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FY24 done, FY25 to see more of regulations
We have seen various regulatory actions in FY24, and consequent price actions. Thus, it becomes imperative to look at what is on the RBI's radar for FY25. The key snippets from RBI's annual report indicates that principally the Central Bank is striving to make its regulations more principles-based, activity-oriented and proportionate to the scale of systemic risk, rather than entity-oriented with focus on harmonization. While there are draft papers on which final guidelines are likely, there also are new areas which the RBI seems to focus:
#1 Harmonizing interest on advances: A big one
One key regulation that the RBI seems to be working on is the harmonization of regulations related to the interest rates across various regulated entities (RE). Currently, extant regulations vary, and the Central Bank aims to harmonize it. There seems to be a possibility it is examining the feasibility of introduction of the external benchmark linked rate (EBLR) system of loan pricing for credit extended by NBFC to select sectors. We have already seen the transitionary impact of such regulations in banks; if replicated in NBFC, these will entail transitionary challenges and could potentially impact during turning rate tables.
#2 Stressed asset resolution: Concerted effort to issue framework
The RBI aims to make concerted efforts toward issuing frameworks in the areas related to resolution of stress in projects under implementation (a portion already out), securitization of stressed assets (discussion paper was issued in January 2023) and expected credit loss. This combination suggests it continues to strive for strengthening of the banks' balance sheet.
#3 Valuation of property: Could be key positive for PSU banks
The Central Bank seems to be working and reviewing guidelines on valuation of properties based on international best practices. While details are awaited, this potentially could be much bigger for public sector banks.
#4 Expected credit loss: Long pending, implementation likely soon
This is much awaited area of focus in its agenda for FY25. It would move toward adopting a forward-looking expected credit loss (ECL) approach. There have been several discussions around the design, and we expect the final draft in some time even as implementation timelines may vary.
#5 Priority sector guideline: Expect some new avenues to be added
The RBI aims to review the priority sector lending guidelines and work toward formulating the next iteration of the National Strategy for Financial Inclusion (NSFI) for CY25-30. We believe new sectors, such as new energy, could be added into the potential priority sector essentially relating to climate funding. While this will benefit the larger ecosystem, few ecosystem players who are directed toward these lending could see transitionary impact, given increased competition.
#6 Governance structure for NBFC: A key focus
The RBI seems to be reviewing the requirements of obtaining prior approval for change in management of NBFC and housing finance companies (HFC), which would result in change in more than 30% of directors, excluding independent directors.
#7 Assurance functions of NBFC: Aims to strengthen
As NBFC expands in both size and complexity, the RBI expects to bolster governance and assurance functions to maintain a constant vigil over potential risks and vulnerabilities. In various instances, it has found inadequate attention being given to assurance functions and independence of assurance functions. While RBI has communicated this to boards, it seems to be one of the key areas of focus and would entail operationally transition challenges as cost of compliance will likely rise.
#8 Framework for web-aggregation of loan products
The RBI is formulating the regulatory framework for web-aggregation of loan products. There has been a recommendation from the Working Group to bring loan aggregation services offered by the lending service providers (LSP) under a comprehensive regulatory framework; the Central Bank is formulating them with the aim that they should be transparent & neutral and to ensure that mis-selling of products does not happen.
#9 Manage liquidity risks: Can amplify vulnerabilities
As per the RBI, one of the key risks is liquidity arising from concentration of funding sources and maturity mismatch. Reliance on a limited number of funding sources can amplify liquidity vulnerabilities, especially during periods of market stress or disruptions in funding channels. We have already seen a set of regulations on this; we expect other actions on this.
#10 Guidelines on connected lending: Likely sooner
connected lending can involve moral hazard, leading to compromise in pricing and credit management. The extant guidelines are limited in scope and are not applicable uniformly to all regulated entities. Thus, it aims to issue a unified regulatory framework on connected lending for all regulated entities.
Our view: FY25 will see a lot of transitions; our preferred picks are large private banks
We have seen a lot of regulatory action in FY24 both for the industry and for specific firms; we expect this to continue in FY25. Gauging from the works in focus for the RBI, we believe NBFC will continue to see more regulations. While the costs of compliance being one, we believe operational transitions will also pose challenges. The movement of interest rate regime for NBFC would pose greater challenges. From a banks' perspective, the transition and guidelines on ECL is the next anticipated move, which will have an impact based on regulatory outcomes. Large private banks seem to be in a structurally better space, and are set to deliver steady earnings growth, led by steady ROA. Against the current backdrop, the upgrade probability to Consensus earnings estimates is high, and this analysis underscores our positive stance. The recent price performance entails that large private banks are trading at attractive valuation with a strong profitability outlook; mid-teen ROE justifies a case for earnings compounding, if not for valuation re-rating. |
