Daily Current Affairs : 15-November-2023
The Centre for Advanced Financial Research and Learning (CAFRAL), initiated by the Reserve Bank of India (RBI), recently sounded an alarm on the growing risks associated with bank financing for Non-Banking Finance Companies (NBFCs). This advisory also shed light on the perils of the digital lending landscape, emphasizing potential threats and hazards. In this essay, we explore the major concerns highlighted by CAFRAL and delve into the intricacies of NBFCs, focusing on their role, risks, and regulatory distinctions.
Major Concerns Highlighted by CAFRAL:
- Inter-Dependency in NBFC Sector:
- Banks’ primary lending to larger NBFCs establishes a web of inter-dependencies.
- Cross-lending within the NBFC sector exacerbates shocks, transmitting them throughout the financial system.
- Historical instances like the IL&FS default in 2018 and DHFL collapse in 2019 triggered liquidity crises, impacting banks’ asset quality and profitability.
- Impact of Contractionary Monetary Policy on NBFCs:
- Contractionary monetary policies lead to risk accumulation in NBFC portfolios.
- RBI’s tightening of policy rates results in higher borrowing costs and diminished profitability for NBFCs.
- To maintain margins, NBFCs often shift towards riskier segments, heightening exposure to unsecured loans and subprime borrowers.
- Risks Associated with Digital Lending Apps:
- Illegitimate digital lending apps pose a threat by collecting personal data for potential misuse.
- Verification challenges of these apps raise concerns about consumer safety and privacy.
- The potential linkage between online lending and traditional banking heightens worries about systemic impacts.
Understanding NBFCs:
- Definition and Activities:
- NBFCs, registered under the Companies Act, 1956, engage in various financial activities such as loans, securities investments, leasing, and insurance.
- Excludes institutions primarily involved in agriculture, industry, goods trading, services, or immovable property trading.
- Criteria for Registration:
- Over 50% of assets as financial assets and more than 50% of income derived from these financial assets.
- Regulatory Authority and Differences from Banks:
- RBI, under the RBI Act 1934, has regulatory authority over NBFCs.
- NBFCs differ from banks in accepting demand deposits, participating in the payment and settlement system, and issuing cheques.
- Deposit insurance facilities, available to bank depositors, do not extend to NBFC depositors.
- Funding:
- NBFCs primarily finance operations through a combination of market borrowing and bank loans.
Important Points:
Major Concerns Highlighted by CAFRAL:
- Inter-Dependency in NBFC Sector:
- Banks’ primary lending to larger NBFCs creates inter-dependencies.
- Cross-lending within NBFCs amplifies shocks, affecting the entire financial system.
- Historical instances like IL&FS default and DHFL collapse triggered liquidity crises.
- Impact of Contractionary Monetary Policy on NBFCs:
- Contractionary policies lead to risk accumulation in NBFC portfolios.
- RBI’s policy rate tightening increases borrowing costs, lowering NBFC profitability.
- NBFCs, to maintain margins, shift to riskier segments, increasing exposure to unsecured loans.
- Risks Associated with Digital Lending Apps:
- Illegitimate apps pose threats by collecting personal data for potential misuse.
- Verification challenges raise concerns about consumer safety and privacy.
- Potential linkage between online lending and traditional banking heightens systemic worries.
Understanding NBFCs:
- Definition and Activities:
- NBFCs engage in various financial activities, excluding specific sectors.
- Criteria for Registration:
- Over 50% of assets must be financial assets, and over 50% of income should be derived from them.
- Regulatory Authority and Differences from Banks:
- RBI, under the RBI Act 1934, regulates NBFCs.
- NBFCs differ from banks in various aspects like accepting demand deposits and participating in the payment and settlement system.
- Funding:
- NBFCs primarily finance operations through market borrowing and bank loans.
Why In News
The Reserve Bank of India (RBI)-established Centre for Advanced Financial Research and Learning (CAFRAL) has brought to light a growing concern related to bank financing for Non-Banking Finance Companies (NBFCs). Furthermore, CAFRAL has sounded an alarm concerning the digital lending sector, pinpointing potential hazards. The research institution also urges caution regarding counterfeit or unauthorized lending applications, underscoring the peril of these apps gathering personal data and presenting risks of misuse and safety issues for users.
MCQs about CAFRAL’s Risk Red Flags
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CAFRAL’s primary concern regarding inter-dependency in the NBFC sector is:
A. Lack of regulatory oversight
B. Cross-lending amplifying shocks
C. Decreasing profitability of NBFCs
D. Insufficient market borrowing
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How does a contractionary monetary policy impact NBFC portfolios ?
A. It leads to higher profitability for NBFCs
B. It reduces borrowing costs for NBFCs
C. It results in risk accumulation in NBFC portfolios
D. It encourages NBFCs to shift towards secure loans
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What is a significant risk associated with illegitimate digital lending apps ?
A. Increased financial inclusion
B. Potential misuse of personal data
C. Strengthening linkages between online lending and traditional banking
D. Enhanced consumer safety and privacy
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How do NBFCs primarily finance their operations?
A. Through demand deposits from the public
B. Through government grants
C. Through a combination of market borrowing and bank loans
D. Through participation in the payment and settlement system
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