Reserve Bank of India's (RBI) recent proposal for the tighter regulatory framework for non-banking financial companies (NBFC) may strengthen their balance sheets but will not address their funding and liquidity issues, says a report.

 Last week, the Central Bank released a discussion paper that proposed a scale-based regulatory approach linked to the systemic risk contribution of shadow lenders. In a report on Monday, Moody's Investors Service said the proposal will commit the largest 25-30 non-banking financial firms to regulations similar to banks regarding capital, credit concentration and governance. "If implemented, the regulations would result in the companies becoming more resilient to credit shocks.

However, the proposals do not address NBFC's funding and liquidity, the key credit weakness of the sector," Moody's said. The proposed new regulations would result in largely harmonized rules between banks and NBFCs on capital and leverage, which would reduce the regulatory arbitrage opportunities for NBFCs against the banks in their lending decisions, it said.

However, changes are proposed to the NBFCs' current lighter liquidity rules, the report said. Banks are subject to strict regulations on maintaining a minimum cash reserve ratio and statutory liquidity reserve, which are not imposed on NBFCs, it said. "This means the proposal does not address the key weakness of the NBFCs and the sector will continue to pose risks to banks' asset quality because banks are the largest lenders to the NBFCs," the report said. The paper has a four-layered regulatory framework for NBFCs.

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