Relevance: Mains: G.S paper III: Indian Economy: Banking
Context
- The RBI working group under Tapan Ray, that was given the task to review one of the troublespots in the NBFC regulatory framework — core investment companies (CICs) — has made some good suggestions.
- While the supervision of CICs can improve going ahead, these regulations, if adopted, may not be able to fix the damage already done.
- The CICs, which hold at least 90 per cent of their net assets as investment in equity, debt or loans in group companies, were under less stringent regulation;
- It was believed that these entities would be taking lower risk since they have exposure to group entities alone.
- But the loopholes in the rules have been exploited by some groups, leading to regulatory problems.
Definition of ‘Group’ in the regulation
- This includes subsidiaries, joint ventures, associates, promoters and related parties — led to CICs dealing with many unregulated entities.
- Many groups had multiple CICs, and each CIC would raise funds independently to invest in group companies or other CICs.
- Thus funds were being raised by CICs, step-down CICs as well as by group companies, increasing the group-level gearing.
- Since some group entities are not governed by any regulator, it was difficult to gauge the extent of leverage in these entities.
- Also, while CICs are currently restricted to dealing only with group entities on the asset side, there is no such restriction on liabilities.
- They can borrow from markets, mutual funds and other investors through commercial papers, non-convertible debentures and inter-corporate deposits, for investing in or lending to group companies.
Restrict the number of layers of CICs
- The suggestion to restrict the number of layers of CICs in a group to two, will help in multiple ways including reducing leverage, improving transparency and making regulation easier.
- Stipulating that capital contribution by a CIC in a step-down CIC, over and above 10 per cent of its owned funds, should be deducted from its adjusted networth, will help rein in the borrowings of these entities.
- The suggestions regarding mandating a group risk management committee, audit committee and nomination and remuneration committee will help improve governance of such groups and ensure that shareholder wealth is protected.
Way forward
- The changes will certainly help improve governance in CICs, the RBI should be careful about the manner in which the rules are implemented.
- The glide path of two years given to existing CICs to reduce the adjusted networth and for step-down CICs to stop investing or lending to other CICs may not be enough.
- Periodic on-site inspection by the RBI is a good idea as is off-site reporting of disclosure relating to leverage at the CIC and the group level.
- But the RBI should ensure that the changes do not lead to fresh problems.