RBI action against financial entities, and the bigger picture

From Paytm Payments Bank to JM Financial Products, there have been a spate of regulatory actions against financial entities recently, some of an unprecedented nature, but with a common thread of compliance, and more often than not of governance-related issues.

In the case of Paytm Payments Bank and more recently IIFL Finance, RBI attributed the action to “material supervisory concerns,” and in the case of JM Financial Products to “serious deficiencies observed in respect of loans sanctioned,” and “serious concerns on governance issues in the company.”

CNBC-TV18 spoke to several industry watchers, sources within the Reserve Bank, and financial institutions, to understand the bigger picture emerging from these actions, and the message for the industry.

Industry watchers say these regulatory actions are good for the industry in the long term, to make them stronger and help build sustainable businesses.

“RBI has been pretty active..and what we are generally seeing is that strong and effective regulatory framework is actually a long-term positive for the financial sector, and for the financial entities- one, from an investor-confidence point of view, and second, for their ability to generate revenues and profits in a risk-controlled manner,” Saswata Guha, Senior Director & Team Head - Financial Institutions, India at Fitch Ratings said.

“As an upper layer NBFC, we go through at least one annual financial inspection and that process is continuous and ongoing… What is very clear is that for business going forward we have to keep governance and compliance right at the centre of everything we do, versus an earlier attitude where compliance was more about checking some boxes,” Gagan Banga, Vice Chairman and managing director of Indiabulls Housing Finance told CNBC-TV18.

Banga added, “This requires a cultural transformation for the sector. I think the sector is being led extremely well by the RBI. I think on a longer-term basis, the way to build steady stakeholder value is via good governance. You can't build continuous value without good governance... Specifically for NBFCs, the RBI has been talking about harmonising regulations of upper layer NBFCs with those of banks and now I would assume supervision would also be harmonised, and that for the sector would be good.”

Other players, too, believe that for a sensitive sector like financial services, governance takes prime importance, and building businesses without guardrails can have larger repercussions for the economy.

“You would see that regulators keep wrapping the knuckles of companies that do not stay in line with the regulations…without guardrails, you cannot really build institutions, you cannot really build the future. And the problem with financial services is that when it misbehave is that the price is paid by the larger economy and the price is paid by the taxpayers in the end. So, because of the regulatory sensitivity of the sector, it is important that governance standards there are kept at the highest level. And especially when you have Goldilocks scenarios, as we have been having last year, generally mistakes are made in bad times,” said Aseem Dhru, MD & CEO, SBFC Finance.

The type of action taken by the regulator has been both targeted and broad-based, as needed in different situations. For instance, RBI took action on the specific business segments in the case of IIFL Finance, only placing restrictions on their gold loan portfolio, or in the case of HDFC Bank earlier- placing an embargo on the digital banking offerings. RBI barred Bajaj Finance from sanctioning and disbursing loans under two specific lending products and Bank of Baroda from onboarding any new customers onto their mobile application.

While these were targeted actions pertaining to concerns in very specific business segments, the regulator has also taken more broad-based actions where necessary to stem any systemic risks, like imposing higher risk weights for unsecured lending.

“What is the most important to recognise is they are targeting specific businesses, with the exception of Paytm Payments Bank..What they are essentially trying to do is contain system risk within a certain business segment,” Guha added while speaking to CNBC-TV18.

The regulator has typically imposed monetary penalties on banks and non-banks for violations of various regulatory norms in the past, even put them under a “prompt corrective action” framework to curtail business in the past, but the nature of recent actions has changed.

“The regulator is clearly upping the ante on two things. One is its regulatory oversight itself. And second is we know that when you have repeated observations and you're not fixing those issues, then they are willing to go all the way to ensure that you fall in line. So it is not just signalling for the NBFCs as what right now you know you are led to believe, it is more a signalling to all the players that you need to fall in line with what is expected,” Aseem Dhru, MD & CEO, SBFC Finance told CNBC-TV18.

Analysts believe that this adds weight to the supervisory framework and ensures entities do business within regulatory norms.

“In certain situations, RBI chooses to go with fines. Typically institutions where discrepancies arise, RBI tends to fine them...It is in specific segments where RBI came across issues, it has not been shy of putting it out in public... What is sort of changing is that RBI is more open to come out and take more stricter action instead of a more internal dialogue, which perhaps may have been the case in the past… It adds weight to the strength of the supervisory framework and it will keep entities on their feet so that they do business within the regulatory framework,” Saswata Guha of Fitch Ratings said.

CNBC-TV18 also spoke to insiders who are familiar with RBI’s workings and what goes behind the regulator taking severe actions against entities.

There are a whole host of tools available with the regulator to put checks in place, and ensure compliance when it finds deviations by entities, explained one of the persons familiar with RBI’s working. First, there are two-way dialogues with the financial entities, explaining RBI’s concerns and allowing them a chance to rectify issues. The entity’s submissions are considered before the regulator takes any action. In other instances, a monetary penalty may be imposed as a rap on the knuckle for a particular entity’s non-compliance. In more severe cases of breaches, after dialogues with the management and warnings, if no corrective or meaningful action is taken to course-correct, the RBI would impose business restrictions or in the worst case, supersede board or revoke the banking license, explained this person.

The Reserve Bank Governor Shaktikanta Das alluded to this, while explaining the action on Paytm Payments Bank in the February monetary policy press conference.

“Over the last few years, as all of you are aware, we have significantly deepened our supervisory systems approach and methods… Our emphasis is always on bilateral engagement with the regulated entities with a focus on nudging them for corrective action and sufficient time is given for undertaking such corrective action. When such constructive engagement, which we undertake, does not work or when the regulated entity does not take effective action, we go for imposing supervisory or business restrictions. Such restrictions which we impose are always proportionate to the gravity of the situation. Please take note that such restrictions are proportionate to the gravity of the situation,” Governor Das stated.

“Being a responsible regulator, being a responsible supervisor, all our actions are in the best interest of systemic stability and protection of depositors' and customers' interests. These aspects cannot be compromised. Individual entities should be mindful of these aspects for their long-term success,” the Governor added.

There is a clear line drawn by the regulator about poor governance and weak compliance not being tolerated, say industry watchers, and the message is clear.

“What I understand is that RBI does look at capital markets, real estate and all such sensitive sectors. They require NBFCs to make specific disclosures around their exposures to all such sensitive sectors and obviously RBI has heightened monitoring around exposures of NBFCs, practices etc to these specific sensitive sectors. Overall culturally, we guys have to transform. We have to get ready to for ensuring that a large part of the senior management’s time is spent on compliance, good governance versus just pursuing business etc. That is cultural transformation. The writing is clear on the wall- if we postpone this, it will be to our harm,” Gagan Banga told CNBC-TV18.

“The messaging from the central bank is very clear that they don't want to take an easy position. Now the message is even stricter to all of us - players that either we fall in line or we would be put in line,” added Aseem Dhru, MD & CEO, SBFC Finance.

Likening the regulator’s role to that of a doctor, Dhru quipped, “The central bank's job is like a veterinary doctor. Whatever it is it is doing is for the interest of the animal, but the animal certainly protests.”