India’s Non-Banking Financial Companies (NBFCs) have started showing significant improvements after stricter regulations were introduced by the Reserve Bank of India (RBI) in 2022. A recent study conducted by economists from the RBI reveals that the sector has bounced back, but it also highlights areas where NBFCs need to be cautious, particularly in managing cybersecurity and climate-related risks.
Impact of RBI’s Scale-Based Regulations (SBR)
The RBI implemented Scale-Based Regulations (SBR) for NBFCs in October 2022, which brought tighter oversight and improved governance in the sector. This has led to a visible improvement in performance metrics. The study found that the gross Non-Performing Asset (NPA) ratio, which was between 4.4% and 10.6% in December 2021, dropped significantly to 2.4% to 6.3% by December 2023.
Profitability on the Rise
According to the study by the RBI’s Department of Economic and Policy Research, profitability indicators such as Return on Assets (ROA) and Return on Equity (ROE) are steadily improving. By December 2023, NBFCs showed a consistent double-digit growth in loans, adequate capital levels, and a reduced delinquency ratio. This positive trend is a testament to the resilience of the sector under the SBR framework.
The RBI’s recent move to expand Prompt Corrective Action (PCA) norms to government-owned NBFCs is also expected to further strengthen the sector’s foundation. NBFCs are diversifying their funding sources and moving away from an over-reliance on bank borrowings, which has helped the sector remain robust despite increased risk weights on loans from banks to NBFCs.
Key Risks: Cybersecurity and Climate Change
Despite these improvements, the RBI study cautions that NBFCs must remain alert to the rapidly evolving financial landscape in India. Emerging risks like cybersecurity threats and climate change pose significant challenges for the sector. As digital transformation accelerates, NBFCs need to invest in robust cybersecurity measures to protect their operations and customers. Additionally, climate-related risks are becoming increasingly important for the financial industry, and NBFCs will need to incorporate climate risk management into their business models.
A Focus on Risk Management
The RBI study emphasizes that risk management, compliance, and internal audits are crucial in ensuring the long-term sustainability of NBFCs. As these financial institutions play a more significant role in India’s financial system, they must take proactive steps to identify potential risks and maintain a secure, sustainable growth path.
