Non-Banking Financial Companies (NBFCs) are an integral part of the financial system, providing financial services to various sectors of the economy. However, like any other financial institution, NBFCs need to be regulated to ensure that they operate in a safe and sound manner, and protect the interests of their stakeholders, especially borrowers. The Reserve Bank of India (RBI) regulates the operations of NBFCs and has laid down various guidelines and restrictions on their lending practices.
In this article, we will discuss the RBI’s Regulatory Restrictions on Loans and advances by NBFCs and their impact on the financial system and borrowers.
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Meaning of NBFCs
NBFCs full form is Non-Banking Financial Companies. These are financial institutions that gives a wide range of financial services. Such as advances, hire-purchase, loans, insurance, leasing, and other services similar to banks. However, unlike banks, NBFCs are not authorized to accept deposits from the public.
It plays crucial role in giving financial services and credit to individuals and businesses. That may not have access to traditional banking services. They are governed by the RBI as per RBI Act, 1934. The guidelines and regulations proposed by the RBI from time to time. NBFCs have become a significant part of the Indian financial system and contribute vitally to the growth of the economy.
Brief about Loan and advances
Loan and advances are a credit facility given by financial institutions like banks and NBFCs to borrowers for a particular time. A loan is a kind of credit facility where a lump sum amount is disbursed to the borrower, and the borrower needs to repay the loan amount with interest.
Advances are also credit facility, where the borrower can avail of funds on a continuous basis up to predetermined limit. Loans and advances are provided to individuals, businesses, and organizations for various purposes. These purposes are personal consumption, investment in assets, working capital requirements, and other operational expenses.
Exclusion list
According to the guidelines of RBI, the term loans and advances does not include loans and advances against:
- Fixed deposits
- Car advances, housing loans, etc. are provided to the NBFCs employee as per scheme applicability to employees.
- Government securities
- Stocks and shares
- Life insurance policies.
Regulatory restrictions on loans and advances by NBFCs
Loans and advances are the most significant regulations, which is imposed by the RBI on NBFCs. Here are some of the regulatory restrictions on loans and advances by NBFCs:
- Rate of interest: NBFCs are needed to charge interest rates, which are reasonable and fair to the borrowers. The RBI has mentioned a fair practices code for NBFCs that outlines the principles of transparency, responsible lending and protection of customers.
- Capital Adequacy: NBFCs are needed to maintain a minimum level of Capital Adequacy Ratio (CAR) to make sure that they have appropriate funds to meet their financial obligations. The minimum CAR for NBFCs is 15% according to RBI instructions.
- Non-Performing Assets (NPA) Classification: NBFCs are required to divide their loans and advances as performing or non-performing based on their repayment status. The RBI has mentioned in their guidelines about NPA’s division and NBFCs need to follow those.
- Priority Sector Lending: NBFCs are required to lend some percentage of their loans to priority sectors. These sectors are Micro, Small, and Medium Enterprises (MSMEs), affordable housing, and agriculture. The present objective for priority sector is lending by NBFCs is 40% of their whole lending.
- Exposure Limit: NBFCs are restricted in case of the amount of exposure. They can have to a single borrower or group of it. The exposure limit for NBFCs is 15% of their owned funds for a borrower and 25% for a group of borrowers.
- Disclosure requirements: NBFCs are needed to disclose many details in relation to their functions. It involves their lending policies, risk management, and financial performances. These disclosures’ objective is liable for accountability and transparency in the NBFCs functions.
Why RBI imposed these regulatory restrictions on loans and advances by NBFCs?
The RBI has imposed regulatory restrictions on loans and advances by NBFCs to make sure of its stability and soundness of the financial system. It also safeguards the borrower’s interests. Here are some of the reasons why imposed restrictions:
- To protect the interests of borrowers: They reply on NBFCs for many financial services such as loans and advances. While, in case NBFCs do not follow their responsibility of lending practices, then borrowers can be exploited. It can also lead to financial distress for them. Therefore, the RBI has imposed regulations on NBFCs to ensure that they can maintain proper NPA classification, adhere to fair practices code, and charge reasonable interest.
- To protect the financial system: NBFCs play a vital role in the financial system by giving financial services to several sectors of the economy. Meanwhile, in case NBFCs are not governed, they can pose a risk to financial system as it is seen in the matter of IL&FS crisis of India. Furthermore, the RBI has imposed regulatory restrictions to make sure that it performs in a safe and sound manner, and do not pose any kind of risk to financial system.
- To secure financial inclusion: To promote the financial inclusion is one of the significant goals of the RBI by extending financial services to poor sections of society. NBFCs is helping and play crucial role in attaining this target. In addition, the RBI has mandated that some percentage of loans and advances by NBFCs be directed towards priority sectors like MSMEs, agriculture, and affordable housing.
Takeaway
Through the above information, we can conclude that the regulatory restrictions are essential for the development and improvement of financial system and the economy. The RBI’s efforts to ensure that NBFCs operate in a safe and sound manner and adhere to fair practices are commendable. It is necessary for the long-term growth and stability of the financial sector.
