Today, a growing number of Non-banking Financial Companies (NBFCs) face immense pressure to drive higher returns. In the pursuit of this goal, some NBFCs are engaging in irregular practices, which can invite strict action by the Reserve Bank of India (RBI).
For instance, the RBI recently imposed restrictions on four NBFCs that were charging exorbitantly high interest rates to borrowers. These lenders can no longer sanction and disburse loans to new customers.
In another instance, RBI found that some Non-Banking Financial Company – Peer to Peer (NBFC-P2P) platforms were promoting loans as an investment product. They were also flouting the prescribed funds transfer mechanisms. In response, RBI intensified its oversight over all 26 registered NBFC-P2P platforms.
In this blog post, we spotlight RBI’s recent warning to NBFCs and the urgency with which NBFCs must course-correct to avoid the pitfalls associated with non-compliance.
We also explore how NBFCs can reap the benefits of technology to balance business growth with a compliance-first culture.
Snapshot of RBI’s Warning to NBFCs
The RBI Governor Shaktikanta Das recently issued a statement warning NBFCs against a “growth-at-all cost” culture. Here is a gist of the statement:
- The warning was issued to all NBFCs, including Microfinance Institutions (MFIs) and Housing Finance Companies (HFCs).
- Though the majority of the NBFC sector was following regulations, some businesses engaged in fraudulent practices to drive higher business returns.
- Examples of such practices include charging high interest and triggering excessive indebtedness for borrowers. These practices threatened the financial stability of businesses, as well as the well-being of borrowers.
- The RBI recommended that NBFCs assess their exposure to risk and, in particular, navigate the growth of the unsecured lending segment proportionally.
- The desired outcome of RBI’s warning was to encourage NBFCs towards self-correction. They can do so by thoroughly reviewing internal practices, cultivating a compliance-first culture, and adhering to fair practices.
Growing Importance of NBFC Compliance
The RBI has outlined a detailed regulatory framework for NBFCs. This framework is becoming more stringent due to the following reasons:
Exponential Growth of the Sector
NBFCs constitute one of the fastest-growing financial services categories. As of June 2024, 9306 NBFCs were registered with the RBI. In March 2024, the NBFC sector’s Assets Under Management (AUM) was pegged at INR 47 trillion and projected to surpass INR 50 trillion in FY25-25.
NBFC’s market credit market share also grew from just one-sixth in 2014 to one-fourth of the total credit share in July 2024. Such growth requires stringent regulation to avoid loan fraud, growth of NPAs, and to safeguard borrower security.
Focus on the MSME Sector
NBFCs play an important role in driving credit access for the underserved MSME sector. In particular, NBFCs have opened up avenues for micro-size businesses, which constitute 90% of the MSME sector.
They also make up 25% of the NBFC sector’s MSME portfolio. Stringent regulations and strong consequences for non-compliance help protect borrowers and prevent NBFCs from incurring losses.
Growing Volumes of Vulnerable Borrowers
NBFCs cater to large volumes of vulnerable borrowers such as farmers and first-time credit customers. For instance, daily wage earners and members of self-help groups are prime customers who gain credit access via NBFC micro-finance institutions.
This segment is more vulnerable to predatory practices and hence, needs more protection.
Growth of Unsecured Business Loans (UBLs)
The lending industry is experiencing early signs of stress due to the accelerated growth of Unsecured Business Loans (UBLs). The UBL segment saw a high growth rate of 67% in FY23, followed by 42% in FY24.
Lack of comprehensive analysis of a borrower’s creditworthiness is now resulting in growing delinquency levels.
Potential Outcomes for Defaulting NBFCs
Today, NBFCs that engage in predatory practices and do not comply with RBI’s regulatory framework are at greater risk of experiencing the following outcomes:
Payment of Fines
Failure to comply with regulations can result in businesses having to shell out large-scale financial payments in the form of fines. Such payments eat into a company’s profits.
Facing Penalties
Besides financial fallout, the RBI can impose penalties on NBFCs. For instance, they can prevent lenders from servicing new customers. Such actions impede faster, more sustainable business growth.
Investment in Financial Resources
Non-compliant NBFCs will need to invest adequate financial resources to manage the fallout. For instance, they may need to make investments in legal services, internal investigations, data security and recovery management, and reputation management services.
Loss of Reputation
When the RBI opens investigations into an NBFC, and if the company is consistently in the news, these outcomes can have a domino effect on an NBFC’s reputation.
For instance, the stock price may take a nose-dive, and investors may pull out of the operation. Existing and new customers may take their business elsewhere.
Shutdown of Business Operations
The company may eventually need to shut down all activities due to the non-sustainability of its operations. On the other hand, the RBI may have it shut down.
How NBFCs Can Harness Tech to Address Challenges
As NBFCs scale, those that make early investments in the right tech-enabled solutions have greater potential to do so sustainably and profitably.
For instance, the adoption of a specialised NBFC loan management system equips NBFCs to function more efficiently.
Here are some of the key advantages that come with the adoption of tech-enabled solutions:
- Automation of the entire loan management workflow, which, in turn, reduces errors, omissions, and duplication and boosts operational efficiency.
- In-depth analysis of a potential borrower’s financial health using a mix of alternative data and evaluation of every bank transaction.
- Superior fraud detection capabilities through the use of AI, which drastically reduces the potential for identity theft, loan fraud, and growth of Non-Performing Assets (NPAs).
- Customised solutions that equip NBFCs to serve customers with relevant and affordable loan solutions.
- A customer-centric debt recovery system that monitors repayments consistently and triggers debt recovery mechanisms early on. This approach helps businesses reduce loan delinquencies and recover debt faster.
- NBFCs can leverage predictive Data Analytics to bring more strategy and accuracy to decision-making.
- NBFCs can run their operations with lean teams that stay focused on driving revenues and profitability.
The Takeaway
The NBFC sector in India has huge potential to grow due to its focus on the MSME, which remains largely underserved in the area of credit access. By making early investments in the right technology, lenders can enable compliance with RBI’s regulations, risk management, and growth at scale.
Adopting this approach empowers lenders to build a strong foundation, paving the way for a sustainable, thriving business.
Finezza offers a comprehensive set of tools and solutions to manage your lending portfolio. Our end-to-end lending management solutions are trusted by brands like ftcash, Hiranandani Financial Services, gromor Finance, and UC Inclusive Credit, to name a few.
Finezza offers several key benefits for NBFCs:
- Automated Loan Management: Streamlines loan origination, processing, and disbursal with end-to-end automation.
- Enhanced Credit Assessment: Provides advanced credit scoring and risk management tools, enabling more accurate lending decisions.
- Regulatory Compliance: Helps NBFCs adhere to financial regulations with built-in KYC, AML, and credit bureau reporting features.
Book a demo to know more.
Leave a Reply