S&P Global Ratings Applauds RBI's Regulatory Initiatives

In November last year, the central bank introduced more stringent regulations on unsecured loans and warned lenders against excessive risk-taking, citing mounting threats to the financial system. Recently, Reuters reported that the RBI has escalated its monitoring efforts to address additional areas in retail lending, such as mortgage-linked top-up loans.

Recent regulatory actions involved restraining IIFL Finance Ltd and JM Financial Products Ltd from issuing gold loans and loans against shares, respectively. Additionally, Paytm Payments Bank Ltd was directed to halt the onboarding of new customers.

In November 2023, Bajaj Finance Ltd faced restrictions on financing for 'eCOM' and 'Insta EMI Card' services. In September 2022, Mahindra & Mahindra Financial Services Ltd was prohibited from conducting recovery or repossession activities through outsourcing agreements.

Additionally, in December 2020, HDFC Bank was banned by the RBI from utilising business-generating IT applications and acquiring new credit card customers due to recurring technological failures, as noted by S&P. These measures mark a departure from the historically lenient financial penalties for violations.

S&P Global credit analyst Geeta Chugh emphasised, "India's regulator has underscored its commitment to strengthening the financial sector."

However, heightened regulatory risks could hinder growth and increase the cost of capital for financial institutions. S&P indicates that the RBI's tolerance for non-compliance, customer grievances, data protection, governance, KYC, and anti-money laundering issues is waning.

S&P highlights that the Reserve Bank of India (RBI), as the financial system regulator, is earnestly committed to enhancing governance and transparency within finance companies and banks.

"Governance and transparency represent significant weaknesses within the Indian financial sector, impacting our assessments," Chugh remarked. She further added, "The RBI's recent initiatives are fostering a stronger and more transparent financial landscape."

The RBI has opted to publicly disclose the primary issues leading to suspensions or stringent actions against concerned entities. Moreover, the central bank has become increasingly vocal in condemning behaviours it perceives as harmful to the interests of customers and investors.

S&P noted that the RBI has pointed out issues such as superficial credit underwriting, collateral overvaluation, and governance concerns in specific financial sector entities.

"We believe that increased transparency will create additional pressure on the entire financial sector to enhance compliance and governance practices," Chugh stated.

S&P Global Ratings noted that the household debt to gross domestic product (excluding agriculture and small and midsize enterprises) in India rose to approximately 24% in March 2024 from 19% in March 2019.

The agency remarked that the growth in unsecured loans has been excessive, now comprising close to 10% of total banking sector loans. The increased focus on compliance, Know-Your-Customer (KYC), and process follow-up are expected to bolster the compliance culture in India, potentially restraining excessive lending practices.

Furthermore, the ratings agency cautioned that these regulatory measures might result in higher compliance costs for the sector, potentially limiting the competitiveness of smaller companies. "In our view, smaller and weaker companies may need to increasingly rely more on originate and distribute models, leveraging co-lending and direct assignments," stated Chugh.

S&P highlighted concerns that certain retail loans, including personal loans, loans against property, and gold loans, might be diverted into stock market investments. The ultimate use of funds in these products is challenging to determine, but industry participants speculate that the RBI and the Securities and Exchange Board of India (SEBI) aim to safeguard small investors by scrutinising these activities more carefully.

"We expect the regulatory actions to drive banks and finance companies to better focus on policies and processes, ultimately enhancing the operational resilience of the system. However, this shift is likely to lead to increased compliance costs for the sector. This may curb the ability of smaller companies to compete in the market," S&P said.

How Can These Regulatory Initiatives by the RBI Impact the Borrowers?

The regulatory initiatives implemented by the Reserve Bank of India (RBI) aimed at enhancing governance and transparency within India's financial system are likely to have several impacts on borrowers:

Restrained Excessive Lending Practices

Given the RBI's emphasis on restraining excessive lending practices and fostering a compliance culture, borrowers may notice lenders adopting more stringent lending criteria. This could result in a more thorough assessment of borrowers' creditworthiness and financial stability before extending loans. While this might make it more challenging for some borrowers to access credit, it could also lead to a more responsible lending environment in the long run.

Improved Protection for Customers

The regulatory measures undertaken by the RBI are intended to protect customers' interests. This could result in increased transparency regarding loan terms and conditions, as well as stricter adherence to regulations governing fair lending practices. Borrowers may benefit from clearer information about their rights and responsibilities when availing of loans, reducing the likelihood of being subjected to predatory lending practices.

Potential Impact on Loan Availability

As financial institutions face increased compliance costs due to regulatory measures, they may become more selective in lending activities. This could particularly affect smaller companies and borrowers with lower credit scores, who may find it more challenging to access credit. Additionally, if smaller financial institutions struggle to compete due to higher compliance costs, borrowers may have fewer options when seeking loans.

Impact of Diverted Retail Loans

Concerns have been raised regarding the diversion of certain retail loans, such as personal loans, loans against property, and gold loans, into stock market investments, which could indirectly impact borrowers. If regulatory scrutiny increases in these areas to safeguard investors, lenders may become more cautious when extending loans for these purposes. Borrowers seeking loans for speculative investments may face stricter scrutiny and potentially higher borrowing costs.

To conclude:

While the regulatory initiatives are aimed at strengthening the financial system and protecting borrowers' interests, they may also introduce challenges such as tighter lending conditions and potentially higher borrowing costs, particularly for certain types of borrowers and financial products. Borrowers should stay informed about regulatory changes and be prepared to adapt to evolving lending practices in the market.

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KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.

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