Focus on Responsible Lending Practices
According to banking sector sources, the RBI has not explicitly prohibited NBFCs from offering new credit to borrowers who have missed repayments. Instead, the regulator wants lenders to clearly define the circumstances under which such loans can be granted and ensure proper safeguards are in place.
The central bank believes that without a well-defined policy framework, the practice may lead to “evergreening” — a risky financial tactic in which lenders extend fresh loans to struggling borrowers so they can repay interest or principal on existing loans. This practice can hide the true level of stressed assets within a lender’s balance sheet.
By insisting on a formal policy approved by the board of directors, the RBI aims to improve governance standards within NBFCs and ensure that lending decisions are supported by risk assessments rather than ad-hoc judgments.
Cases Found During Inspections
During inspections, regulators found instances where borrowers who had defaulted on one loan product — such as a vehicle loan — were granted another loan, such as a home loan or a loan against property.
While such lending decisions may sometimes be commercially justified, RBI officials want NBFCs to clearly explain why a new loan was approved despite existing payment delays. The policy must outline risk evaluation methods and demonstrate that the new credit is not being used merely to repay earlier debt.
Financial sector experts say the central bank’s stance indicates a stronger push for transparency and stricter credit monitoring in the rapidly growing shadow banking sector.
Understanding Loan Stress Classification
Under existing RBI guidelines, a loan becomes a non-performing asset when the borrower fails to pay interest or principal for more than 90 days. However, the system tracks early signs of stress through a classification known as Special Mention Accounts (SMA).
A loan is categorized as SMA-0 immediately after the first missed payment. If the repayment delay extends between 31 and 60 days, it becomes SMA-1. A delay between 61 and 90 days moves it to SMA-2. These classifications help lenders detect financial stress before an account turns into a full NPA.
RBI inspectors have indicated that in certain situations, even a newly sanctioned loan could be classified as SMA-1 if the borrower already has another overdue loan account. This approach shifts the focus from the loan product to the borrower’s overall credit health.
IndAS and Risk Monitoring
The issue is particularly relevant for larger NBFCs that follow the Indian Accounting Standards (IndAS) framework. Companies with a net worth exceeding ₹250 crore are required to adopt these standards, which emphasize economic value and forward-looking risk assessment.
Under IndAS, lenders must recognize potential credit losses earlier than under traditional accounting methods. Once a loan repayment is delayed beyond 30 days, the system requires lenders to account for a “significant increase in credit risk” and set aside higher provisions for possible losses.
This framework is considered more rigorous because it forces financial institutions to acknowledge risks sooner rather than waiting for a borrower to default completely.
Industry Experts Weigh In
Experts in financial regulation believe the RBI’s latest move is aimed at strengthening internal governance within NBFCs. According to industry consultants, most lenders do not typically include provisions for lending to stressed borrowers within their standard credit policy.
If such lending is permitted, regulators want it to be governed by strict criteria approved at the highest level of the organization. This includes risk evaluation, borrower assessment, and safeguards to ensure the funds are not being used to artificially keep older loans afloat.
Regulatory specialists say this approach aligns with the RBI’s broader principle-based framework that emphasizes strong risk management, internal control systems, and transparent governance practices.
Implications for NBFC Sector
The RBI’s directive could have significant implications for NBFCs, particularly those dealing with retail lending segments such as vehicle finance, property loans, and consumer credit. Lenders may now need to revisit their credit policies and strengthen risk monitoring mechanisms.
While the new approach may slow down loan approvals in certain cases, experts believe it will ultimately enhance financial stability and reduce hidden credit risks within the sector.
As India’s shadow banking sector continues to expand rapidly, the central bank’s emphasis on governance and accountability is likely to play a crucial role in maintaining confidence in the financial system.
