We cover why the RBI has been harsh on NBFCs lately.

The news

On the 17th of October, RBI issued a press release, sending a shockwave across the lending sector. It banned four Non-Banking Finance Companies (NBFCs) from disbursing loans:

  1. Asirvad Micro Finance Limited (a subsidiary of Manappuram Finance)
  2. Navi Finserv Limited (of Sachin Bansal)
  3. DMI Finance Private Limited (owning Zestmoney)
  4. Arohan Financial Services Limited

This crackdown highlights the RBI’s growing concerns about some aggressive practices in the lending sector.

Why did the RBI decide to ban their lending business?

1. Excessive Interest Rates: 
These NBFCs were found to be charging very high interest rates, which went against the RBI’s guidelines for fair and reasonable lending practices.

2. Irregularities in Loan Assessments:
These NBFCs did not correctly evaluate the borrowers’ household income and their ability to repay the loans, especially concerning small-value loans.

3. Evergreening of Loans:
They were trying to make their loan books look healthier than they actually were by giving a new loan to a borrower just to help them repay an existing one to avoid labeling it as a bad loan.

Interestingly, this came after the RBI showed concern several times in the past few months.

For instance, last week, RBI questioned the ‘growth at any cost’ approach of NBFCs. In June this year, it raised several red flags regarding consumer loans given by NBFCs and asked for closed monitoring of the same.

So what makes RBI stay so cautious about these issues and what could happen if left unchecked?

Well, it could create three major problems for India’s financial system.

Impact of lack of regulatory oversight

1. Financial Instability:
Loose measures can lead to an increase in the number of bad loans, weakening the financial health of these institutions.

2. Negative Impact on Borrowers:
Borrowers, especially those with lower incomes, could find themselves trapped in a debt cycle because of the high interest rates and evergreening practices.

3. Market Confidence & Investment Concerns:
A lack of regulatory oversight can create a perception of instability in the financial sector, hampering the sustainability of the strong financial system.

To conclude

While NBFCs play a crucial role in providing access to credit, especially to those who may not be served by traditional banks, their rapid growth and aggressive lending practices can create severe consequences if left unregulated.