Credit: The Original Alternative To AIF?

Probably the most outspoken of various regulatory worries in many months, the RBI’s latest circular takes the award for bluntness. For a usually stiff-upper lipped regulator, it went ahead to state that its: “Regulated entities (REs) make investments in units of AIFs as part of their regular investment operations. However, certain transactions of REs involving AIFs that raise regulatory concerns have come to our notice.”

With this, the RBI is tightening its regulations for lenders regarding investments in alternative investment funds, aiming to tackle concerns about potential ever-greening of original loans. Evergreening involves financial institutions providing new credit to conceal the nature of issues with the outstanding debts.

The central bank aims to halt transactions involving the replacement of direct loan exposure from lenders to borrowers with indirect exposure through investments in units of AIFs. This refers to investing in AIFs that are exposed to the customers of the lender. The RBI has instructed lenders to refrain from investing in any AIF scheme with downstream investments, either directly or indirectly, in a debtor company of the lender.

Furthermore, if a regulated entity or a lender is already an investor in an AIF scheme that proceeds to make downstream investments in companies linked to the RE (those that have borrowed from or received investments from the RE), the RE must divest its investments in that AIF scheme within 30 days from the date of the downstream investment.

The most assertive regulatory measure is as follows: non-compliance within the stipulated timeframe will compel the lender to make a complete 100% provision for those investments. It’s going to be one hell of a Merry X'mas and a Happy New Year ahead for many of these entities as they have to unwind their transactions.

Years ago, due to a lack of ample distribution and market products, banks resorted to push-sales, creating a sort of monopoly as they were the predominant lenders in terms of size and scale. But surprisingly, the regulator did not adequately push its entities to bring customer friendly relevant products to the market.

Subsequently, non-banking financial companies, commonly known as shadow banks, experienced rapid growth to cater to clients overlooked or neglected by traditional banks. However, these shadow banks faced the challenge of operating in shallow Indian debt markets, where traditional lenders predominantly pursued highly rated corporates and governmental business. This situation persists with occasional disruptions and lack of regulatory support.

Parallelly, the growth of fintech lending, based on the overarching digital public infrastructure and newer credit assessment methodology and algorithms, helped bring new-to-credit and shunned-by-banks customers, and pushed up credit access with varying results, including regulatory worries.

However, the recent swift expansion of private credit funds, often lacking credit expertise but having fund-raising capability, poses a risk by serving consumers without access to lending entities regulated by the RBI. This prompts a crucial question: if regulated lending entities do not find merit in their borrowing, is there a fundamental issue? Or is it a simple issue of current lenders not understanding such a segmental customer need?

Not necessarily, as commonly heard from those launching private credit funds, which frequently lack detailed disclosures. However, addressing this falls within the purview of SEBI as the regulator of such funds. One significant claim is that these private credit funds primarily attract high net worth individuals and institutional investors with a risk appetite. But what about contagion effect, if one such fund implodes.

Or will these private credit funds evolve as parallel shadow-financiers (the NBFCs are considered the original shadow financiers)? It depends on the RBI and SEBI’s subsequent actions. One supporting factor for these regulatory measures is the RBI's possible observation that credit exuberance is manifesting in various forms, with the potential to negatively impact credit market sentiment and encourage imprudent borrowing behaviour. The Dec. 19 RBI circular is an indicator of it using its regulatory tools to influence the markets towards better behaviour.

However, this prompts a long-overdue introspection. When will the RBI analyse the utilisation and impact of its diverse banking licence categories?

Many of these categories were introduced at different points over the past 40 years. One can reasonably infer that numerous categories have deviated from their initial purpose or outlived it or unserve it, transforming them into instruments for widespread complacent banking. Many of them have no purpose or even a competitive strategy. Much of Indian banks offer the same products and compete for the same consumer segments, without a semblance of differentiation.

Undoubtedly, as banking supervision quality gradually improves with every cycle, the regulator gains better insights into what these licences should not entail. But by when?

The solution lies in a thorough and urgent evaluation of the business viability and the underlying purpose for each banking licensce category. It entails realigning those that are practical, closing or providing a transition pathway for those non-impactful to borrowers, and exploring the initiation of new, impactful, and relevant categories.

In a market like India, hungry for assets, the essence of cracking the banking model revolves around liabilities. This underscores why the RBI exercises caution with bank owners, given the trust and fiduciary nature inherent in public deposits.

The precise concern for economic growth is: where will credit-access originate from, if the number of lenders, the depth of lending capability and differentiated segmental lending expertise do not improve? Relying solely on existing banks may not be sufficient to carry the burden of the national aspiration to become a significant global economy.

Is credit still a fundamental challenge? This prompts consideration of whether historical banking practices and existing banking-hierarchy or systemic issues hinder the full realisation of a dynamic and accessible credit environment.

Consider the potential consequences of regulatory inaction in developing newer lending entities. A silent regulatory stance may inadvertently steer consumers towards riskier or unconventional lenders. Regulators, beyond merely enforcing rules, have the critical responsibility of identifying evolving market needs. The strategic creation of new licensing categories, aligned with current societal requirements, should be an integral part of their role. Failure to adapt may not only impede economic growth but expose consumers to unregulated and potentially hazardous lending practices. This dilemma underscores the need for a forward-thinking regulatory approach—one that actively anticipates market shifts, fosters innovation, and safeguards consumers from the allure of precarious financial avenues. The question remains: should regulators merely respond to market changes, or should they be at the forefront, shaping a financial landscape that meets the diverse and dynamic needs of society?

Is the RBI relinquishing credit-market development to others?

Srinath Sridharan is a policy researcher and corporate advisor.

The views expressed here are those of the author, and do not necessarily represent the views of NDTV Profit or its editorial team.