Recently the Reserve Bank of India (RBI) cracked the whip against four non-banking financial companies (NBFCs) and their micro-finance institutions (MFIs) for charging outrageously high interest rates on loans. This action by the RBI proves that there is now emphasis on unscrupulous lending and hence the necessity of customer protection and fair practices that however, will increase the cost of borrowing.
Why the RBI acted against these Entities
There were several material supervisory concerns raising RBI’s bar to act against these entities. Pricing policies of these companies including their WALR and the interest spread ahead of their cost of funds were observed to be over-and above the requisite norms. The RBI had earlier come out with cautionary/informational or regulatory circulars to prevent biased pricing and to check unsavoury practices including innovative techniques of pricy microloans but such practices exist in the sphere of irregularities.
Further, the RBI notes lapses on the parts of regulated entities in compliance with the regulatory expectations on determining household income and the borrowers’ existing and projected month-end obligations. Such non-compliance included concerns such as even lending, when new loans are used to repay old loans, and gold loan portfolios. In addition, the RBI observed that these entities lacked adequate disclosures in relation to interest rates and fees, and outsourced essential banking services.
Has Borrowers End up Paying Much More Than Appropriate Interest Rates
Several factors make borrowers pay very high interest on the amounts that they have borrowed. These NBFCs and lending apps still don’t state the interest rates and the extra charges which mean borrowers do not understand the actual amount they are paying for credit. Unbeknownst fees and charges also reduce the cost of borrowing making it hard for the borrowers to contain his / her costs of repayments.
Another factor includes lending at post sanction/ execution interest rates from the date of sanction or entry into the loan agreement rather than the date of actual disbursement of cash. This is even more costly than charging interest on money that has not been borrowed because the consumers are even paying on the money they have not owned and hence, the high cost of borrowing. Third, interest for loans disbursed or paid during the month is charged fully for the month, resulting to exorbitant charges.
The RBI has also encountered situations where lenders apply the entire amount for computing interest even though they have received one or more advance instalments. This leads to borrowers paying interest on loan balances that they have never seen or used in any way. These unfair practices cause high-interest rates that NBFCs and lending apps impose on borrowers and financial pressure on those clients, which makes it impossible to repay the money on time.
The Impact of RBI's Action
The measures taken by the RBI will have a far reaching effect across the financial sector against these entities. This way, RBI seeks to deal with instances of high powered money creation and companies and borrowers are protected from unscrupulous lending practices. The central bank has also established a public list of the authorized P2P players and provided its customers with a database of the identified false digital lending applications.
RBI action is considered as a welcome step towards improving the overall credibility of the nascent financial sector and safeguarding the borrowers. This will be a wake-up call for other NBFCs and MFIs to ensure that they maintain proper and reasonable prices on their products and not to indulge in sharp practices that can be foul to consumers of their products. This paradigmat is expected to open up opportunities for other responsible players in the NBFC segment to come into operation and ensure balance for borrowers.
The recent action of the RBI against four NBFCs and the MFIs connected with it for charging usurious price point to the fact that the financial sector requires more transparency and fair play. Through regulation of most advanced and sophisticated methods of loan sharks and blatant high-interest rates, RBI seeks to safeguard the borrowers from exploitation. The banking industry’s action by the Central Bank is billed to bring about serious effects on the top of it, it is billed to fashion out responsible policies on lending in the country. Applicants should be wary and always keep abreast with the real cost of borrowing in order to be victorious over unfair financial practices.
NBFCs
NBFCs are an essential part of the financial system because they extend several services and products in the same manner that the banking institutions offer, but they are governed by different laws. These entities play the main role of providing credit and financial facilities to different tiers of society including the segments, which have little or no access to conventional banks.
What Are NBFCs?
