The Reserve Bank of India (RBI) has directed large non-banking financial companies (NBFCs) to discontinue offering new lines of credit to companies.
The move comes at a time when RBI is concerned that repayment arrangements of such loans can mask financial stress, postponing identification of defaults.
A line of credit is a working capital-like flexible loan facility under which companies can borrow and repay multiple times against an approved limit, and renewal of the existing ones.
RBI has also asked NBFCs not to roll over these facilities at the time that existing pacts expire.
There is no official word on aggregate exposure, but estimates suggest that NBFCs have advanced or committed Rs 50,000 crore to Rs 60,000 crore under this lending program.
Regulatory Concerns Behind The Move
Unlike banks, NBFCs do not have information on real-time cash flows of the borrower, and hence, financial distress cannot be identified at an early stage.
Lines of credit are also not fixed as the borrowers can withdraw funds when needed and repay in a non-linear fashion.
In the majority of cases, repayment of the interest part occurs in the initial phase, whereas repayment of principal is delayed.
RBI has expressed concern that such a structure would enable borrowers to use additional drawdowns for paying off incurred debt, essentially rolling over the loans without showing signs of stress until the total sanctioned amount is drawn.
This could cause a lag in detecting financial distress and increase the risk of defaults going undetected for an extended duration of time.
The RBI is of the opinion that these types of loan products should be left to banks, who have stronger monitoring systems in place and visibility of borrowers' information.
Impact On NBFCs And Lending Industry
This directive will likely have a radical impact on NBFCs, as flexible credit products are a staple for most lenders to businesses who do not have access to bank finance.
Without being in a position to roll over such lines of credit, NBFCs may also lose their loan portfolios, with a negative consequence on overall revenues and profitability.
Large NBFCs with multiple lending businesses may consider switching over to other structures of loans, but smaller institutions relying on these products may lose liquidity.
Alternatives May Be Elusive For Borrowers
Small businesses and solo professionals, the largest users of NBFC credit lines, may find it difficult to access short-term working capital.
Such borrowers lack the credit record or collateral to secure a traditional bank loan, and hence, flexible credit facilities emerge as a viable financial product.
With NBFCs withdrawing from this segment, the companies will have no choice but to opt for more disciplined loan products with stricter eligibility criteria and repayment conditions.
Will Banks Fill The Vacuum?
As NBFCs step aside, the demand for working capital loans and overdrafts by banks is set to rise. However, banks like to have more robust risk assessment criteria and can ask for additional documentation or collateral, thereby withholding access to many small businesses. This might lead to liquidity deficiencies in particular industries, particularly those that rely on revolving use of credit.
A Broader Regulatory Shift
RBI’s directive is part of its broader efforts to align NBFC regulations more closely with banking norms. In recent years, the central bank has introduced stricter oversight for non-bank lenders, especially after the liquidity crises triggered by defaults in the sector. Globally, similar credit structures are typically offered by banks rather than non-bank lenders, and RBI’s move follows this trend of ensuring greater financial stability.
Borrowers will need to shift their financing plans, relying increasingly on bank loans, although they will have stricter terms. The transition can cause short-term dislocations, especially among industries that use liquid credit. As the financial climate matures under these pressures, the final impact will depend on how effectively businesses and lenders adapt to the new regulatory environment.
