Why can't a Hindustan Unilever kind of ecosystem work in the financial services business to reach the unbanked and underbanked?

"Hindustan Unilever never attempts to sell a soap directly to me. The company will go to its mass distributor; the mass distributor will go to the kirana store, and the kirana store will give me the soap. That's how that ecosystem works," explianed Abizer Diwanji, the financial services head at EY India, while furnishing this analogy in connection with the banks and NBFC arrangements with fintechs in reaching out to the underbanked and unbanked.

He was speaking at the Assocham's National Summit on NBFCs & Infrastructure Financing held in Mumbai today.

Recently, banks, NBFCs, and fintechs have been on the radar of the Reserve Bank of India (RBI) for taking advantage of regulatory gaps and posing problems for the financial system, especially in personal and other unsecured loans. 

The RBI has come out with a series of regulatory measures to put a check on any malpractices in the lending business. 

In June last year, the RBI capped the first loss default guarantee (FLDG) mechanism between banks and NBFCs with fintechs, where the latter promises to cover the loss way of of possible NPAs. This guideline now restricts the ability of banks and NBFCs to take on a higher exposure of loans from originators like fintechs which have a much better sense of the customer. 

While some fintechs might have exploited regulatory gaps to promise unreasonable amounts by of FLDG, most were doing a good job of finding new segments, customers, and introducing new ways of underwriting loans for traditional banks and NBFCs.

In November last year, the RBI also made credit from banks to NBFCs costlier. It increased the risk weight requirement (meaning higher capital) for banks by an additional 25 percentage points to 125%. This has impacted many fintech NBFCs as they depended on banks for funding support.

In this banking and Hindustan Unilever analogy, Diwanji explained that the kirana gives credit to a customer because the kirana understands the customer better, and Hindustan Unilever also knows that it cannot win in this game. "When the kirana gives me credit, I consume more. When I consume more, the profits of Hindustan Unilever go up. That's how the system has to work," said Diwanji.

"So, the banking system also has to rely significantly either on a co-lending basis through additional comfort that the NBFC can give to the bank or on a lending basis where comfort comes from the bank's funding to the NBFC," he said.

Diwanji asked, "Why can't a Unilever kind of ecosystem work in the financial services business, the NBFC or the microfinance institution (MFI), which is better able to assess credit?"

In an earlier panel, R. Lakshmi Kanth Rao, Executive Director, Reserve Bank of India (RBI), said that the growing size of NBFCs necessitates a shift from pure activity-based regulation to a framework that considers both activity and scale to effectively manage risk. 

"There could be lesser importance given to compliance due to lighter regulations in the past. However, with increased scale, NBFCs are required to meet stricter compliance requirements. They need to diagnose their compliance systems and adhere to the guidelines issued by RBI," he said.

“The NBFCs have to balance business, prudence, and compliance,” said Rao.

RBI Governor Shaktikanta Das, while speaking on the subject "Keeping the Financial System Resilient, Future Ready, and Crisis Resistant" this week, said that both regulated entities and supervisors need to be vigilant to risks, if any, in the business models of organizations.

"While business models may be designed to drive profitability and growth, they sometimes contain vulnerabilities that may not be apparent. The pursuit of business growth is important, but it should never come at the expense of taking on unacceptable risks," said Das.

"Robust risk mitigants are essential for ensuring the long-term success and resilience of a regulated entity as well as the overall financial system," he added.