Banking & Finance: Compliance taking the centre stage

21 Mar 2024 , 05:48 PM

In the words of the RBI governor, financial stability is a ‘public good’ that RBI has achieved with great efforts, and it intends to preserve and strengthen the same. Consequently, compliance is taking the centre stage with 4x increase in RBI penalties on regulated entities (FY20-23). Increasingly, these penalties are imposed for failure to follow the required processes, deficiencies in risk management practices and protection of customer interests after RBI increased oversight of non-bank entities in the last few years. Analysts of IIFL Securities channel checks indicate that RBI has: 1) increased frequency and depth of inspections 2) deputed on-site inspectors at major NBFCs for continuous supervision 3) developed risk-based supervisory framework, SPARC, enabling RBI to take pre-emptive actions. Analysts of IIFL Securities also believe that the era of light touch regulations for FinTechs has ended with the central bank proposing to set up FinTech SRO. Additionally, RBI may be mulling a revamp of existing penalty structures, which may include: 1) increase in penalty amounts 2) remuneration claw back for top management or 3) imposition of additional capital charge, per some news reports. While RBI’s enhanced and pro-active supervision bodes well for the sector’s long-term health, it also warrants closer investor attention in case of the first few instances of regulatory censure, which could be a precursor to more stringent actions by the central bank. 

RBI turning up the compliance heat on regulated entities 

In recent quarters, analysts of IIFL Securities have anecdotally come across multiple instances of RBI imposing fines / penalties on banks/NBFCs or other regulated entities. They note that increasingly, these penalties are being imposed for contraventions of not only statutory compliances, but also for failure to follow the required processes, deficiencies in risk management practices and protection of customer interests.

Sectoral data of last few years corroborates this: instances of penalties imposed by RBI have increased 4x since FY20, led by Cooperative banks (84%), NBFCs/HFCs (6%) and PSU and Pvt Banks (6%). Co-operative Banks were brought under the purview of RBI after the PMC bank crisis in FY20. Since then, RBI has not only revamped the regulations and oversight for co-op banks, but has also been pro-active to enforce course correction. This is evident from ~20x increase in penalties on Co-operative banks in the last four years.

Similarly, after the DHFL crisis, RBI has not only strengthened the regulations for NBFCs (through scale based regulations), but has also improved its oversight of their business and processes to ensure compliance in letter and in-spirit by reducing the regulatory grey area. Analysts of IIFL Securities channel checks indicate that the nature and frequency of RBI inspections have now increased and become more detailed. RBI has also deputed on-site inspectors for most of the large NBFCs for continuous supervision. This is in addition to the annual RBI audit of these entities. Indeed, some of the recent RBI measures such as tightening of AIF / ARC regulations, issuance of KFS, noncompounding of penalties, etc., can be attributed to the enhanced supervision of business practices of these regulated entities. 

Besides, RBI has also developed a SPARC (Supervisory Program for Assessment of Risk and Capital) based supervisory program that focuses on risk-based supervision, which is more forward looking and helps to take pro-active and pre-emptive actions preventing risk build up. As part of SPARC, the central bank also undertakes theme based study of topical sectors / events / practices that has the potential to create potential systemic risks to financial system. RBI’s clamp-down on unsecured lending early on in the cycle by increasing risk weights can be attributed to this risk-based supervision for the sector as a whole.