Fund Regulatory and Development Authority and the Forward Markets Commission (since merged with Sebi) be merged under one regulator to be called the Unified Financial Authority. The FSLRC recommended that micro-prudential regulation (health of individual firms) be conducted through a non-sector specific approach. For macro-prudential regulation that governs systemic risk, it suggested adding a strong legal framework to the Financial Stability and Development Council (FSDC). The FSDC was recommended by the Raghuram Rajan committee in 2008 and is a committee made up of all the regulators, including the government of India, and is charged with coordinating prudential stability.

To the best of my knowledge, the FSDC has not met officially since the IL&FS crisis. It has become a clunky body devoid of teeth (as the FSLRC recommendation is not implemented) and has become just another regulatory agency in a potpourri of them.

The FSLRC did not go far enough in recommending a more focused scope for RBI and in recommending a regulator with teeth for macro-prudential supervision that spanned sectors we call NBFCs as well as others like housing finance and insurance. The IL&FS crisis and the “hiss and tell" episode from Cobrapost are warning indicators for us to get our act together in terms of systemic risk. The various financial sectors in a large, heterogeneous economy such as India will inexorably become more linked with time. It is time to focus on systemic risk and the only way to do that is to simplify and give that specific scope to one regulatory agency.

P.S. “Even if a snake is not poisonous, it should pretend to be venomous," said Chanakya.

Narayan Ramachandran is chairman, InKlude Labs. Read Narayan’s Mint columns at www.livemint.com/avisiblehand