What was the warning given by RBI to NBFCs in the October monetary policy?

The RBI governor gave a pat to NBFCs (non-banking finance companies) in the MPC statement, acknowledging that they have recorded strong growth, enabling the flow of credit to the remote areas and to the unbanked segments, helping financial inclusion. But, it gave a warning to some NBFCs who are chasing rapid growth in business by following irregular practices. The central bank warned that such growth is unsustainable.

This warning should be seen in the context  of RBI’s recent actions against NBFCs such as JM Financial and IIFL in the recent past, asking them to cease operations in certain segments.

Which categories of NBFCs has RBI specifically mentioned in the monetary policy?

The RBI has said that microfinance institutions (MFIs) and housing finance companies are pressured by their investors to show large profits. This is driving them to charge usurious rates of interest, which become even more exorbitant when the processing fee is added. The central bank has also pointed to frivolous penalties on consumers to drive returns.

What has been the RBI’s approach in dealing with malpractices in advancing credit in the recent past?

The central bank has been closely monitoring the rapid growth in loans to individuals since the pandemic. The problem is that within retail loans, unsecured personal loans and credit card loans have shown sharp growth, increasing the risk for lenders. Two, the retail segment was edging out loans to corporates and industries. Third, many lenders began using unsavoury practices to drive retail loans.

The central bank has been increasing its scrutiny of the retail loan books in recent months.  Wherever any regulatory lapse was found, the lenders were given time to rectify them. If the lenders were found non-compliant after the end of the time given, action was taken against them, such as restricting their operations in some segments, imposing monetary penalties, etc.

What has the RBI said about the employee incentives given in NBFCs?

The central bank says  that the high growth in NBFC credit could be more due to the ‘push effect’, as NBFC employees are being given targets for driving business. This could result in loans being given to sub-prime borrowers who do not have the capacity to repay them. Further, to mask the non-performing assets, these loans are rolled over into fresh loans, further boosting the credit growth numbers.

RBI’s review of books of NBFCs has shown malpractices such as many  accounts being linked to the same PAN number, fake IDs being used to open accounts, some accounts being closed within a few days of opening and so on.

The central bank has, therefore, told NBFCs to review their employees’ compensation packages. If a large proportion of a variable pay linked to customer acquisition, it can lead to the deployment of unsavoury practices to show growth.

Are such malpractices rampant across NBFCs?

No, the governor clarified in the press conference that the lapses were seen only in some entities and the central bank is engaging with them bilaterally. But it has issued a warning to all entities in the sector to put appropriate checks in place.

What is RBI’s concern regarding inoperative deposits, mule accounts, etc?

A recent review of FATAF (Financial Action Task Force) to prevent money laundering and terror financing flagged that the systems to check money laundering were very weak in small finance banks, co-operative banks, and other smaller lending institutions.

Deposit accounts which are not operative are easy channels through which money can be laundered. Similarly, miscreants can use mules or people willing to allow accounts to be opened in their names to create fake accounts through which they can carry out nefarious activities.

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