The Reserve Bank of India's move to allow banks to buy loans from NBFCs — and treat the process as priority sector lending — represents a slight relaxation in the tight framework of regulations that now govern the non-banking financial sector. This will not only make the funding window for NBFCs a little more secure, it will also help prevent interest costs from spiralling higher for those who borrow from such NBFCs. When the RBI announced two months ago that bank lending to NBFCs would no longer qualify as priority sector lending, that was a blow to the industry. The RBI's reservations were about the end use of funds or their misuse. Funds classified as priority sector lending were going elsewhere and the money was misused by some NBFCs. More recently, one of the causes for concern has been the rapid growth of the gold loan business of a couple of NBFCs.
NBFCs have also come under the scanner because of opportunities for regulatory arbitrage. While banks have traditionally functioned under tight regulatory control and supervision, the former enjoyed a shade more freedom and flexibility. This has often led to banks and industrial groups lending money through an NBFC to avoid closer scrutiny. No one can quarrel with the RBI's intention to get banks to lend directly to the priority sector. However, ground realities being what they are, it makes sense for banks to collaborate with NBFCs and see their role as complementary, rather than competitive. To some extent, this was happening, as banks did chase NBFCs in an effort to buy up their portfolios and thus fulfil their priority sector targets. (NBFCs largely served the single-truck owner market and this qualified as priority sector lending). This situation changed to some extent when the priority sector tag was removed. NBFCs engaged in pure asset financing found their access to funds getting costlier and their clients bearing a higher burden. Given the current environment of a looming slowdown in the economy, higher financing costs can only further decelerate growth in the commercial vehicles industry. The point these NBFCs are making is that their funding of trucks and tractors has been a significant contribution to the goal of financial inclusion — long before the term became fashionable. Now, they think they are being penalised for the sins of a few. Arguably, the banks, especially private and foreign banks, would have struggled to meet their priority lending targets if the earlier rule had stayed. Given their limited network and reach in rural areas, these banks can now invest in securitised paper of NBFCs or buy their loans to fulfil statutory obligations. So, this relaxation will also do these banks some good.