5th March 2025 (11 Topics)

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IMF’s Warning on NBFC Exposure

Context

The International Monetary Fund (IMF), in its Financial Sector Assessment Programme (FSAP) for India, has warned that Non-Banking Financial Companies (NBFCs), especially large state-owned infrastructure financing firms, have significantly increased their exposure to the power and infrastructure sectors.

What’s the issue?

While banks have reduced direct exposure to these sectors after the 2016 banking crisis, NBFCs have taken on a larger role, increasing systemic risks.
If major NBFCs face distress, it could spill over to banks, corporate bond markets, and mutual funds, causing widespread financial instability.
IMF’s Key Recommendations

Financial Stability Over Social Goals: IMF suggests prioritizing financial stability over developmental goals to avoid future crises.
Regulating State-Owned NBFCs: Large state-owned NBFCs should have the same regulations as private NBFCs.
Strengthening Banks’ Capital Base: Some public sector banks (PSBs) need more capital to support lending in crisis situations.
Enhancing Crisis-Response Mechanisms: The RBI should prepare liquidity policies for potential systemic shocks in NBFCs.
Policy Alignment with Global Standards: India should implement:

Risk-based supervision of insurers
Pillar-2 capital charges for banks
International Financial Reporting Standards (IFRS)
Better oversight of financial conglomerates

Impact on India’s Financial Sector

The IMF considers India’s financial system systemically important globally, making these recommendations crucial for maintaining stability.
If ignored, an NBFC crisis could trigger a domino effect, affecting banks, corporate lending, and investment markets.

What Are NBFCs?

NBFCs are financial institutions that provide banking-like services but do not hold a banking license. They are regulated by the Reserve Bank of India (RBI) and operate under the Companies Act, 2013.
Key Features of NBFCs:
- Cannot accept demand deposits (like savings accounts).
- Offer loans and credit facilities, including vehicle loans, housing finance, SME lending, and microfinance.
- Engage in investments, leasing, hire purchase, and asset management.
- Do not provide payment services such as issuing cheques like banks.
NBFCs are regulated primarily by the RBI, but other regulators like SEBI, IRDAI, and NHB oversee sector-specific NBFCs.
Classification of NBFCs: NBFCs are categorized based on activities and size:
- Based on Activity
  - Asset Finance Companies (AFCs) – Provide loans for asset purchases like vehicles, machinery, etc.
  - Loan Companies – Offer direct lending to individuals and businesses.
  - Investment Companies – Invest in securities like stocks and bonds.
  - Infrastructure Finance Companies (IFCs) – Finance infrastructure projects (roads, power, etc.).
  - Housing Finance Companies (HFCs) – Provide home loans.
  - Microfinance Institutions (MFIs) – Offer small loans to low-income individuals.
- Based on Size and Regulation
  - Systemically Important NBFCs (NBFC-ND-SI) – NBFCs with assets above ?500 crore, requiring stricter regulation due to potential systemic impact.
  - Deposit-taking NBFCs (NBFC-D) – Allowed to accept term deposits (subject to RBI approval).
  - Non-Deposit Taking NBFCs (NBFC-ND) – Cannot accept public deposits.

PYQ

Q: With reference to the Non-banking Financial Companies (NBFCs) in India, consider the following statements: (2010)

They cannot engage in the acquisition of securities issued by the government.
They cannot accept demand deposits like Savings Account.

Which of the statements given is/are correct?

1 only
2 only
Both 1 and 2
Neither 1 nor 2

Solution: (b)

Little has changed in the Income-Tax Bill, 2025

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IMF’s Warning on NBFC Exposure

What’s the issue?

Impact on India’s Financial Sector

What Are NBFCs?

PYQ