Fitch Rtgs: India’s NBFI Regulatory Changes to Strengthen Sector Stability

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Fitch Rtgs: India’s NBFI Regulatory Changes to Strengthen Sector Stability
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(The following statement was released by the rating agency) Fitch Ratings-Hong Kong/Singapore/Mumbai-26 January 2021: The proposed changes to India's regulatory framework for non-bank financial institutions (NBFIs) unveiled in the Reserve Bank of India's (RBI) discussion paper on 22 January are likely to enhance the sector's stability, says Fitch Ratings. We believe that the reforms would preserve NBFIs' niche business models, and could improve the funding environment for some entities by strengthening investor confidence in the sector. For the sector as a whole, the proposed measures should strengthen governance and risk management, although we do not view these areas as major credit weaknesses for Fitch-rated Indian NBFIs. The longer-term impact of such reform would also depend on its implementation, and robust regulatory and market scrutiny will be key in holding entities to higher standards. Larger entities face enhanced disclosure requirements, and tighter risk and capital management requirements, which would likely be credit positive. The scale-based regulations reflect calls for closer supervision of large NBFIs that have grown more systemically significant. We believe the moves to strengthen risk controls and frameworks should be manageable for Fitch-rated NBFIs. For example, they should already comfortably meet the suggested requirement for “Upper Layer” NBFIs, expected to include 25-30 of the largest entities including Fitch-rated names, to maintain a minimum common equity Tier 1 ratio of 9%. We view proposals to appoint auditors by rotation, as well as requirements to disclose information such as the incidence of covenant breaches and asset quality divergence as credit positive. Unlike banks, many NBFIs have appointed the same auditors for many years. In addition, lending to directors and senior employees would be restricted, reducing governance risks. Requirements to implement a core banking solution (credited for improving efficiency and reducing operational risks in banks) and introduce an internal capital adequacy assessment process (ICAAP) could further strengthen the framework for monitoring and managing risks. Most large NBFIs' systems are already integrated with banks and payment portals, and we believe additional costs to meet the core banking solution requirement would be manageable. However, the measure could pose a more significant expense for mid-sized NBFIs. For NBFIs in the Upper Layer, listing may be made mandatory. This would affect only a few corporate-backed NBFIs, and should not present a challenge given their parents' experience in capital markets. In general, business models should not be significantly affected, but some lending activities could be curtailed by the suggested changes, especially in real estate. The RBI is looking to restrain lending to early-stage development projects that have not yet received regulatory approval, and has proposed added internal controls for lending against land acquisition. Some entities have built up exposures to these risky areas in recent years, which have become a point of vulnerability for the sector. The suggested new rules could curb a further run-up in such exposures in the longer term. The suggested reform would also raise NBFIs' standard provisioning requirements on commercial real estate lending, to be in line with those for banks. Fitch-rated Indian NBFIs do not engage in real estate lending, other than IIFL Finance (B+/Rating Watch Negative). However, if IIFL is placed in the Upper Layer, any added provisioning from this proposal is unlikely to be significant relative to the firm's broader provisioning needs in light of the pandemic. NBFIs with assets below INR10 billion (around USD130 million) would continue to operate under current frameworks, but additional rules aligning non-performing loan recognition and a new leverage cap of 7x would add to regulatory robustness. The central bank further highlighted the need for a resolution framework for failing NBFIs. This would be another important element in the regulator's financial stability toolkit. Contact: Siddharth Goel Associate Director, Non-Bank Financial Institutions +91 22 4000 1760 Fitch Ratings Wockhardt (NS: WCKH ) Tower, West Wing, Level 4 Bandra Kurla Complex Mumbai Maharashtra 400051, India Elaine Koh Director, Non-Bank Financial Institutions +65 6796 7239 Duncan Innes-Ker Senior Director, Fitch Wire +852 2263 9993 Media Relations: Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com Wai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com Bindu Menon, Mumbai, Tel: +91 22 4000 1727, Email: bindu.menon@fitchratings.com The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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