Most of us have seen the news regarding RBI banning a few NBFCs from lending a fresh. I would like to share some context and reflection on this action.
On October 17th, RBI barred four NBFCsββfrom sanctioning and disbursing fresh loans starting October 21st. This followed reports that these institutions charged their borrowers excessive interest rates. The Morgan Stanley report observed that more regulatory action might follow in the sector.
How does RBI publicly hint at the concern before actual action through monetary policy?
In the monetary policy announcement on October 9th, Shaktikant Das emphasized that while the health of banks and NBFCs is strong, there are concerns. He praised NBFCs for robust credit growth but cautioned against unsustainable practices. He stressed:
- Avoiding an imprudent βgrowth at any costβ approach.
- Warning against chasing high returns on equity with aggressive business targets, unreasonably high processing fees and penalties.
- Urging NBFCs to review their compensation practices.
RBI gives enough warnings β direct and indirect
RBI has a history of issuing direct and indirect warnings to ensure financial stability. There are many instances where RBI had warned some NBFCs, without naming them, before taking any action.
Impact of removal of pricing cap a couple of years ago
In March 2022, RBI removed the pricing cap for microfinance loans, allowing lenders to set their interest rates, with the expectation that they would remain fair and transparent. Before the removal of the pricing cap, microfinance loans had a cap set at 12% points over the entityβs cost of funds, also called a spread. This was intended to ensure that interest rates remained fair and affordable for borrowers.
However, post-deregulation, some institutions misused this freedom. According to the Business Standard report, the four barred NBFCs had spread around 14%, resulting in interest rates of 26-28%.
Reason why RBI focuses on this regulation
Deregulation does not mean that the institutions can exploit consumers. RBI wants to maintain financial stability and protect consumers from predatory practices.
What RBI-regulated entities can learn from it?
NBFCs and other financial entities should take this as a stern reminder to prioritize sustainable business practices, strong risk management frameworks, and adherence to regulatory guidelines. They should ensure their growth strategies are prudent and customer-centric.
Why do financial institutions and borrowers need RBI and need to respect it?
RBI acts as a guide and enforcer, ensuring that financial institutions operate ethically and sustainably. Its role is crucial in maintaining the health of the financial system – which includes macroeconomy, banks, NBFCs and even borrowers. Thus, respecting RBIβs regulations and guidance helps ensure long-term stability and trust in the financial sector. At times, it gives a few warnings directly or indirectly. The institutions need to understand the purpose of such warnings and act accordingly. If they fail, they face RBIβs actions.
Concluding remarks
I believe that the lines between fair and unfair practices are often blurred while thinking of profits and returns. We need anchors like management, processes, shareholders, and regulators to guide us. Therefore, governance, ethics, and compliance become important. Even Governor Das highlighted the importance of compliance and risk management in his speech.
I’ve been writing about the GRC (governance, risk management, and compliance) framework on LinkedIn and my blog. I urge you to check those posts.
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