The government is considering measures such as raising the deposit acceptance limit of eligible non-banking finance companies (NBFCs), introducing deposit insurance, and providing a dedicated liquidity window for NBFCs to reduce their cost of funds so that they can extend loans to key sectors such as agriculture and micro, small and medium enterprises (MSME) at cheaper interest rates, two officials said.

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Next to agriculture, the MSME sector is the backbone of the Indian economy, with about 30% share in its GDP, 45% of manufacturing output and 48% of exports, while providing 111 million people with employment. Both agriculture and MSME sectors are facing huge credit gaps. About 39% of 63.4 million MSMEs have not yet accessed loans through any formal channel.

Hence, there is an urgent need to expand formal but affordable credit facilities through NBFCs if India has to become the world’s third-largest economy by 2030, the officials said, requesting anonymity.

“Interest rates charged by NBFCs are, however, high, which may go up to 26%, depending on the nature of loans. Interest rates are high because cost of funds for NBFCs are high compared to commercial banks. Hence, various proposals under consideration to reduce their costs,” one of them said.

The national budget for 2024-25 may boost MSMEs by integrating them with international markets, digital support for global competitiveness, easing compliance for the goods and services tax, and providing them with low-cost credit, HT reported on November 14.

Unlike commercial banks, most NBFCs cannot accept low-cost deposits from the general public. Their sources of funding are comparatively expensive, since they lend after borrowing from banks and markets, including external commercial borrowings. Most of the new NBFCs do not accept deposits (NBFCs-ND), as there is a virtual freeze on registration of deposit taking NBFCs (NBFCs-D) since 1998.

Cost of funds are soaring for NBFCs as central banks of all major economies have raised interest rates to tame inflation. In these circumstances, there are some proposals under discussion to reduce the cost burden of NBFCs by diversifying sources of funding, particularly for lending to priority sectors, a second official said.

“Deposit acceptance limit of NBFCs-D could be raised. Besides, their deposits could be provided with insurance cover similar to the ones available for deposits in commercial banks (to minimise risks and reduce costs),” he said.

“We may consider a dedicated liquidity window for NBFCs for their short-term liquidity requirements and may allow upper layer NBFCs to take public deposits under strict regulations,” he added. “By reducing risk weight of loans under priority sector and by making all bank lending to NBFCs for on-lending to the priority sector could also reduce the borrowing cost for NBFCs.”

The upper layer NBFCs (NBFCs-UL) are identified by the Reserve Bank of India as warranting enhanced regulatory requirements. At least the top 10 eligible NBFCs in terms of their asset size are generally called the NBFCs-UL. Their numbers are currently 15.

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“Allowing NBFCs to take deposits would require them to strictly observe strong regulatory norms like commercial banks, which will mar the nimbleness of NBFCs and may lead to loss of the inherent flexibility they currently have,” an expert said, seeking anonymity. Banks are highly concentrated in urban and semi-urban areas, leaving large credit gaps for the rest of the country, which is partly met by NBFCs because of their nimbleness, he added.

Out of an estimated 6.34 crore MSMEs, only 2.5 crore have ever received formal credit, official data show. The disbursal of loans to MSMEs in 2020-21 was over ₹9.5 lakh crore, substantially up from ₹6.8 lakh crore in the preceding financial year, mainly because of the government’s Aatmanirbhar Bharat (self-reliant India) scheme of Emergency Credit Line Guarantee Scheme, which provided 100% credit guarantee to lenders.