Regulatory Framework For NBFCs: Here Are The Challenges And Opportunities

In 2021, the RBI came up with a regulation that an audit firm can only audit a certain number of NBFCs. The auditors need to be changed after every three years

NBFCs definitely need to be more careful and hence for the same set of customers they should have higher provisioning.

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By Abhishek Thakkar

Anyone who understands the NBFCs would know that every few months there are new/modified regulations governing NBFCs. These regulations possess challenges, however, if those are taken in the right spirit and worked on, it provides great opportunities, not only from a regulatory angle but also from business and economy as a whole. Today, I would like to talk about three such challenges that have sort of disrupted NBFCs at first but in the long run provided tremendous opportunities.

Challenges

1. Ind AS & ECL: Now one would feel how 'Ind AS' is a challenge and even if it is, it’s something that is affecting many other industries and not only NBFCs. But, here’s the catch. Who are the biggest competitors of NBFCs? It’s the Banks right! And that’s where the challenge lies. Banks don’t have to follow Ind AS. But NBFCs do have to. Imagine a borrower whose account is standard with the bank. In such cases, banks will be required to create provision (equivalent to ECL) of just 0.4 per cent. Now, if the same borrower has borrowed from NBFC also, they will have to follow entire ECL provisions and will have to create a different ECL for the same borrower (in most of the cases higher). This completely changes the Profit & Loss account of NBFCs. Maybe the large NBFCs don't get affected that much by this but start-ups/nascent stage NBFCs do get affected as their competitors show much better P&L with the same sort of customers as borrowers.

2. First Landing Default Guarantee (FLDG): In the past 12 to 15 months, if a single thing that attracted a lot of attention in the NBFC regime, it's FLDG. There were many companies, whose business model were based on FLDG line, however, the RBI in September 2022 put a full stop on it.This forced all those start-up/Fintechs who based their Business on FLDG to pivot/shut down their business. Cut to the first half of 2023, the RBI allowed FLDG of 5 per cent.

3. Change in Auditors: In 2021, the RBI came with a regulation that an audit firm can only audit a certain number of NBFCs. Further, the auditors need to be changed every three years. (Of course, there are certain exemptions to it based on the scale of the NBFCs) This resulted in all those NBFCs who had legacy firms as auditors for years to change their auditors. Now, again one would think, what’s a big deal here. However, with ever changing economic and accounting regulations, changing auditor is a tough task.

However, as I said above, every challenge presents an opportunity in the long-term if tackled correctly in the right time. So, let's see what opportunities each of the above challenges offer.

Opportunities

1. Ind AS & ECL: Though, this entire Ind AS & ECL may result in higher P&L for NBFCs as compared to their competitor banks, one school of thought believes that this is the right thing. Banks generally have higher capital and hence their risk appetite is also higher. On the other hand, NBFCs definitely need to be more careful and hence for the same set of customers they should have higher provisioning.

2. First Landing Default Guarantee (FLDG): In this case, though the industry was largely affected, in the long run it is necessary that only the registered and acknowledged players get into the business. So, that the RBI as well as other regulators can have a better control, fair practice is prevalent, and risk–reward ratio is also maintained the way it should be.

3. Change in Auditors: This is one point where most of the participants in the industry realised that even though it creates a lot of hardship in the short term, however from an investors point of view and also from a corporate governance point of view, having a different set of eye auditing your books at regular interval is in the best of the interest for everyone.

The writer is the CFO at Niyogin Fintech Ltd.

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