Context: The government is actively considering a proposal from the Reserve Bank of India (RBI) seeking more powers to improve its regulatory and supervisory mechanism for Non-Banking Financial Companies (NBFCs).

Why is this being proposed?

Recent defaults and delays in loan repayments by a section of NBFCs have shaken the confidence in the financial markets, leading to fears that potential solvency risks at certain companies can be contagious.

Liquidity for NBFCs with default ratings has completely dried up, creating broader challenges for policymakers.

What changes are being sought by RBI?

In the light of recent developments, there is a case for having a fresh look at their regulation and supervision. Need of the hour is to have an optimal level of regulation and supervision so that the NBFC sector is financially resilient and robust.

Need:

More powers will enable RBI to close regulatory gaps between banks (which are tightly regulated) and NBFCs. The RBI has already reduced the periodicity of the NBFC supervision to 12 months from 18 months earlier.

What is the scale of the challenge?

NBFCs were the largest net borrowers of funds from the financial system with gross payables of around Rs 8.44 lakh crore and gross receivables of around Rs 7.23 lakh crore as on end-March 2019.

These companies depend largely on public funds such as bank borrowings, debentures and commercial papers, which account for 70 per cent of the total liabilities of the sector.

When banks and mutual funds stop fresh loans to NBFCs facing default possibility, it can potentially lead to contagion in the financial markets.