Opinions are divided on whether the Reserve Bank of India (RBI) was justified in its latest regulatory direction to four NBFCs (non-banking finance companies) asking them to ‘cease and desist’ from sanctioning and disbursing loans. Of the four NBFCs, two are microfinance players and two are investment and credit companies offering retail and MSME loans. RBI has cited their lending rates and spreads not being in line with its microfinance regulations and Fair Practices Code violations in support of its order.

In addition to their ‘usurious’ loan pricing, RBI has found the NBFCs not adhering to its income and asset classification norms, and not providing mandated disclosures to borrowers. While RBI has been criticised for being too harsh on the NBFCs, experience in the last couple of years suggests that it resorts to this extreme measure only when repeated warnings fail to yield results. Some new-age lenders do seem to take compliance rather lightly when it comes to chasing new segments of borrowers. RBI officials have warned lenders not to push the limits on unsecured retail lending.

However, if the NBFCs concerned are to take remedial action it is important for RBI to clarify what it considers ‘usurious’ on the pricing of loans. Prior to March 2022, there was very little ambiguity on this because RBI regulations had a clearly defined cap on microfinance loans (officially defined as collateral-free loans to households with less than ₹3 lakh annual income). The cap was set at a 10-12 percentage point margin over the lender’s cost of funds or 2.75 times the base rate of the top five commercial banks, whichever was lower. In March 2022 however, noting that most lenders were treating the rate cap as an informal benchmark, RBI did away with the cap and mandated that lenders not charge ‘usurious’ rates. However, recent reports of some NBFCs extending loans at 40 per cent plus with additional penalties and fees, suggest that a section of the industry is flouting the spirit of this regulation. Nor has competition between lenders, as RBI hoped, helped lower borrowing costs for really needy borrowers. RBI should perhaps consider going back to explicit norms on lending rates for microfinance loans. Given that two of the NBFCs affected by its order are not microfinance lenders, RBI also needs to clarify if it is opposed to high rates only with respect to microfinance loans or frowns upon them for all borrowers. The latter may not be a tenable position. With savvier retail borrowers relying on loans for conspicuous consumption and risky activities such as derivatives trading, capping rates for all borrowers entails moral hazard. Lenders also need freedom to price loans to reflect default risks.

Finally, when putting out ‘cease and desist’ orders, RBI also needs to bear in mind that many NBFCs now raise retail money through the bond markets. Sudden business curbs on NBFCs with retail bond exposure can undermine confidence in this still-nascent market.

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