‘Over-reliance on unsecured loans, capital market funding can be source of grief for NBFCs’

Mumbai: Over-reliance on unsecured lending and capital market funding can “bring grief” to non-bank lenders in the long run, Reserve Bank Deputy Governor Swaminathan J has cautioned. In an address to heads of assurance functions of non-bank finance companies at an RBI-organised conference on Wednesday, Swaminathan also warned against over-reliance on algorithms for taking lending calls.

He also went public with the RBI’s disappointment at the tendency of “misguided or intelligent interpretation” of rules to “circumvent regulations” and termed this as a “significant threat” to the financial system’s integrity. The career commercial banker-tuned-regulator also flagged the risk limits for certain products or segments like unsecured lending are “way too high” to be sustainable in the long run.

“There appears to be a fancy among most NBFCs to do more of the same thing, such as retail unsecured lending, top up loans or capital market funding. Over reliance on such products may bring grief at some point in time later,” he said.

In the aftermath of the Reserve Bank of India’s (RBI) increasing of the risk weights on unsecured lending to dissuade lenders from piling up such riskier exposures, there were murmurs of borrowed money being put to bet on the capital markets which had led the RBI to ask lenders to monitor the end use of funds. On the issue of algorithm-based lending, he said many entities are turning to rule-based credit engines to accelerate growth in books.

“While automation can enhance efficiency and scalability, NBFCs should not allow themselves to be blinded by these models. It is crucial to recognise that rule-based credit engines are only as effective as the data and criteria upon which they are built,” he said.

Overreliance on historical data or algorithms may lead to oversights or inaccuracies in credit assessment, particularly in dynamic or evolving market conditions, he said, asking NBFCs to maintain a clear-eyed perspective on their capabilities and limitations, and to undertake monitoring efforts.

Speaking about the tendencies to circumvent regulations by misguided or intelligent interpretations for individual gains, Swaminathan said such practices undermine regulatory effectiveness, compromise stability and fairness in the

market.