Multiple banks lending to the same NBFCs dilute post-sanction monitoring

Speaking on the issue of increasing interconectedness between banks and NBFCs, RBI Deputy Governor Swaminathan J said on Thursday that the culture of multiple lenders giving funds to the same entities is leading to a dilution of post-sanction monitoring.

“It is becoming a lose-lose game for everyone because neither the risk gets monitored at the underwriting stage because of the large lenders’ group, and more importantly, in the post-sanction monitoring, there is a complete dilution because everyone thinks the rest of the world will take care. This is an issue that the banking industry will have to think through and decide whether you want to be one among many lenders,” Swaminathan said at SBI’s Banking and Economic Conclave.

The central bank has noticed that lender groups consist of 20–40 lenders, he said, adding that while weak-rated NBFCs say they need multiple lenders because banks are only willing to take small exposure, the well-rated ones say they want to keep multiple limits so they can draw down credit from whichever bank quotes the best price. Banks, on their part, do not want to be left out and therefore choose to be part of multiple lenders’ groups.

inter-connectedness

While there have been no alarming indicators as yet, the regulator does not want an “extraordinary inter-connectedness” building up and later posing a contagion risk for us, which is why it had to introduce certain measures to curtail the exuberance, he said, refrencing the recent hike on risk weights on bank lending to unsecured retail loans and NBFCs.

“While the banking sector growth has been 12–12.5 per cent, the growth in the credit to services sector grew by about 20 per cent, and within that, growth in the financial sector, which is financing to NBFCs, grew by 30 per cent. And it is not just one year’s growth; it is a trend that we have seen for the last two to three years. A huge interconnectedness gets built when the banks are financing an entity that is in the same sector, which is likely to pose a contagion risk,” he said.

Thus, banks need to remain alert to the risks inherent in their business models and mitigate them by reviewing their growth plans while putting in place adequate risk management systems to handle the emerging risks.

“It is imperative for boards of banks and NBFCs to fix suitable sectoral and sub-sectoral exposure limits and monitor them closely to avoid any sectoral concentration, adverse selection, or dilution of underwriting standards,” he said.

While the growing collaboration between banks, NBFCs, and fintechs is driving innovation in products, services, and business models, an important consideration is the cautious adoption of model-based lending through analytics.

“Banks and NBFCs should exercise caution in relying solely on preset algorithms, ensuring that these models are robust, regularly tested, and recalibrated as needed to maintain robust underwriting standards,” he said, adding that this is because recent global events have demonstrated that sometimes even safe business models can fail.