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New NBFC norms
Dr A K Sen Gupta
(This is the concluding part of the article titled "Wisdom of new NBFC regulatory norms" carried in Tuesday's edition)The history of financial-market regulation in the world has shown that such reactive behaviour often tends to over-react thus defeating the very purpose for which regulation is meant. Development of the market itself is a natural victim of such regressive regulation. For example, scrapping of repo-mechanism as a result of the security-scam in early 90s virtually resulted in death of vibrancy in money market operations. The stringency in regulation by Bank of England pursuant to the fraud in Barings Bank has reportedly caused considerable increase in work-load both for the central bank and the commercial banks. Though protection of the interest of the depositors and maintenance of the stability of the financial system are the prime objectives of any financial regulation, developmental aspects can not be overlooked. What is needed is to strike a balance between the two approaches.The
latest measures announced by the RBI concerning the regulation of NBFCs are a classic case of over-reaction by the central bank in the face of some isolated cases of fraud that may, in the long run, prove to be counter-productive. For example, in July 1996, the rates of interest that can be offered by NBFCs to the depositors were deregulated. In the last credit policy directives, this policy of interest-rate deregulation was extended to the commercial banks as well. The stipulation in the new policy guidelines prescribing a cap of 16 per cent per annum by way of interest to the investors on part of NBFCs is not only regressive but has also removed the concept of level-playing field among players in the financial intermediation market. While this cap may today appear to be attractive in view of comparably much lower rates being offered by the main competitors that is the banks, it may not remain so in case market interest rates go up in future. In addition, the move of the financial markets towards
deregulation has not only been reversed, but taken a shift towards re-regulation. Even the arbitrary fixation of ceiling of public deposits with reference to net owned funds (NOF) of a NBFC has placed these institutions at a position of great disadvantage. It is a well accepted fact that the financial intermediaries, by and large, are highly geared ones compared to their corporate counterparts. The average gearing ratio (debt to equity) of a bank in India is minimum at a level of 10 to 1. This includes the public deposits and other loans and borrowings. In terms of the recent guidelines of the RBI, even the highest rated NBFC can raise public deposit to an extent of 3 times of its NOF. By and large, banks while funding such NBFCs do not go beyond the level of 2:1 that is debt to be twice the NOF meaning thereby under the present circumstances, the maximum debt that cans be raised by a NBFC will be to the tune of 5 times its NOF. This could imply shortage of working funds for such companies in the short run.
Similar is the case with capital adequacy ratio which has been raised to 10 and then to 12 per cent to be achieved by 31st March, 1999 against that of 8 per cent applicable for banks. Prudence in regulation should not result in discrimination against a set of players that is the NBFCs making the whole concept of competition meaningless. As if this is not adequate, the Reserve Bank has cautioned the depositors to be circumspect and satisfy themselves about the financial soundness and health of the companies before placing their deposits. No such caution, though implied, has ever been issued for the banking sector meaning thereby such approach is purely discriminatory. The acceptable period of the deposits has also been prescribed between 12 months and 5 years; this is again improper not only in the light of the fact that banks can accept fixed deposits for a maturity period of 10 years, but also purely from the perspective of asset-liability management. This arrangement can result into both interest-rate
risk and liquidity risks because of mismatch in maturity between assets and liabilities. For example, it will be unwise for a NBFC to enter into a lending/investment/leasing decision for a period of more than five years. Lots of responsibility have been vested with the auditors of such companies as they have to submit a separate report to the board of directors giving certificate expressing their satisfaction regarding adherence to stipulations laid by the central bank. In addition, there is also an obligation on part of the auditor to report to the Reserve Bank in case there is some violation on part of the company in complying with any of the provisions stipulated by them. No doubt, auditors carry immense responsibility in bringing out the misrepresentations in the final accounts of the companies they audit. This issue also came to fore when the auditors of Barings Bank were taken to court of law for their failure to bring out the wrong deeds of the rogue trader. Nevertheless, the issue of monitoring of
compliance or otherwise with the stipulations of the central bank should be left to the latter rather than shifting the responsibility to a third party. In conclusion, it can be stated that the recently prescribed guidelines of RBI have obviously placed the existing NBFCs in a position of disadvantage compared to their banking counterparts. For any competition to be meaningful, two conditions must be satisfied; the playing ground should be even and the players should be armed with equal armoury. The second condition was never satisfied as banks still hold more than 85 per cent market share in the whole arena of financial intermediation in view of their superior network as well as long-standing goodwill. Now with these regressive guidelines, even the playing ground has been made highly uneven. The argument that the NBFCs should position themselves by creating a market niche does not hold good as many of them will be forced to close down on account of these guidelines. Possibly, the government is
contemplating to bring in the foreign players under the guise of these strict norms. The author is a professor in SP Jain Institute of Management & Research, Mumbai.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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