Context
The Reserve Bank of India’s recent bulletin highlights the resilience of the Non-Banking Financial Companies (NBFC) sector under the Scale-Based Regulations (SBR) framework.
Overview of the NBFC Sector
The NBFC sector too has remained responsive to this change: credit growth rates are well over the double-digit levels, capital adequacy ratios are largely healthy and NPAs have been cut significantly. Further, post the SBR framework implemented in October 2022, the gross NPA ratios have seen a huge upliftment. By December 2023, these ratios have come down to between 2.4% and 6.3% in contrast to December 2021 4.4% to 10.6% ratios. Such improvement implies that upstream risk management and the quality of the assets of the sector has improved.
Key Performance Indicators
Credit Growth
The NBFC sector has maintained strong credit growth throughout 2023, driven by several factors:
- Diverse Funding Sources: In order to manage their risks linked to the increasing bank’s loan rates, NBFCs have modified sources of funds. This comprises secured retail credit which is gold loans, vehicle loans and housing loans.
- Expansion into New Markets: The said sector has also ventured into industrial and service industries to boost its overall talented seeded growth patterned trend.
Profitability Metrics
The profitability of NBFCs has improved significantly, as indicated by:
- Positive trends of the Return in Assets (RoA) and Return on Equity (RoE).
- Better sovereign and subordinate gross NPAs have improved the overall performance and profitability in multilayer NBFCs.
Regulatory Compliance
Some of the top NBFCs recognized as belonging to the Upper Layer under SBR schematic include the likes of LIC Housing Finance, Bajaj Finance, L&T Finance among others. These firms have either been able to meet or have started processes of CATO – compliance with the regulatory necessities. The extension of the norms of PCA (Prompt Corrective Action) to the government owned NBFCs is likely to add more credibility to the regulators and also to the financial prudency of the division.
Regulatory Framework: Scale-Based Regulations
The SBR framework specifies channels of NBFC based on the size, systemic impact and risk taking capacity of NBFCs. This differentiated structure enables administrative standards that improve assets and capital mechanisms and risk management procedures.
Key components of this framework include:
- Enhanced Risk Management: According to RBI, NBFCs need to step up on the risk front to better manage their environment for changes in market scenarios.
- Financial Assurance Functions: INTERNAL AUDIT AND COMPLIANCE For organizations to be able to provide resilience given the dynamic financial environment they have to ensure compliance to internal audit and compliance measures.
Emerging Risks and Challenges
Despite the positive outlook, several emerging risks require attention:
- Cybersecurity Threats: NBFCs are also at risk since, with the expansion of digital platforms, they have become vulnerable to cyber risks. Ensuring the protection of the growing amount of financial data requires enhancing cybersecurity systems.
- Climate Risks: The threat that climate change brings to the financial industry has new and unique implications for NBFCs. Climate change will become more relevant and evident and therefore analysing the climate-related risks to businesses will be important for organisations’ sustainability in the future.
- Evolving Regulatory Environment: With the emergence of new regulation, NBFCs have to be always in line with the regulation changes to be able to cope up with the risks arising out of new regulations.
Conclusion
This resilience of the NBFC sector under the hood of scaled based regulations is quite a signal of its confidence and growth possibility in the Indian financial market. Due to better quality of assets, strong credit momentum and sound compliance strategy the sector remains better prepared for the future. However, addressing emerging risks such as cybersecurity threats and climate change will be crucial for maintaining stability and fostering sustainable growth in this dynamic environment. The proactive approach taken by NBFCs in diversifying funding sources and enhancing risk management practices will be key drivers in navigating these challenges effectively.
Source: The Hindu