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Mumbai, March 13: A working group constituted by the Reserve Bank of India (RBI) has called for tighter norms regarding the flow of bank funds to non-banking finance companies (NBFCs) to prevent them from “playing” in the capital market.

The group has recommended that the entire exposure of a bank to NBFCs, which do not accept public deposits, could be treated as part of the capital market exposure of the bank. “This may not sound logical. However, the recommendation is based on the premise that money is fungible. The bank finance availed of by an NBFC can be used for business purposes and the owned funds of the NBFC can be channelised to the capital market. Thus, although the bank finance is not directly diverted to the capital market, the availability of bank finance enables the NBFC to play in the capital market by apparently using its own funds,” the group added.

In India, there are more than 10500 NBFCs and a large number of them do not accept public deposits. These companies raise resources through debentures and securitisation while some of them use the commercial paper (CP) route. The working group’s recommendation, therefore, will disappoint many players in this sector, who are already complaining of non-availability of bank finance.

The group has also made a host of other proposals. These are aimed at preventing a systemic problem that may arise if bank funds are channelled into the capital market.

Another area that the group feels should be monitored relates to the NBFCs raising unlimited amount of commercial paper and “playing in the capital market”. A commercial paper is a money market security issued by large banks and companies. It is generally used to purchase inventory or manage working capital. The group has suggested that commercial paper be treated as public deposit. It wants the central bank to impose a borrowing limit, which could be a multiple of the capital funds of NBFCs.

According to the group’s recommendations, the central bank may consider imposing a limit on the extent of bank finance that can be extended to an NBFC that do not accept public deposits. The limit could be fixed at a certain percentage of the total capital of the bank. “Alternatively, banks may not be permitted to take exposure in an NBFC if its debt-equity ratio is larger than an acceptable level,” the group added.

On foreign banks that have set up NBFCs as their subsidiaries, the group said this has been done to benefit from regulatory arbitrage. “A bank’s NBFC subsidiary, which grants retail loans, coupled with a bank ATM, can circumvent the branch authorisation restrictions imposed on the bank by extending its outreach substantially,” it said.