[By Shriyansh Singhal]
The author is a student of National Law University Odisha.
Introduction
The Reserve Bank of India (‘RBI’) has initiated a new regulation aimed at aligning the regulatory frameworks of Housing Finance Companies (HFCs) with Non-Banking Finance Companies (NBFCs) to ensure greater consistency and financial stability. The RBI decision align with the guidelines stated in paragraph 4 of the dated 22nd October 2020 which recommended gradually harmonizing the regulations governing HFC and NBFC entities over the next two years, for a smoother transition. Changes of significance have been implemented in the following areas; (a) guidelines for receiving deposits that HFC registered certificate holders can receive or retain; (b) guidelines for accepting public deposits by NBFC holding certificate holders; and (c) additional significant directives, to both HFC and NBFC entities.
Rationale Behind the Proposal
The Reserve Bank assumed the responsibility of overseeing HFC operations from the National Housing Bank (‘NHB’) starting on 09 October 2019. It had implemented different guidelines treating HFC as a subset of NBFC entities. The rules governing both HFC and NBFC sectors were reviewed to ensure alignment in regulations while considering the features of HFC operations.
After reviewing the current regulations given to HFCs, RBI decided to release updated guidelines. Some of the laws related to NBFCs have also been looked into and a few changes have been made to them and the same will come into force from 1st January 2025. At present, NBFCs and HFCs which are allowed to accept deposits from the public are under higher measures on prudential regulation of deposits. This shift toward a unified regulatory regime is intended to address potential risks, ensure the safety of public deposits, and maintain financial stability.
Introduction of Key Changes
Increased Liquid Assets and Safe Custody
Earlier, the HFCs had to maintain 13% of the public deposits in the form of liquid assets as per Section 29B of the NHB Act, 1987. The previous regulations have set this requirement at 10% while the new regulations have increased the same to 15% which is to be implemented gradually by July 2025. This moderated rise starting from 13% on January 1, 2025, and 15% in July is targeted to ensure that HFCs have adequate cash flows to fulfill their obligations. This change aligns HFCs with the NBFC liquid assets regulation and is expected to improve the liquidity profile of the housing finance sector.
The regulation concerning the safety of liquid asset custody has been revised to be comparable to the regulation of NBFCs. It is now compulsory for the HFCs to park their liquid funds with the entities as mentioned in the Master Direction – Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016. This change enhances the definition and safeguards in liquid asset management, ensuring that HFCs have a sound mechanism for protecting the depositors’ funds.
According to the new guidelines, HFCs are also required to sustain complete asset coverage for the public deposits that are made. This stipulation, which was previously enforced for NBFCs, ensures that HFCs possess sufficient assets to support their held deposits, thereby lowering the risk of financial failure. In situations where the asset coverage falls below the required level, HFCs must promptly notify the NHB, enabling regulatory supervision and reducing potential threats to depositors’ funds.
Stricter Credit Rating & Deposit Ceiling
HFCs now must have a minimum credit rating of investment grade to accept public deposits. This explicitly annual review means that a lower rating during the year would render the HFC ineligible to accept any new deposits or renew existing ones until the rating is regained. Through this means, the central bank is ensuring that the firms are of reasonable financial integrity. Since HFCs are public deposit-taking institutions to that extent, the safety aspect of the public’s money is secure. Concurrent with this, the leverage of HFCs has been brought down hugely by not allowing them to take in public deposits in 1995, they could accept up to 300 percent of their net worth in public deposits but by mid-1996 they were forced to cut this limit down to 150 percent.
Terms of public deposits have been reduced from a maximum of 120 months to 60 months. This adjustment is intended to enhance asset-liability management by reducing the long-term interest rate risk on HFCs and achieving a better maturity match between assets and liabilities.
Restriction on Investments in Unquoted Shares
The modified regulations bring HFCs in line with NBFC rules, whereby there were pre-existent limits on unquoted shares that the housing sector lender could invest in. Said investments are also considered a part of the HFC’s overall exposure to the capital market and they need to set their internal limits accordingly. This will ensure that HFCs do not have undue exposure to completely illiquid and volatile investments, putting their financial stability at risk.
The new rules for HFCs have been modified in line with NBFC regulations as there were already limits on unquoted shares an entity could invest, the people said. These investments are also deemed to be part of the overall capital market exposure weathered by HFCs and they must fix internal limits for these as well. This would help HFCs not have full domestic exposure and reduce the chances of them having high levels of completely illiquid (and now volatile) investments that could jeopardize their financial stability.
Impact of the Amendment
The convergence of regulations is anticipated to have several effects on the housing finance system and the financial services industry as a whole since the New Depository and Asset cover norms are expected to enhance the liquidity position of HFCs. Aggregated excess liquidity would make HFCs more efficient and well capable of withstanding depositors’ demands as regards funds even during enhanced financial stress.
This will bring a ceiling on the excessive deposit mobilization by HFCs due to reasons such as being able to reduce the end deposit ceiling from three times to 1.5 times the Net Owned Fund (‘NOF’) and the presence of stringent credit rating criteria. These changes have the effect of ensuring that HFCs remain risk averse by preventing the institutions from excessive churns of public deposits but rather sensibly protecting them. Those governance standards with respect to HFCs and utilization of liquid assets with regards to safe custody and restrictions on the number of operational branches will also get better. These changes will help in the proper control of liquid assets by managing proper scope and volume of the geographical expansion of the HFCs.
It could be that the newer outer norms may be a challenge for smaller HFCs, especially to those with low credit ratings or poor financials. The decrease in the deposit ceiling and the tougher requirements on credit ratings may constrain these firms in raising funds from the public through deposits and hence they may have to go looking for alternative funding sources.
The Way Forward
The recent approach adopted by the regulators is commendable, but other measures will be needed to sustain the housing finance market. On the other hand, HFCs will have to transform in light of these challenges by liquidating management, enhancing corporate governance, and developing alternative financing sources. RBI’s regulatory intervention will also be sought to monitor HFC compliance with the norms and protection of depositors’ interests.
Additionally, there is a need for more financial literacy initiatives to educate depositors about the risks associated with various financial institutions, including HFCs and NBFCs. Such measures will assist their clients the depositors in making the right choices and avoiding risks.
Conclusion
The process of bringing regulatory rules concerning HFCs and NBFCs under one roof systematically alters India’s financial regulatory architecture. During this increase in standards, the RBI seeks to assist HFCs in becoming more stable and protect their depositors. While the growth in limitations on expenditure may be difficult due to some HFCs especially the smaller ones, it is, however, needed particularly, to guarantee the sustainability of the housing finance markets. In this transition period when the HFCs are facing new norms, all efforts should be directed toward financial prudence, management of high governance behaviour, and protection of depositor’ concerns.