Microfinance Focus, January 3, 2012: The Reserve Bank of India has released a study showing the high dependency of Non-Banking Financial Companies (NBFCs) on Banks for their funding. The study claims that the heavy reliance makes the financial system vulnerable in a stressful situation.

There seems to be a strong growing systemic financial inter-connectedness between banks and NBFCs. This has even more systemic concerns than NBFCs directly raising resources by way of public deposits. NBFCs’ high dependency on banks for their funding results in funding of medium to long term assets from the short term sources, RBI said in statement.

Analysing the sectoral deployment of credit by the banking system, the report reveals that their lending to NBFCs have been on the consistent increase from 2007 to 2011 from around 2.75 per cent in May 2007 to 4.80 per cent by March 2011 confirming NBFCs’ reliance on the banking system for their major chunk of funds. Though this percentage is apparently smaller, any failure or crisis at few NBFCs can still have its implications, the report says.

The study has suggested that the correct policy choices should include promoting an appropriate degree of diversity in channels for financing, along with a balanced set of incentives for complementary development of banking and NBFCs and markets in promoting economic growth.

Given a regulated approach rather than restrictive policy approach, NBFCs will be able to play a more positive role for the promotion of economic activities that are not served by the banking system. Further, NBFCs may be encouraged with proactive policy measures to create a healthy competition for the banking system, while also provide wider choice to investors for savings.

Going forward, there is a requirement for redefinition of ‘systemically important NBFCs-ND’ (Non-Deposit). Higher liquidity requirements against excessive reliance on wholesale short term funding and higher capital requirements for inter-financial sector and intra-financial sector exposures are some of the key prudential requirements that need consideration, the study says.

Indian microfinance sector is one of the major beneficiaries of priority sector lending by banks. However, post microfinance crisis in Andhra Pradesh, banks reduced their funding to NBFC-MFIs by 77 percent. Even a year later, the bank funding is down by 65 percent creating a severe liquidity crunch in the sector.