The Reserve Bank of India’s (RBI) proposal of restricting specific real estate funding by non-banking financial companies (NBFC) may strengthen their balance sheets but will not address their funding and liquidity issues, said a report by Moody’s Investors Service.
Last week, RBI released a discussion paper in which it proposed a scale-based regulatory approach linked to the systemic risk contribution of shadow lenders.
Moody’s in its report said, “if implemented, the regulations will result in companies becoming more resilient to credit shocks. However, the proposals do not address NBFCs’ funding and liquidity.”
The investor service said that the proposal will commit the largest 25-30 NBFCs to regulations similar to banks regarding capital, credit concentration and governance.
“If implemented, the regulations would result in the companies becoming more resilient to credit shocks. However, the proposals do not address NBFC’s funding and liquidity, the key credit weakness of the sector,” Moody’s said.
It noted that the proposed new regulations would result in largely harmonised rules between banks and NBFCs on capital and leverage, which would reduce the regulatory arbitrage opportunities for NBFCs against the banks in their lending decisions.
However, no changes are proposed to the NBFCs’ current lighter liquidity rules. Banks are subject to strict regulations on maintaining a minimum cash reserve ratio and statutory liquidity reserve, which are not imposed on NBFCs.
“This means the proposal does not address the key weakness of the NBFCs; the sector will continue to pose risks to banks’ asset quality because banks are the largest lenders to the NBFCs,” it said.
The paper has proposed the regulatory framework of NBFCs based on a four-layered structure- base layer (NBFC-BL), middle layer (NBFC-ML), upper layer (NBFC-UL) and top layer.
Moody’s said if the proposal is implemented “the largest 25-30 NBFCs will be classified as NBFC-Upper Layer (NBFC-UL) and would need to maintain a minimum Common Equity Tier 1 (CET1) ratio of 9 per cent compared with 8 per cent for banks.”
They will also be subject to the similar rules that already apply to banks, such as a maximum leverage ratio, standard asset provisioning, credit concentration and exposure limits, corporate governance and group structure.
The NBFCs will need board-approved policies for concentration in riskier sectors such as real estate, which has been a source of asset quality problems for NBFCs.
“We expect most rated NBFCs will be classified as NBFC-UL,” said the Moody’s report.
The banking regulator is proposing to initially keep the NBFC-top layer empty, but will move companies into this category if it sees elevated credit risk in those companies, it said.