Hello!

Welcome to the 87th edition of The Pattern, a weekly publication where we dissect and delve into the latest rumblings from the world of technology, finance, and banking. Let’s get started. 

Speed-limits for rocketships 

If you must know anything about the Indian financial sector,  it’s that most of the time, we’re making up things as we go. And it’s not necessarily a bad thing. 

The banks are stable and prudent, non-banks are proactive, and FinTechs are driven. But, the regulatory regime is where we shine. RBI is one of the most forward-looking regulators in the world, but it’s also notoriously obsessed with consumer protection and industry stability. 

And hence, comes the duality. 

On the one hand, the central bank has ushered in an era of innovation through UPI, real-time payments, digital credit, and more. On the other hand, though, the same regulator has to be the watchdog and ensure that no participant is breaching the guardrails and endangering neither the industry’s nor the end consumers’ wellbeing. 

This might sound dizzying, and it is! Both for the regulator and the regulated. 

This is why the industry goes into a frenzy when the RBI tells lenders to keep aside extra risk cover for unsecured lending. This happened last week, and we’ve seen reactions ranging from welcoming the move to banks revising their interest margin guidance to entities exploring other avenues than unsecured lending for their growth plans. 

Because when the RBI brings the stick, everyone must fall in line. However, the regulator doesn’t seem to be done yet. It knows more than we do, and its warnings about potential stress in unsecured portfolios might have more serious underlying reasons than one assumes. 

Too close for comfort? 

And this is the first step of many. The regulator not only wants to bring sanity back into the burgeoning retail credit market but also wants to ensure that banks and NBFC lenders do not self-combust in this race to the top (and profits).

RBI Governor Shaktikanta Das made it clear in a recent address where he used the scary C-word. 

“NBFCs are large net borrowers of funds from the financial system, with their exposure from the banks being the highest…Banks are also one of the key subscribers to the debentures and commercial papers issued by NBFCs. Needless to state that such concentrated linkages may create a contagion risk,” Das told participants at an industry conference. 

Contagion risk. It’s a strong phrase and gets scarier when the chief regulator uses it in a public gathering of industry participants. 

The RBI is worried about the too-close-for-comfort relationship between banks and NBFCs. The central bank noted that even as NBFCs mostly borrow from banks to lend further, they are again beneficiaries of more capital from banks that often buy NBFCs' debt and fund-raising instruments. 

What happens next? As a result, the RBI is worried that a chain reaction might set off if the economy overheats. It’s the same money funding NBFC instruments, providing them capital for lending, and then being lent to perhaps the same borrower set that banks are targeting. 

This is why the RBI wants more monitoring, reduced exuberance, and no unexpected jumps in any portion of the loan books - specifically the unsecured bit. 

“Expansion of the credit portfolio itself and pricing of the same should be in sync with the risks envisaged," Das said, adding that NBFCs must actively find other ways to fund their capital needs and reduce exposure to multiple banks simultaneously.  

It’s not clear exactly how much of this caution will translate into regulation immediately but it’s clear that the RBI is acting on more evidence than just instinct. Even as the industry pushes back and seeks to re-evaluate its directives, the regulator might already have its mind made up. 

Sustainability is the flavour of the season, after all. 

This is all from me this week. As always, leaving some reading recommendations and interesting data points below. 

Reading list 

1. Lenders asked to avoid risks: Finance Minister

2. Transforming Credit Underwriting: The Power of Alternative Data in Income Estimation

3. Regulations must support innovation: RBI deputy governor Rajeshwar Rao

4. RBI Governor flags bank-NBFC links as 'contagion risk'

5. FIDC Requests RBI To Re-Evaluate Higher Risk Weights For Bank Loans To NBFCs

6. Lenders facing known and unknown challenges, need agile responses: Bank chiefs

7. Why an advanced rules engine should be the core of lenders’ ONDC strategy

Between the digits 

41.2% - Bank borrowings contribute a large chunk of the total capital for NBFCs. The increased risk weights are expected to make this capital expensive and increase borrowing costs. 

84,000 crore - RBI’s increased capital adequacy requirements are likely to cost an estimated Rs 84,000 crore, according to Crisil estimates . The agency expects unsecured lending to experience slower growth in FY24. 

USD 125 million - L&T Finance has signed a massive loan pact with the Asian Development Bank for up to USD 125 million to support financing in rural and peri-urban areas in India. 

Thank you for reading. If you liked this edition, forward it to your friends, peers, and colleagues. You can also connect with me on Twitter here and follow FinBox on LinkedIn to never miss any updates.  

Cheers,

Mayank

All opinions expressed are my own and do not necessarily reflect the views of FinBox or its promoters.