India’s NBFI regulatory changes to strengthen sector stability, says Fitch

The longer-term impact of such reform will also depend on its implementation. Robust regulatory and market scrutiny will be key in holding entities to higher standards.

   
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The proposed changes to regulatory framework for non-bank financial institutions (NBFIs) unveiled in the Reserve Bank of India’s recent discussion paper are likely to enhance the sector’s stability, according to Fitch Ratings.

“We believe that the reforms will preserve NBFIs’ niche business models and can improve the funding environment for some entities by strengthening investor confidence in the sector,” it said.
“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.”

The longer-term impact of such reform will also depend on its implementation. Robust regulatory and market scrutiny will be key in holding entities to higher standards.
Larger entities face enhanced disclosure requirements besides tighter risk and capital management requirements which will likely be credit positive. The scale-based regulations reflect calls for closer supervision of large NBFIs that have grown more systemically significant.

Fitch said the moves to strengthen risk controls and frameworks should be manageable for Fitch-rated NBFIs. For example, they should already comfortably meet the suggested requirement for ‘upper layer’ NBFIs to maintain a minimum common equity tier one ratio of 9 per cent.
Requirements to implement a core banking solution (credited for improving efficiency and reducing operational risks in banks) and introduce an internal capital adequacy assessment process can further strengthen the framework for monitoring and managing risks.

Most large NBFIs’ systems are already integrated with banks and payment portals. “We believe additional costs to meet the core banking solution requirement will be manageable. However, the measure can pose a more significant expense for mid-sized NBFIs,” said Fitch.
In general, business models should not be significantly affected, but some lending activities could be curtailed by the suggested changes, especially in real estate.

The suggested reform will also raise NBFIs’ standard provisioning requirements on commercial real estate lending to be in line with those for banks, said Fitch.