By 29 August, 2011

The Reserve Bank of India may increase lending and provisioning rules for financial firms that do not operate as banks, tightening regulations for an industry that has grown rapidly owing to light-touch regulation.

Non-bank finance companies (NBFCs) in India provide mostly small loans to consumers and businesses, but do not have the same capital requirements and sectoral exposure limits as banks.

In an effort to limit the impact of potential loan defaults and overexposure to inflation-sensitive sectors, the Reserve Bank of India has recommended in a report released on Monday that asset classification and provisioning rules for NBFCs be aligned with those that govern banks.

"The recommendations, in the long run, are going to be very good as it will help in containing the spillover risks in the banking sector," said I. Unnikrishnan, managing director of Manappuram Finance.

Fast growth in the loosely regulated NBFC sector since 1997 and the steady increase in bank loans to the sector has raised concerns that problems in the industry could spread to banks.

"In the short-run, there could be some minor hiccups -- like increasing capital requirements as that will increase the cost of capital for the company," Unnikrishnan said.

The RBI has proposed to increase the risk weights, or the amount of funds to be set aside, for capital markets lending to 150 per cent and to commercial real estate to 125 per cent, from 100 per cent for both sectors currently.

"The steady increase in bank credit to NBFCs over recent years means that the possibility of risks being transferred from the more lightly regulated NBFC sector to the banking sector in India can no longer be ruled out," the RBI said in its report.

The RBI also suggested raising capital requirements for NBFCs to a minimum Tier I capital adequacy ratio of 12 per cent from the current 7.5 per cent.

"There are some positive aspects like they have not restricted non-banks to be in any businesses," said Rajeev Jain, chief executive officer at Bajaj Finance, an NBFC of Bajaj Group.

NBFCs account for around 11 per cent of bank assets.

Deposit-taking NBFCs included Fullerton Financial Services, Mahindra & Mahindra Financial Services and Bajaj Finance, while units of JP Morgan and L&T Capital Holdings, Reliance Retail Finance, Nomura Capital, and Citicorp Finance, among others, were non-deposit taking NBFCs, the RBI release showed.

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