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CAFRAL Highlights Growing Risks in NBFC Financing

Context:

The Centre for Advanced Financial Research and Learning (CAFRAL), established by the Reserve Bank of India (RBI), has drawn attention to an escalating risk in bank financing for Non-Banking Finance Companies (NBFCs). Additionally, CAFRAL has issued a warning regarding the digital lending landscape, identifying potential dangers. The research body also cautions against fake or illegitimate lending apps, emphasizing the risk of these apps collecting personal data and posing threats of misuse and safety concerns for users.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

  1. Major Concerns Highlighted by CAFRAL
  2. What are NBFCs?

Major Concerns Highlighted by CAFRAL:

Inter-Dependency in NBFC Sector:
  • Banks primarily lend to larger NBFCs, creating a network of inter-dependencies.
  • Cross-lending within the NBFC sector amplifies shocks and transmits them across the financial system.
  • Instances like the IL&FS default in 2018 and DHFL collapse in 2019 triggered a liquidity crisis and affected banks’ asset quality and profitability.
Impact of Contractionary Monetary Policy on NBFCs:
  • Contractionary monetary policy results in risk accumulation in NBFC portfolios.
  • Tightening policy rates by RBI leads to higher borrowing costs and lower profitability for NBFCs.
  • To maintain margins, NBFCs shift lending to riskier segments, increasing exposure to unsecured loans and subprime borrowers.
  • Increased exposure to capital markets through equity and mutual fund investments exposes them to higher credit, market, and liquidity risks.
Risks Associated with Digital Lending Apps:
  • Warning about illegitimate digital lending apps gathering personal data for potential misuse.
  • Difficulty in verifying the legality of these apps poses risks to consumer safety and privacy.
  • Concerns about potential losses from online lending impacting traditional banking if linkages between the sectors strengthen.
  • Fake/illegal apps request extensive personal information, raising privacy and safety concerns for users.
  • FinTech growth has led to approximately 1100 lending apps available for Indian Android users across 80 app stores, increasing product diversity.

What are NBFCs?

  • An NBFC, registered under the Companies Act, 1956, engages in various financial activities, including loans, securities investments, leasing, and insurance.
  • Excludes institutions primarily involved in agriculture, industry, goods trading, services, or immovable property trading.

Criteria for Registration:

  • A company is registered as an NBFC by the RBI if over 50% of its assets are financial assets and more than 50% of its income is derived from these financial assets.

Regulatory Authority:

  • The Reserve Bank, under the RBI Act 1934, has the authority to register, lay down policy, issue directions, inspect, regulate, supervise, and exercise surveillance over NBFCs.
Differences from Banks:
  • NBFCs cannot accept demand deposits from the public, unlike banks.
  • NBFCs are not part of the payment and settlement system, and they cannot issue cheques like banks.
  • Deposit insurance facilities, available to bank depositors, are not extended to NBFC depositors.

Funding:

  • NBFCs primarily finance operations through a combination of market borrowing and bank loans.

-Source: The Hindu


June 2024
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