IMF Raised Concerns Related to NBFCs 

Syllabus: GS3/ Economy

Context

• The International Monetary Fund (IMF) has raised concerns about potential financial instability in India due to the concentrated exposure of Non-Banking Financial Companies (NBFCs) to the power and infrastructure sector.

Major Highlights

• The IMF report titled “India Financial System Stability Assessment” focuses on power sector loans.
  • The IMF studied banks’ resilience in a potential stagflation scenario, where growth slows and inflation rises.
• Dependence on bank borrowings for financing increased since fiscal 2019.
  • In fiscal 2024, 63% of power sector loans were from the top three Infrastructure Financing Companies (IFCs), a type of NBFC.
  • This share increased from 55% in 2019-20.
• Concerns: It raises concerns about financial instability in India due to NBFCs’ high exposure to the power and infrastructure sectors.
  • High exposure to the power sector, which faces structural challenges, increases financial instability risks.
  • NBFCs are interconnected with banks, corporate bond markets, and mutual funds, which could amplify stress if vulnerabilities arise.
• Stress tests showed public sector banks (PSBs) may struggle to maintain a capital adequacy ratio (CAR) of 9% during stagflation.
  • RBI mandates a CAR of 12% for PSBs and 9% for scheduled commercial banks.
• Regulatory Concerns: State-owned NBFCs are exempt from large exposure limits, raising regulatory concerns.
• Recommendations: 
  • Strengthening liquidity regulations for NBFCs, especially those with significant infrastructure exposure.
  • Closer monitoring of NBFCs’ lending patterns and improved risk management frameworks to prevent financial disruptions.
  • State-owned NBFCs should face the same regulatory standards as private NBFCs to ensure fairness.
  • Emphasized the need for better data sharing on NBFC credit and exposure.
  • Prioritizing financial stability over developmental motives for banks.

What are Non-Banking Financial Corporation (NBFCs)?

• Definition: A company registered under the Companies Act, 1956, engaged in loans, advances, and acquisition of shares/stocks/bonds/debentures/securities issued by government or local authorities, or other marketable securities.
• Exclusions: Does not include institutions primarily involved in:
  • Agriculture activities;
  • Industrial activities;
  • Sale/purchase of goods (except securities);
  • Provision of services;
  • Sale/purchase/construction of immovable property.
• Residuary Non-Banking Company: A company whose principal business is receiving deposits under any scheme or arrangement (lump sum or installments) is also classified as a non-banking financial company (NBFC).
• NBFC Key Functions: 
  • Provide financial products to individuals and businesses.
  • Fund infrastructure and development projects.
  • Offer investments in securities.
• Regulatory Oversight: The functions of NBFCs are managed by both the Ministry of Corporate Affairs and the Reserve Bank of India (RBI).

What is the difference between banks & NBFCs?

• NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:
  • NBFC cannot accept demand deposits;
  • NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
  • Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Source: TH