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RBI is shrinking NBFC regulation—why it’s not enough

In a system where risk is concentrated in a handful of large institutions, the case for regulating thousands of small, non-systemic entities is not obvious.

The Reserve Bank of India’s latest proposals on non-banking financial companies, or NBFCs, mark an important shift in thinking at the RBI. They attempt to align regulation with risk by shrinking the scope of regulation at the bottom and expanding supervision at the top.

However, the scale of this change is more modest than it appears. It stops short of confronting a more fundamental question: Why regulate non-deposit-taking NBFCs at all?

The question matters because NBFCs are central to India’s credit architecture. A disproportionate share of riskier, small-ticket, and last-mile lending—whether to MSMEs, informal households, or first-time borrowers—happens through NBFCs rather than banks.

Firms such as Muthoot Finance, with its gold-backed lending model, or Bajaj Finance, with its consumer durable financing and digital credit products, have demonstrated how NBFCs can expand access to credit. They have innovated on underwriting and distribution in ways that traditional banks have not. Questions of regulation, therefore, have a direct bearing on their ability to scale.

How large is the deregulation, really?

The RBI’s first proposal, effective this month, seeks to exempt NBFCs from registration if they meet three conditions: (i) no customer interface, (ii) no public funds, and (iii) assets below Rs 1,000 crore.

At first glance, this appears to be a significant deregulation. But in practice, the entities that will drop out are a relatively narrow class—primarily, corporate treasury vehicles, group financing arms, and small to medium-sized holding companies. These are, in effect, “invisible” NBFCs. They are internal financing arms within a manufacturing or real estate group that move capital across subsidiaries but have no interaction with external borrowers or depositors. Equating these invisible NBFCs with companies such as Muthoot Finance or Mahindra Finance obscures a basic distinction in the system. These entities do not lend to the public or raise funds from it. Exempting them is sensible and was long overdue.

A large number of small NBFCs are, in fact, customer-facing. Consider a small NBFC financing second-hand commercial vehicles or tractors in a district market, or one providing........

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