Next Generation Financial Sector Reforms for Growth

A well-functioning and vibrant financial sector serves as a bedrock for economic progress and is a key pillar which would help the country fulfil its economic ambitions of becoming a US$5 trillion economy in near future. The sector has ably supported the country to achieve a remarkable turnaround in growth and move up from being a US$320 million economy in the 90s to over US$4.0 trillion economy at present. The sector is also undergoing a dynamic transformation, driven by factors like innovation in technology, digitisation, financial deepening, etc. to suit the changing milieu and risk patterns.

Over the last few years, the government has taken bold steps to build a robust financial sector that fits the unique development needs of the nation. The main thrust of reforms has been on the creation of efficient and stable financial institutions (IBC, NCLT etc), financial inclusion (DBT), creating technology stacks (UPI, AePS, e-KYC, online interoperable BCs / Bank Mitras, e-Sign, digital locker etc) and development of money and securities markets.

The government has also implemented several reforms for Non-Banking Financial Companies (NBFCs) to enhance their functionality and stability. However, existing reforms have not fully addressed the challenges of a rapidly changing global landscape. Hence, a more concerted push towards the next generation of financial reforms assumes critical importance, to ensure that the financial sector is adaptable, efficient, and well equipped to handle the complexities of global economic systems. The sectors in focus are the non- banking financial institutions (NBFC) and the insurance sectors.

Strengthening the NBFC Sector

Let us first take the NBFC sector. The sector has played a pivotal role in complementing the banking sector in meeting the credit demands of small businesses, entrepreneurs and individuals.

However, despite their growing significance, NBFCs face multiple challenges such as regulatory limitations, funding constraints, operational disparities with banks, etc. which come in the way of their expansion. Addressing these challenges is essential to unlock the full potential of NBFCs and ensure their sustained contribution to economic growth. A comprehensive set of reforms, which would effectively rejuvenate the NBFC sector and enhance its contribution to the India growth story, is given below.

Diversification of Capital Sources

The first suggestion relates to the diversification of its capital sources by encouraging alternative funding channels such as equity infusion, foreign investments, and securitization of assets. Specifically, there are constraints in obtaining long-term debt finance for NBFCs engaged in long-duration financing such as for housing and infrastructure. The Government and the regulators may look at alternatives such as collateralised refinance for long-term lending, platform for tapping the large pool of NRI investments through quasi-equity & debt financing and channelising long-term funds with insurance companies and provident funds into long-term finance through credit-enhanced refinancing platforms. This would provide stability and reduce dependence of NBFCs on limited traditional borrowing methods.

The government and regulatory bodies should also introduce policies that facilitate easy access to global capital markets and venture capital investments. Additionally, the development of a robust secondary market for NBFC-issued securities can enhance liquidity and attract more investors. The possibility of tax collected at source by issuers on interest on long-term securities, to make the instruments tax-paid and, therefore, attractive for secondary market investors, is worth looking into.

Level Playing Field and Regulatory Reforms

Secondly, steps should be taken towards strengthening NBFCs by ensuring that it operates on a level playing field with banks. Regulatory measures should be tailored to allow well-performing NBFCs to access low-cost funds through controlled deposit-taking mechanisms with adequate liquidity reserve requirements. This is especially important for housing finance companies. Moreover, NBFCs should be permitted to offer a wider range of financial products, including payment services and insurance distribution, thereby expanding their market reach and profitability.

Further, to prevent unfair competition and maintain financial stability, the government and the Reserve Bank of India (RBI) should address regulatory arbitrage. This involves creating a framework which allows the NBFCs to operate with greater functional autonomy while adhering to risk management standards comparable to those for banks.

Streamlining Licensing Requirements

Third, the licensing requirements should be streamlined to facilitate ease of doing business. For this, an updated tiered licensing system, based on risk and operational scale, may be implemented, to differentiate between small-scale financial service providers and large, systematically important NBFCs and for allowing for quicker approvals and lower compliance burdens for smaller, emerging NBFCs while maintaining appropriate regulatory oversight. Minimum vintage at each lower tier of NBFC with satisfactory compliance and governance can be a structured way of ensuring the emergence of quality players.

Furthermore, digital-first NBFCs may be encouraged with a separate licensing mechanism for fintech-driven financial service providers. This will accelerate innovation, financial inclusion, and accessibility to credit in remote and rural areas.

Reforming the Insurance Sector

Let us now turn to the insurance industry. This sector plays a critical role in providing financial protection to individuals and businesses. It fosters economic stability, encourages investment, and facilitates long-term development.

The government has implemented several reforms in the insurance sector, primarily focused on increasing Foreign Direct Investment (FDI) and promoting competition. Lately, foreign Direct Investment (FDI) limit in insurance has been raised from 74 per cent to 100 per cent for increasing the flow of foreign capital which should lead to greater innovation, increased competition, and enhanced financial security.

However, while the existing reforms would help to uplift the sector, much more is required to address issues of value creation, competition, technology, low penetration and affordability.

First, the country would benefit from a tiered framework which allows customisable insurance policies such as selecting specific health or motor insurance components for consumers. Such customised policies would offer more relevant and cost-effective coverage and improve the affordability and accessibility towards a specific insurance product. Hence, regulators should establish guidelines to promote such offerings, ensuring broader financial protection and inclusion, especially for the underserved “missing middle” population that often struggles to get access to insurance. There is a case for encouraging long-term health insurance through health savings account to provide social security for the future generations at affordable cost.

Second, regulatory intervention to define industry-wide standards across healthcare and insurance parameters could significantly improve service quality and drive greater health insurance penetration in India. Standardized norms and pricing frameworks would create a more structured and reliable ecosystem, ultimately benefiting both insurers and policyholders.

Third, there is a critical need to bring catastrophic events under the insurance umbrella. Introducing NAT-CAT insurance within the regulatory framework could provide significant benefits, not only protecting consumers but also strengthening the overall economy. The possibility of creating a NAT-CAT pool managed independently in the manner of Protection and Indemnity Clubs (P&I). But with appropriate adjustments, to tax regime can help create a sufficient pool for NAT-CAT loss funding. There is scope for the International Financial Services Centre such as GIFT City to initiate catastrophe bonds and P&I Clubs specific to Indian risks.

Lastly, there is also a need to address some basic constraints faced by insurance companies. General insurers are plagued by leakage of premium from uninsured vehicles specifically amongst commercial vehicles and two-wheelers which needs to be addressed by the Centre and States through digital platforms. For Life insurers, there is a need to free up investment regulations to permit investments in start-ups and unlisted entities as they provide pools of assets with long duration and greater ability to absorb volatility.

To conclude, the financial sector has a critical role in taking India to the next phase of economic growth. Hence, it is important to simplify, streamline and reduce compliance costs. We should not forget that India’s ambitious goal to achieve developed nation status hinges significantly on the robustness of its financial sector.

Source: CII ARTHA – ISSUE 8