NBFC Standards Improved After RBI Action, But Compliance Uneven, Says Fitch

India's stringent regulatory actions on non-banking finance companies in recent years have generally improved standards, but compliance remains uneven across the industry, according to Fitch Ratings.

While enforcement actions on various Indian NBFCs have raised scrutiny of the sector's governance practices in recent years, standards have generally improved with tighter regulatory requirements and heightened market attention.

In 2021, the Reserve Bank of India introduced measures to strengthen governance standards, such as requiring independent compliance functions, auditor rotation, and whistleblower mechanisms. These were especially for larger NBFCs. However, the global rating agency believes that the success of these measures has an impact on effective implementation, with current practices still uneven across the sector.

The recent regulatory actions on IIFL Finance Ltd., JM Financial Products Ltd., and ECL Finance Ltd. show ongoing risks, prompting a step in the regulator's supervisory drive, Fitch Ratings said.

To mitigate lapses in financial operations, the RBI has taken several regulatory actions against lenders in the recent past. In March, it barred IIFL Finance from sanctioning or disbursing gold loans and JM Financial Products from providing financing against shares and debentures.

According to Fitch, governance and compliance issues can greatly diminish customer and market confidence, which could potentially undermine funding and business activities for these companies.

"Severe non-compliance may result in stringent regulatory sanctions, which can negatively affect the issuer's franchise strength and heighten the risk of default, especially if liquidity buffers are thin," the report said.

The Infrastructure Leasing & Financial Services Limited fiasco in 2018 and Dewan Housing Finance Ltd. in 2019 are examples of weak governance practices. The report identifies several governance risk factors common among such cases, including concentrated decision-making, complex accounting and group structures, frequent related-party transactions, aggressive growth strategies, and less-experienced management.