Proposed regulatory norms for NBFIs will enhance stability: Fitch

Proposed changes to India's regulatory framework for non-bank financial institutions (NBFIs) or NBFCs are likely to enhance the sector's stability, Fitch Ratings said on Wednesday.

The longer-term impact of such reform would also depend on its implementation, robust regulatory and market scrutiny, it said.

"We believe that the reforms would preserve NBFIs' niche business models, and could improve the funding environment for some entities by strengthening investor confidence in the sector," the ratings agency said in a note.

"For the sector as a whole, the proposed measures should strengthen governance and risk management, although we do not view these areas as major credit weaknesses for Fitch-rated Indian NBFIs."

As per the note, the proposed new norms entail larger entities to face enhanced disclosure requirements, tighter risk and capital management requirements, which would likely be credit positive.

The scale-based regulations, said the report, reflect calls for closer supervision of large NBFIs that have grown more systemically significant.

"We view proposals to appoint auditors by rotation, as well as requirements to disclose information such as the incidence of covenant breaches and asset quality divergence as credit positive."

"Unlike banks, many NBFIs have appointed the same auditors for many years. In addition, lending to directors and senior employees would be restricted, reducing governance risks."

Besides, requirements to implement a core banking solution and introduce an internal capital adequacy assessment process (ICAAP) could further strengthen the framework for monitoring and managing risks.

"Most large NBFIs' systems are already integrated with banks and payment portals, and we believe additional costs to meet the core banking solution requirement would be manageable."

"However, the measure could pose a more significant expense for mid-sized NBFIs."

Furthermore, the report pointed out that for NBFIs in the 'Upper Layer', listing may be made mandatory.

"This would affect only a few corporate-backed NBFIs, and should not present a challenge given their parents' experience in capital markets."

"In general, business models should not be significantly affected, but some lending activities could be curtailed by the suggested changes, especially in real estate."

Additionally, the RBI is looking to restrain lending to early-stage development projects that have not yet received regulatory approval, and has proposed added internal controls for lending against land acquisition, Fitch said.

"Some entities have built up exposures to these risky areas in recent years, which have become a point of vulnerability for the sector. The suggested new rules could curb a further run-up in such exposures in the longer term.

In addition, NBFIs with assets below Rs 10 billion would continue to operate under current frameworks, but additional rules aligning non-performing loan recognition and a new leverage cap of '7x' would add to regulatory robustness.

"The central bank further highlighted the need for a resolution framework for failing NBFIs. This would be another important element in the regulator's financial stability toolkit."

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