The Indian financial system is anchored by two major intermediaries: traditional banks and Non-Banking Financial Companies (NBFCs). While banks operate under the Banking Regulation Act, 1949, NBFCs are companies registered under the Companies Act, 1956, which primarily engage in lending, investments, and other financial services which are governed by Chapter III B of the Reserve Bank of India Act, 1934. Over the years, both entities have played complementary roles in driving financial inclusion and supporting economic growth. However, as India's financial sector becomes more integral to the country's ambitious development goals, the Reserve Bank of India (RBI) has introduced a wave of regulatory reforms, marking a shift towards tighter oversight that both banks and NBFCs must now prepare to navigate.
The Shift Towards Greater Regulatory Vigilance
RBI's growing concern about unsecured lending and financial stability has placed both banks and NBFCs under a sharper regulatory microscope. The gross non-performing assets (GNPA) ratio for banks has improved to a multi-year low. However, the central bank has flagged a potential risk build-up, particularly in unsecured personal loans and advances to large borrowers, which could lead to "latent stress" in the sector. In response, the RBI has taken a proactive stance. Measures include tightening norms for consumer credit, requiring higher risk weights for unsecured loans, and introducing a Scale-Based Regulatory (SBR) framework for NBFCs. The overarching aim is to preemptively address systemic vulnerabilities before they threaten macroeconomic stability.
NBFCs: From Light-Touch to Scale-Based Regulation
Traditionally, NBFCs enjoyed a more relaxed regulatory environment compared to banks. This allowed them to flourish and fill critical credit gaps, particularly in underserved sectors such as MSMEs and rural financing. However, the 2021 introduction of the Scale-Based Regulation (SBR) signaled the RBI's intent to bring NBFCs closer to the regulatory rigor faced by banks.
The SBR framework categorizes NBFCs into four layers —base, middle, upper, and top, depending on their asset size, business activity, and perceived risk. Larger NBFCs in the "upper layer" face requirements akin to banks, including stricter capital adequacy norms, governance standards, and risk management practices. This transition, while aiming to safeguard financial stability, imposes operational and compliance challenges which many NBFCs may not be fully equipped to handle yet.
A Funding Stress Test for NBFCs
With these new regulations, NBFCs also face an impending challenge in their funding strategy. According to a Business Standard report, many NBFCs heavily rely on banks for funding, accounting for over 40% of their borrowings. As banks become more cautious in lending to NBFCs (especially in the wake of heightened regulatory risk weights), a potential liquidity crunch may emerge.
The situation is further complicated by RBI's efforts to curb regulatory arbitrage, where NBFCs could access bank-like advantages without equivalent oversight. Consequently, NBFCs must pivot towards diversified and longer-term funding sources, such as capital markets or foreign borrowings, which may be more expensive or harder to access for smaller players.
Digital Disruption and Readiness for 2030
Adding another layer of complexity is the ongoing digital transformation in India's financial services ecosystem. The digital adoption by NBFCs and banks, driven by UPI, digital lending, CBDCs, and fintech collaborations, is reshaping the financial landscape. With the growing digitization of credit disbursement, credit scoring based on alternative data, and real-time KYC, regulatory frameworks must evolve to supervise these innovations without stifling them. This evolution, however, introduces new risks such as data privacy, cybersecurity, algorithmic biases in credit underwriting, and third-party dependencies. The RBI's oversight must now straddle both traditional prudential norms and emerging tech-driven vulnerabilities. For banks and NBFCs, this means investing heavily in RegTech (regulatory technology), risk analytics, and cyber defense infrastructure to remain compliant.
Towards a Harmonized Regulatory Architecture
A broader trend emerging is the convergence of regulatory standards across banks and NBFCs. With the RBI increasingly narrowing the gap in capital, liquidity, and governance norms, the distinction between the two sectors is beginning to blur. This trend is in line with international practices such as the Basel III norms, which emphasize uniformity in risk management across financial entities regardless of their form. Yet, this harmonization comes with trade-offs. For banks, greater scrutiny of their off-balance-sheet exposures to NBFCs may limit their risk appetite. For NBFCs, increased compliance costs could impact their profitability and agility. Therefore, policy design must strike a balance between financial stability and credit flow continuity.
Recommended Read: A Framework for Governance and Regulatory Risk Mitigation
Conclusion
The RBI's next wave of regulatory disruption is neither arbitrary nor unexpected. It is a necessary recalibration to align the financial sector with India's aspirations of becoming a $7 trillion economy by 2030. The central bank's forward-looking approach aims to ensure that rapid credit expansion does not come at the cost of financial soundness. For banks, this means upgrading risk models, reducing overexposure to unsecured lending, and embracing digital governance. For NBFCs, it calls for strategic consolidation, technology integration, capital augmentation, and transparent disclosures. Ultimately, preparedness will depend not just on regulatory compliance, but on institutional resilience, adaptive strategy, and visionary leadership. Those who evolve swiftly will not just survive the oversight wave, instead, they will ride it to lead the next era of financial innovation.
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