NBFCs: Can banks still benefit from regulatory arbitrage?

Until recently, non-banking financial companies (NBFCs) were less-stringently regulated than banks by the Reserve Bank of India (RBI), and were thus considered an arbitrage boon in disguise by the financial services sector. NBFCs became a vehicle for business activities that banks were unable to undertake due to regulatory restrictions.

Like banks, NBFCs were sought to be regulated by the RBI (albeit through a different department), but there was a significant disparity in regulation levels. It is noteworthy that the regulatory focus was then on deposit-accepting NBFCs (D-NBFCs). This was because such entities were effectively putting retail deposits at risk (i.e. playing with public money) and in that sense had bank-like features. For a long time, non deposit-accepting NBFCs (ND-NBFCs) were lightly regulated.

While the RBI laid down various exposure norms for banks, there were no similar restrictions for ND-NBFCs. This allowed ND-NBFCs that were sponsored by banks (predominantly foreign banks) to extend loans without limits, and also to extend loans to sectors and for purposes from which banks were prohibited.

Sonali Sharma is a partner and Suprio Bose is an associate at Juris Corp. The firm is a full-service law firm based in Mumbai and specializes in financial transactions including capital markets and securities, banking, corporate restructuring and derivatives.