RBI Urges NBFCs to Diversify Funding Sources Amid Emerging Risks

The Reserve Bank of India (RBI) emphasizes the need for Non-Banking Financial Companies (NBFCs) to diversify funding sources to mitigate risks. The 2023-24 report highlights challenges like cybersecurity threats and offers strategies such as innovative co-lending models. Despite risks, NBFCs show double-digit growth and improved asset quality.

The Reserve Bank of India (RBI) has underscored the critical need for Non-Banking Financial Companies (NBFCs) to diversify their funding sources as part of a comprehensive risk mitigation strategy. While the reliance of NBFCs on banking institutions has slightly decreased, it remains considerably high, according to the RBI's recent report.

The report states, "The dependence of NBFCs on banks remains high, notwithstanding some moderation; NBFCs need to further diversify their sources of funds as a risk mitigation strategy." It highlights the necessity for NBFCs to expand their funding avenues to reduce concentration risks and address emerging challenges such as cybersecurity threats, evolving concentration risks, and climate-related financial risks linked to certain industry loans.

The RBI cautioned against adopting an imprudent "growth at any cost" approach, which could undermine the sector's stability, urging NBFCs to establish robust risk management systems. "An imprudent 'growth at any cost' approach would be counter-productive, and a robust risk management framework should be implemented," the report advises.

The central bank also recommended that NBFCs enhance customer grievance redressal mechanisms, adhere to fair practices, and refrain from imposing excessively high interest rates. These measures, as emphasized in the report, are vital for maintaining the NBFC sector's relevance in a rapidly transforming financial environment.

Despite these associated risks, the report identifies positive developments in the NBFC sector for the financial year 2023-24. It indicates that NBFCs have experienced consistent double-digit growth in their balance sheets, underscoring the sector's growing significance in domestic credit intermediation. Likewise, Housing Finance Companies (HFCs) showed strong double-digit credit growth, adjusted for recent mergers, with improved asset quality across various NBFC layers.

The RBI acknowledged innovative strategies like the First Loss Default Guarantee (FLDG) framework and co-lending model as effective tools for helping NBFCs extend their market reach. Additionally, the consolidated balance sheet of All India Financial Institutions (AIFIs) expanded at a slightly higher rate during 2023-24, as Public Depositories (PDs) surpassed their minimum bidding commitments and achieved required annual turnover ratios.

The report concludes with a dual focus for NBFCs: harnessing growth opportunities while maintaining financial stability through diversification, innovative practices, and reinforced risk management frameworks.

(With inputs from agencies.)