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A tactical and strategic blunder
The proposed norms on NPA recognition are both a tactical and strategic blunder on the part of the RBI.

Regulatory agencies dealing with different segments of the financial sector, at times, do get into each other’s way. The differing approach, which the SEBI and IRDA adopted over, who should regulate equity-marked linked insurance products is a case in point.

Since these were two different regulators, one could understand the jurisdictional conflict. More difficult to understand are situations where a single regulator adopts diametrically opposite approaches on a particular policy issue. Such contrasting approaches by a single regulator render a larger economic objective impossible of achievement.

A clear example of such mutually defeating approaches by a single regulator is the Reserve Bank of India’s proposed norms on asset classification for the NBFC sector.

 

Proposed norms – several aberrations…

The RBI issued draft guidelines in December 2012 on prudential norms for NBFCs. The draft guidelines say that the period for classifying loans into the non-performing category (NPA) for the NBFC sector, which is presently 180/360 days, shall be progressively brought down to 120 / 90 days. The RBI says the new norms will bring parity with commercial banks and thereby reduce regulatory arbitrage between different segments in the financial lending business.  

A study of the issue shows that the focus on reducing regulatory arbitrages enjoyed by NBFCs actually blurs and blinds the RBI to both tactical (near-term) and strategic (long-term) financial and economic objectives.

Tactically, the proposed move goes squarely against the RBI’s own recent policy moves and even the global trend towards bringing in financial regulations which operate in a counter-cyclical manner.

Greater discretion in loan loss provisioning, provisioning even for standard assets and counter-cyclical capital buffers are some of the notable features of the evolving policy regime focusing on counter-cyclical financial regulation.

The idea is that buffers and reserves are to be built during good times so that financial institutions are not forced to cut back on their intermediation activities (primarily lending) during bad times. Such cutting back during economic downturns could aggravate the prevailing weak economic climate, making an overall economic recovery even more difficult.

In the backdrop of the difficulties which the US, the UK and in the Euro zone are now facing in promoting increased lending to the stressed real economy, one cannot agree more with the concept of counter-cyclical financial regulation. But, is the RBI paying attention to all that?

It does not seem so if the proposed norms on NPA recognition in an already weak economy are any indication.  Leave alone high-flown concepts such as counter-cyclical financial regulation. More critically, changes in the NPA recognition formula would hit hard at the livelihoods of millions of SMEs in India. Productive assets will be blindly re-possessed by financiers directly.

 

Myopia towards strategic goals

The proposed norms are also indicative of a myopic approach to the national objective of financial inclusion. For such a vast country with significant differences in wealth distribution, it goes without saying that we cannot have a one-size-fits-all policy in the financial sector. Similar types of financial institutions with uniform financial and prudential norms are also not appropriate to India.

Therefore, to talk of the NBFC sector ‘enjoying’ some regulatory arbitrage itself is a complete negation and repudiation of the underlying economic reality in India of large-scale financial exclusion.

In the instant case it can be argued that only because of the differential NPA identification norms for NBFCs have they been able to make some significant in-roads in financing the SME and micro business sector such as small road transport operators, small manufacturing units, small traders and other enterprises.  

In all, one can say that the proposed norms on NPA recognition are both a tactical and strategic blunder on the part of the RBI.

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