India's Regulatory Action May Raise Cost Of Capital For Institutions, S&P Says

S&P Global Ratings said the Reserve Bank of India (RBI) is showing a serious commitment to improve governance and transparency at finance companies and banks, but its recent measures may increase the cost of capital for institutions.

India's financial system regulator’s recent measures include restraining IIFL Finance Ltd. and JM Financial Products Ltd. from disbursing gold loan and loans against shares, respectively, and asking Paytm Payments Bank Ltd. to stop on-boarding of new customers, S&P said in a statement.

Earlier in December 2020, the RBI suspended HDFC Bank from sourcing new credit card customers after repeated technological outages, it added.

The rating agency noted that these actions are a departure from the historically nominal financial penalties imposed for breaches.

"India's regulator has underscored its commitment to strengthening the financial sector," said S&P Global credit analyst Geeta Chugh. "But the increased regulatory risk could impede growth and raise the cost of capital for financial institutions."

S&P said the RBI’s recent measures will curtail lenders' over exuberance, enhance compliance culture, and safeguard customers, but the drawback will be higher capital costs for institutions.

ADDITIONAL PRESSURE

The rating agency said the RBI's recent actions demonstrate scant tolerance for any potential window-dressing of accounts. These actions include the provisioning requirement on alternative investment funds that lend to the same borrower as the bank/finance company, it added.

"We believe that increased transparency will create additional pressure on the entire financial sector to enhance compliance and governance practices," Chugh said.

S&P said it expects the regulatory actions to drive banks and finance companies to better focus on policies and processes, ultimately enhancing the operational resilience of the system. However, this shift is likely to lead to increased compliance costs for the sector and may curb the ability of smaller companies to compete in the market, it noted.

Nevertheless, this shift will reinforce the importance of the compliance culture within the industry and help fortify the institutional framework of the sector, S&P said.

GROWTH CURB IN FY25

S&P said combined with tight liquidity, the RBI's new measures are likely to limit credit growth in the next fiscal year ending March 2025. It projected loan growth to decline to 14% in FY25 from 16% in FY24, reflecting the cumulative impact of all these actions.

The rating agency said stricter rules may disrupt affected entities and increase caution among fintechs and other regulated entities. Additionally, the RBI's decision to raise risk weights on unsecured personal loans and credit cards aims to constrain growth, it added.

The increased emphasis on compliance, know-your-customer (KYC), and diligent follow-up of processes will likely strengthen the compliance culture in India and potentially curb excessive lending practices, S&P said.

HIGHER RISK PREMIUMS?

S&P expects the investors in the financial sector will seek a higher premium for the increased regulatory risk associated with their investments.

This risk stems from the potential for tighter regulation, such as business embargoes, which can dent a company's earnings and reputation, it said.

"The risk premium that equity investors charge may increase, potentially affecting sector valuations," Chugh said. “We expect the funding cost for the system could rise and potentially lead to longer lending processes for lenders.”

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