RBI Warns NBFCs: Strict Norms for Lending to Existing Loan Defaulters

The Reserve Bank of India (RBI) has intensified its scrutiny over the lending practices of Non-Banking Financial Companies (NBFCs). The central bank has expressed concerns regarding instances where NBFCs provide fresh credit to borrowers who have already defaulted on their previous loan obligations. According to RBI officials, annual inspections revealed that some companies were bypassing risk management protocols. The regulator's primary objective is to eliminate the practice of 'evergreening' and ensure that the asset quality of financial institutions is reported with absolute transparency and accuracy.

Prevention of Loan Evergreening Practices

Evergreening refers to the practice where a financial institution grants a new loan to a distressed borrower specifically to enable them to repay an existing overdue debt. According to officials, this tactic is often used to mask the true extent of bad loans on a company's balance sheet, while under current regulations, any loan installment remaining unpaid for 90 days must be classified as a Non-Performing Asset (NPA). By providing fresh funds to cover old defaults, companies attempt to avoid this classification, which can mislead stakeholders about the institution's financial health, while the RBI has reportedly questioned at least three major NBFCs regarding cases where vehicle loan defaulters were granted fresh property or home loans.

Requirement for Board-Approved Lending Policies

The RBI has mandated that NBFCs must have a comprehensive policy, approved by their respective boards, before extending credit to customers with a history of default. The regulator clarified that it isn't imposing an absolute ban on such lending, as it remains a commercial decision for the company. However, the policy must clearly outline the specific circumstances under which such loans are permissible. Plus, companies must establish internal control mechanisms to ensure that new credit isn't utilized solely to keep old accounts 'standard' on paper. These directives are particularly focused on NBFCs with a net worth exceeding ₹250 crore.

NPA Classification and SMA Monitoring Framework

To monitor credit accounts effectively, the RBI utilizes a structured timeline for delinquency. As per the guidelines, a loan account is classified as a Special Mention Account-0 (SMA-0) immediately upon the first instance of a missed payment. If the delay extends between 31 and 60 days, it's categorized as SMA-1, and a delay of 61 to 90 days places it in the SMA-2 category. Once the 90-day threshold is breached, the account is officially declared an NPA. The RBI emphasized that NBFCs must adhere to these classifications transparently to reflect the actual credit risk within their portfolios.

Implementation of IndAS and ECL Models

NBFCs following the Indian Accounting Standards (IndAS) face even more stringent requirements regarding risk assessment. Under IndAS, the 'Expected Credit Loss' (ECL) model is employed, requiring companies to estimate potential losses from the moment a loan is originated rather than waiting for an actual default. According to the framework, a payment delay of more than 30 days is viewed as a significant increase in credit risk, necessitating immediate financial provisioning. The RBI believes that integrating board-approved policies with the ECL model will foster better governance and risk management within the shadow banking sector.

Strengthening Governance and Risk Management Standards

This regulatory push is part of the RBI's broader strategy to mitigate systemic risks within the non-banking financial sector. The regulator has made it clear that the absence of a specific internal policy doesn't grant companies the liberty to engage in high-risk lending without oversight. NBFCs are now required to focus on the intrinsic quality of their loan portfolios and maintain adequate capital buffers. According to officials, future inspections will involve a detailed review of how these board-approved policies are being implemented on the ground to maintain the integrity of the national financial system.