View: How NBFCs can play a critical role in India's development by providing credit to segments ignored by banks
NBFCs have been integral to India's formal credit system since Independence, complementing banks in distributing credit. The sector has occasionally been marred by financial accidents, but it has proved resilience each time, followed by improved regulatory frameworks.
The first instance of imposing an NBFC regulatory framework was in 1963, empowering RBI to supervise, regulate and control them effectively. This was initiated after a slew of fly-by-night operators denting the trust of household depositors (most NBFCs back then accepted deposits). Multiple government committees since then prompted a series of changes in the NBFC regulatory landscape:
- The 1998 reforms redefined guidelines for deposit-taking licenses.
- Regulations in 2006 introduced systematically important NBFCs.
- The 2022 guidelines on scale-based regulations minimised regulatory arbitrages between banks and upper-layered NBFCs.
Despite this long history of coexistence of NBFCs and banks, the Indian credit system is dominated by the latter. Lending by commercial banks accounts for 62% of total credit, followed by 20% from the corporate debt market and 18% from NBFCs. If we account for bank investments in the debt market and NBFCs, the share in overall credit can rise well above 75%. Such a homogenous credit system is likely to be more exposed to economic shocks, resulting in a severe credit crunch when bank credit dries up and the equity market declines.
Ex-US Fed governor Alan Greenspan had once remarked, referring to the Asian Financial Crisis: 'The lack of a spare tyre is of no concern if you do not get a flat tyre. East Asia had no spare tyres.' Here, spare tyres are alternate credit sources, like NBFCs. We had seen similar occurrences in India,
