RBI Study sought Cap on Borrowings by Non-banking Finance Companies from Banks

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Reserve Bank of India (RBI) raised red flags over the high dependability of non-banking finance companies (NBFCs) on the banking system because the apex bank feels that the higher dependence would mean systemic vulnerability in the context that NBFCs are involved in higher risk activities vis-à-vis the banking system.

The higher borrowings of NBFCs from the banking system tend to raise concerns about their liquidity position. More so, if such reliance happens to increase further.

The banking system's exposure to NBFCs-D (deposit taking) was observed to have considerably increased over the years. The concerns to be further accentuated in case the banks' own liquidity position becomes tight at the time of crisis or even at crisis like situation.

The consolidated balance sheets of NBFCs (both the categories i.e. deposit taking and non-deposit taking and systemically important companies) revealed that more than 68 per cent of the consolidated balance sheet constitutes borrowings. 30 per cent resources of the total 68% are borrowed from banks and financial institutions as at the end of March 2011.

Borrowings by way of debentures issued by the NBFCs constituted around 33 per cent and of which a sizeable portion is subscribed by the banking system.

Non-banking finance companies (NBFCs)
NBFCs do not have any exposure limit on their capital market related activities unlike the banking system. Moreover compared with regulation of banking sector, NBFCs in general, are less stringently regulated as pointed out by various Committees and Working Groups.

The total size of the balance sheet of NBFCs-ND-SI (non-deposit taking and systematically important) reached to Rs 730366 crore as at the end of March 2011, from Rs 170957crore as at the end of March 2005 growing more than four fold.

The NBFCs-D which is a better regulated segment as compared to NBFC-ND-SI makes up to just around 14 per cent of the latter. The systemically important non-deposit taking NBFCs have grown faster by nearly 7 fold as at the end of March 2011 when compared with the size of deposit taking NBFCs.

As NBFC-ND-SI companies are not permitted to raise public deposits, borrowings constitute the major component of their liabilities at around 74 per cent by end of March 2005, coming down to around 65 per cent by end-March 2009 on account of the global financial crisis, and thereafter rose to 69 per cent by end-March 2011.

RBI Study
According to a RBI study, non-deposit taking NBFCs is likely to lead to more systemic risks, owing to their reliance on banks for funding needs. The study discouraged NBFCs from raising public deposits, these become non-deposit taking, while increasingly substituting public deposits with borrowings from the banking system.

Non-banking financial companies heavily depend on banks for meeting their funding needs, as many of these are not allowed to raise deposits. However, by borrowing through banks, these indirectly use public deposits, on a much larger scale than by raising deposits on their own.

The study mentioned that due to high inter-connectedness, the vulnerability of the financial system may increase due to high inter-dependability.

Apart from suggesting a cap on the borrowing limit of ND-NBFCs from banks, the working paper also suggested NBFCs should diversify their sources of funds.