Regulating NBFCs: Balancing responsibility and accountability

Indian NBFCs
NBFCs are catalysts of financial transformation, and their regulation holds the key to economic growth with stability.

In the vast ecosystem of the financial world, the Non-Banking Financial Companies play a unique role within its respective sector. It is important to recognise that NBFCs are not competitors, but partners of the traditional banking system. During the period between 2008 and 2018, the management of NBFCs has been commendable, with their operations primarily focused on specific sectors like housing and gold. However, it is imperative to understand that regulation plays a pivotal role in governing the activities of these entities, ensuring responsible and accountable functioning.

The presence of regulations serves as a framework, offering guidelines to ensure the smooth functioning of NBFCs. However, the mere existence of regulations is insufficient to fully control and regulate these entities. The key lies in the effective implementation of these regulations.

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Effective regulation of NBFCs

Effective implementation necessitates translating regulatory requirements into actionable steps and consistently enforcing them across the NBFC sector. This requires a proactive approach from regulatory authorities, including regular monitoring, inspections, and audits of NBFCs to ensure adherence to established rules and standards. Swift and appropriate action must be taken against any violations or non-compliance discovered during the monitoring process.

Additionally, effective implementation calls for the establishment of robust mechanisms to promptly report and address any breaches or irregularities. Clear channels of communication between regulatory authorities and NBFCs should be established, facilitating the reporting of potential violations by employees, customers, or other stakeholders. Timely and accurate reporting enables regulatory bodies to respond swiftly, taking necessary measures to mitigate risks and protect the interests of investors and the broader financial system.

Moreover, ensuring effective implementation of regulations requires regulatory agencies to have adequate resources and expertise. Well-trained staff possessing the necessary knowledge and skills are essential to understand the intricacies of the NBFC sector and effectively assess compliance. Investment in technological infrastructure and systems is also crucial, enabling efficient monitoring, data analysis, and risk assessment.

Collaboration and coordination among the central bank, securities regulator, and other relevant authorities are key to effective implementation. Sharing information and engaging in interregulatory cooperation enhance supervision, helping identify potential risks or issues that may transcend different sectors or entities. Especially for systemically important companies, the exchange of information between regulators is crucial to ensure comprehensive risk assessment.

Regulatory bodies such as PFRDA, SEBI, and RBI should be involved to effectively regulate NBFCs. Establishing an inter-regulatory forum for discussions related to such companies is critical to address the existing gaps in the system, where regulators might lack sufficient information or fail to recognize important aspects when approached by stakeholders.

Recognizing warning signs and potential risks within companies is a key responsibility of regulators. However, the current regulatory framework lacks an active platform for effectively managing and addressing company information. Additionally, the rise of cybercrime poses a significant challenge, leaving regulators in a vulnerable position, only able to respond after the damage is done.

The interconnected nature of the global village further complicates the task of regulators in preventing such crises. To tackle these challenges, the implementation of AI-based supervision can aid in detecting red flags, averting crises, and enabling regulators to intervene before asset-liability mismatches occur in NBFCs. This is particularly important in areas like education loans, which have demonstrated harmful impacts in specific regions.

Significant coordination among regulators is required, where they should meet and collaborate to address the issues at hand. It may not be needed at the highest level, but at levels where they can effectively tackle and resolve problems. Furthermore, enhanced supervisory practices, coupled with necessary assistance, are required.

It would be advantageous for India to establish a centralized supervisory entity that ensures consistent supervision across different companies and entities. Proper training of individuals to identify and address problems is of utmost importance. Additionally, regulations should encompass the entire digital space, considering the future conflicts that will inevitably arise online.

While NBFCs genuinely strive to thrive, there may be a few instances tarnishing their reputation. In Uttarakhand, for example, entities like Ram Singh Brisht have emerged as reliable sources for education loans and housing loans. Given the limited presence of banks in towns like Ram Singh Brisht’s, there is a need for a cooperative relationship between NBFCs and banks.

Larger banks and smaller NBFCs can join forces to support one another, bridging the gap and providing financial services to underserved regions. NBFCs are an integral part of the financial landscape. Their efficient functioning and effective regulation can contribute to the stability and growth of the overall economy.