NBFCs are Non-banking institutions functioning as banking institutions. The Reserve Bank of India (RBI) is responsible for regulating banks operating in India in accordance with the terms of the RBI Act of 1934. Depending on operations, NBFCs can be categorized into: Asset finance companies, Investment companies, Loan companies, Infrastructure finance companies & Micro finance institutions.
Key Characteristics of NBFCs
- No Banking License: NBFCs do not possess a banking license and therefore cannot accept demand deposits such as, savings deposits.
- Diverse Services: NBFCs provide credit, financial leasing, hire-purchase services, insurance, and underwriting and other investment services.
- Target Segments: NBFCs can be very selective in the type of business they offer focusing on segments that may be underserved or completely ignored by larger banks such as SMEs, agriculture based populace or high risk clients.
- Regulatory Oversight: NBFCs are under the regulatory control of RBI but it is imperative to understand that they function under different rules than a bank. This enables them more freedom in some areas but with the following restrictions.
How NBFCs Work
- Credit Provision: NBFCs mainly involve in financing activities, especially, they give credit to others. Variable loan products are personal, business, automobile and housing loans available in the financial markets. The speed at which NBFCs process and approve loans is faster than that of banking institutions.
- Asset Financing: The NBFCs involved in the asset finance companies offer company financing for acquisition of assets like vehicles, machinery and equipment. They allow companies to enter into important contracts and utilities without spending much formally.
- Leasing and Hire Purchase: NBFCs provide leasing and hire purchase facilities, helping the persons or companies to make use of properties for which they agree to pay in stages. This is especially helpful to SME's that require the use of equipment and machinery in the course of their business.
- Microfinance: Micro finance institutions, which are a part of NBFCs, the financial solutions aimed to unserved population and micro enterprises.
RBI
Established in 1935, the Reserve Bank of India (RBI) is the supreme monetary authority of India, tasked with overseeing the nation's monetary system and evaluating its monetary norms. The RBI was set up in March 1935 and it forms an important institution in managing the financial systems besides encouraging economic development. It has vital responsibilities such as Overseeing Non-Banking Financial Companies which are institutions offering banking like services but without a license.
Role and Functions of the RBI
The RBI's primary responsibilities include:
- Control over monetary policy and methods for distributing the money supply in a way that maintains price stability and economic expansion.
- Overseeing functioning of banks
- Overseeing other financial institutions.
- Managing the nation's foreign exchange reserves and overseeing the foreign exchange market.
- Controlling and creating circulation of money.
Regulation of NBFCs
NBFCs are of much importance in the financial sector since they offer credit and financial products to different parts of the economy, more so the segments that may not access such products from deposit taking institutions. Keeping their stability and the borrowers’ interests in mind, the RBI has created a stringent regulatory structure of NBFCs.
- Registration and Licensing: NBFCs have been made compulsory to get registered with RBI and acquire a certificate for doing the business. They are expected to maintain and control capital in certain levels and also to follow covenants as provided by law.
- Prudential Norms: RBI prescribes guidelines for NBFCs, such as capital standard, classification of assets, and standard of provisioning and limit of operation. These norms keep NBFCs financially healthy and the risks cantered by them under control.
- Corporate Governance: The RBI has established some criteria in an effort to improve the NBFC's accountability, transparency, and ethical behaviour. This also includes some specific prospective for boards of directors, audit committees and measures related to internal controls.
- Customer Protection: RBI has laid down measures that prevent the exploitation of customers as well as check misleading loan pricing. It mandates NBFCs to declare the rates of interests,fees and other charges that over and specifically barred them from engaging in usurious practices.
- Periodic Reporting and Inspection: The NBFCs are also responsible to file some reports such as financial statements and reports of compliance with the RBI at periodic interval. Each centre is required to complete annual inspection, as well as the audit to check the financial performance and compliance with the standards by the RBI.
- Regulatory Oversight: The RBI matches its frequency of monitoring and supervising NBFC with those of a continuous channel. This has requires evaluating their risk control measures, how they have been performing financially and whether they are in compliance to set standard norms.