Reserve Bank of India Walks The Talk

The idiom, “All bark and no bite”, doesn’t seem to have a place in the Indian banking regulator’s lexicon.

Just about a week after giving a stern warning to errant non-banking financial companies (NBFCs), the Reserve Bank of India (RBI) last week? issued an order directing four??of them?to cease and desist from sanctioning and disbursing fresh loans.

Asirvad Micro Finance Ltd, Arohan Financial Services Ltd, DMI Finance Pvt Ltd and Navi Finserv Ltd form this quartet.

“Usurious pricing” apart, these NBFCs were found to be not complying with regulatory guidelines on the assessment of household income and the borrowers’ ability to service the monthly instalment of loans. Among other deviations, they also seemed to have indulged in “evergreening” of loans – the practice giving fresh loans to pay off the earlier ones.

The RBI order has not mentioned the cross-selling of different products by the NBFCs. I don’t know about these four but typically, beyond loans, the NBFCs sell different products to their borrowers.?Earlier, mobile phone, insurance policies,?solar lantern and inverter light were on sale list. Now, pressure cooker, mixer-grinder and even TV and refrigerator are sold along with loans.?A necessary precondition for loan disbursement is, in many cases, the sale of such products. The RBI has probably bunched the “other income” thus generated with the interest rates charged by the NBFCs.

Of the four, DMI has the biggest loan book – Rs 13,160 crore as of June 2024, followed by Asirvad (Rs 11,327 crore), Navi (Rs 9,110 crore) and Arohan (Rs 6,737 crore).?

When it comes to growth, DMI tops the list at 47.76 per cent growth. Asirvad comes second (33.7 per cent), followed by Navi (32.67 per cent) and Arohan (27.95 per cent).

Asirvad’s gross bad loans are 2.99 per cent; after adjusting write-offs, these shoot up to 7.7 per cent. Comparable figures for Arohan are 2.5 per cent and 4.39 per cent.?DMI's?gross bad loans are 2.54 per cent and that of Navi 1.7 per cent. Asirvad has seen 8.77 per cent fresh slippages in June, Navi Finserv 6.58 per cent and DMI 3.51 per cent.

Asirvad enjoys the highest margin?(NIM) -- the difference between the cost of funds and the earnings from loans?-- ( 17.29 per cent), followed by Navi (16.35 per cent), Arohan (13.32 per cent) and DMI (11.46 per cent).

?“The Reserve Bank is closely monitoring the incoming information and will take measures, as may be considered necessary,” RBI Governor Shaktikanta Das had said in his October monetary policy statement, referring to what’s happening in the NBFC sector.

He didn’t beat about the bush. Das’s three critical observations are:

# Some of the NBFCs are aggressively pursuing growth without building sustainable business practices and risk-management frameworks. An imprudent “growth-at-any-cost” approach would be counterproductive for their own health.

#? Some of them – including microfinance institutions (MFIs) and housing finance companies (HFCs) – are chasing excessive returns on equity, driven by their investors. They are making money by charging “usurious” interest rates and “unreasonably high processing fees and frivolous penalties”. Their balance sheets are growing, mainly because of the “push effect” rather than the demand for loans.

# Variable pay and incentive structures in the compensation package of some of the NBFCs are “purely target driven”. Such practices could affect the work culture and customer service.

The universe of NBFC is vast. There are at least 9,325 NBFCs and 94 HFCs. Going by the RBI classification, nine NBFCs and five HFCs form the upper layer, the rest of the HFCs and 404 NBFCs comprise the middle layer, and 8,912 NBFCs make for the base layer.

One may be tempted to ask: Do we need so many NBFCs? No one can deny that we are a credit-starved nation. According to the World Bank, India’s domestic credit to the private sector, at 55 per cent of GDP in 2020, is remarkably below the world average (148 per cent), and the lowest among its Asian peers — China (182 per cent), South Korea (165 per cent), and Vietnam (148 per cent). But supervising so many NBFCs is not easy.

Another question is: While the RBI has taken an exemplary action to keep the errant NBFCs on their toes, should it have taken a graded approach? Together, the four NBFCs have a loan portfolio of Rs 40,334 crore. Their assets are far higher – Rs 50,693 crore. Even though all four have a healthy capital base (between 22 per cent and 52 per cent capital adequacy ratio), the banking system has exposure to them.

Yes, I am talking about the interconnectedness of banks and NBFCs. While the RBI has been vocal about its discomfort with the NFBC sector for quite some time, before issuing the cease and desist order, should the regulator have served notices on why such an extreme step should not be taken against them? This would have made the financial system aware of specific instances of wrongdoings and, at the same time,?embarrassing?the entities concerned.

Let’s look at the larger picture. Collectively, nine upper-layer NBFCs had a total asset of Rs 14.25 trillion in June – close to one-fourth of the sector’s total loan portfolio. In the past one year, between June 2023 and 2004, their credit growth has been close to 27 per cent. Retail loans account for at least 60 per cent of the loan portfolio of the upper-layer NBFCs.

The gross bad loans of this segment rose by close to 24 per cent in absolute terms, but in percentage terms, such loans have declined because of high credit growth. The amount written off by these NBFCs has also risen.

The total borrowings by nine NBFCs during this period have grown by almost 40 per cent – from around Rs 7 trillion to Rs 10 trillion. In percentage terms, the growth in borrowings from banks is double that of borrowings from the market.

The total loans of the middle-layer NBFCs are close to Rs 52 trillion. Their loan growth has been far lower – close to 12 per cent. Their exposure to retail loans, in percentage terms, is much lower than the upper-layer NBFCs. It’s around 23 per cent of total advances, up from close to 21 per cent a year ago.

Both gross and net bad loans of the middle-layer NBFCs have declined in absolute as well as percentage terms, but the amount of loans written off has risen handsomely – from around Rs 21,700 crore to Rs 32,100 crore.

Bank borrowings continue to be around 40 per cent of the total borrowings of this segment, but the growth in bank borrowing in the first quarter of the current financial year (FY25) has declined. It seems that after the increase in risk weight for unsecured loans, banks have become careful about lending to the middle-layer NBFCs, while their trust in the upper-layer NBFCs remains intact.

There are around 100 MFI-NBFCs – 25 of them belong to the middle layer and 75 are in the base layer. Their credit growth was around 23 per cent between June 2023 and June 2024. Both gross bad loans and write-offs have risen in the first quarter of FY25.

Overall, the regulator’s concern seems to be over retail loans, which form around 62 per cent of the advances of the upper- layer NBFCs and 55 per cent of middle-layer NBFCs. The gross bad loans, in percentage terms, have fallen in the first quarter of FY25, but the slippages are higher in retail loans, except for in education and vehicle loans. The worry is for gold loans, credit card receivables and MFI loans.

The NBFCs, which have been punished and are likely to be punished?should bring down the usurious interest rates, high fees and penalties without losing. They need to follow the norms both in letter and spirit.

This column first appeared in Business Standard.

The writer is a Consulting Editor with Business Standard and Senior Adviser to Jana Small Finance Bank.

Writes Banker's Trust every Monday in Business Standard.

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