RBI reveals unscrupulous practices in the NBFC sector

In a recent revelation, the Reserve Bank of India (RBI) has uncovered a covert financial practice known as evergreening, exposing the intricate strategies employed by non-banking financial companies (NBFCs) to manipulate their financial positions.

Within this scenario, an NBFC lacking a banking license, restricted to accepting fixed deposits, engages in lending with its own funds and a portion of these deposits. The challenge arises when a borrower encounters financial obstacles, triggering regulatory constraints that mandate delays beyond 90 days be classified as Non-Performing Assets (NPAs).

To navigate potential NPAs, the NBFC turns to evergreening. Collaborating with an Alternative Investment Fund (AIF), operating outside the RBI's jurisdiction under the Securities and Exchange Board of India (SEBI), the NBFC convinces a struggling borrower to issue bonds. The AIF then purchases these bonds using funds provided by the NBFC.

The intricacy lies in the borrower repaying the original loan within the stipulated 90-day window, allowing the NBFC to sidestep NPA classification. In reality, the loan term is extended through the intervention of the AIF.

Addressing potential risks, if the borrower defaults on the AIF loan, the NBFC is not directly affected. The AIF investment does not fall under NPA norms, and the fund typically has a fixed maturity period, providing a buffer for potential defaults.

In response to these financial maneuvers, the RBI issued a directive, imposing restrictions on NBFC-AIF collaborations:

NBFCs must verify if an AIF has purchased bonds from any company that has transacted with the NBFC in the past 12 months.

If such a nexus exists, the NBFC must cease dealings with the AIF within 30 days.

Failure to comply results in the NBFC making provisions in its books, incurring a financial setback.

This regulatory intervention aims to curb evergreening practices and prevent the masking of underlying financial issues within the NBFC sector. As this unfolds, NBFCs proficient in evergreening may face consequences, impacting their stock prices and credit ratings. Additionally, AIFs, which often raise funds from entities such as the Small Industries Development Bank of India (SIDBI), may experience challenges in fundraising as SIDBI exercises caution in light of the new rule. The financial landscape is undergoing a transformation as the RBI endeavors to instill transparency and integrity in the industry.