Over-reliance on unsecured loans, capital market funding can be source of grief for NBFCs: RBI DG

Over-reliance on unsecured lending and capital market funding can bring grief to non-bank lenders in the long run, Reserve Bank Deputy Governor Swaminathan J has cautioned.In an address to heads of assurance functions of non-bank finance companies at an RBI-organised conference on Wednesday, Swaminathan also warned against over-reliance on algorithms for taking lending calls.He also went public with the RBIs disappointment at the tendency of misguided or intelligent interpretation of rules to circumvent regulations and termed this as a significant threat to the financial systems integrity.

Over-reliance on unsecured lending and capital market funding can ''bring grief'' to non-bank lenders in the long run, Reserve Bank Deputy Governor Swaminathan J has cautioned.

In an address to heads of assurance functions of non-bank finance companies at an RBI-organised conference on Wednesday, Swaminathan also warned against over-reliance on algorithms for taking lending calls.

He also went public with the RBI's disappointment at the tendency of ''misguided or intelligent interpretation'' of rules to ''circumvent regulations'' and termed this as a ''significant threat'' to the financial system's integrity. The career commercial banker-tuned-regulator also flagged the risk limits for certain products or segments like unsecured lending are ''way too high'' to be sustainable in the long run.

''There appears to be a fancy among most NBFCs to do more of the same thing, such as retail unsecured lending, top up loans or capital market funding. Over reliance on such products may bring grief at some point in time later,'' he said.

In the aftermath of the Reserve Bank of India's (RBI) increasing of the risk weights on unsecured lending to dissuade lenders from piling up such riskier exposures, there were murmurs of borrowed money being put to bet on the capital markets which had led the RBI to ask lenders to monitor the end use of funds.

On the issue of algorithm-based lending, he said many entities are turning to rule-based credit engines to accelerate growth in books. ''While automation can enhance efficiency and scalability, NBFCs should not allow themselves to be blinded by these models. It is crucial to recognise that rule-based credit engines are only as effective as the data and criteria upon which they are built,'' he said.

Overreliance on historical data or algorithms may lead to oversights or inaccuracies in credit assessment, particularly in dynamic or evolving market conditions, he said, asking NBFCs to maintain a clear-eyed perspective on their capabilities and limitations, and to undertake monitoring efforts.

Speaking about the tendencies to circumvent regulations by misguided or intelligent interpretations for individual gains, Swaminathan said such practices undermine regulatory effectiveness, compromise stability and fairness in the market.

''Such practices erode trust and confidence in the financial sector, potentially exposing consumers, investors and the broader economy to risks and vulnerabilities,'' he said, making it clear that the RBI will not hesitate to initiate supervisory action as has been demonstrated in recent moves of the regulator.

Swaminathan said the heft of NBFCs has grown during the recent past and they now account for a fourth of bank credit as against one-sixth in 2013.

''As NBFCs expand in both size and complexity, they must bolster governance and assurance functions to maintain a constant vigil over potential risks and vulnerabilities. It is crucial to ensure that the rapid growth and adoption of technology do not happen by side stepping the importance of robust risk management practices,'' he said.

He asked the NBFCs to pay adequate attention to cyber security risks, saying the primary risk faced by entities on the this front includes the threat of data breaches and unauthorised access to sensitive information.

Risk management and internal audit functions have to urgently build on their skill sets so that they are able to assess periodically, the IT and cyber security stance and preparedness of their entities, he said.

He also asked lenders to watch over the threat of concentration risk by paying attention to their business models and went public with the RBI's disappointment at the low importance given to assurance functions at NBFCs.

''It is disconcerting to note that NBFCs have the lowest average number of compliance staff relative to their size compared to other sectors like commercial and cooperative banks.

''Despite regulatory measures aimed at ensuring the autonomy of these functions, it is disheartening to encounter instances where heads of assurance functions are given junior positions within the hierarchy or there is lack of direct access to the board,'' he said.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)