THE Security and Exchange Commission of Pakistan has sought public comments on proposed amendments to the regulatory framework for non-bank financial companies.

These seek to improve access to finance, particularly for housing, and to promote a culture of savings and investment with increased participation of retail investors in the capital markets.

Besides, the SECP intends to strengthen the criteria for the promoters and majority shareholders, and to focus on the operations of NBFCs, which are also being categorised as lending NFBCs, fund management NBFCs and advisory NBFCs.

Overall, the proposed regulatory amendments are positive, but sadly appear not to have tackled the issues related to lending NBFCs presented in the report of the Non-Bank Financial Sector Reform Committee earlier constituted by the SECP

These amendments, the SECP feels, have struck a balance between the inherent risk in the operating structure of the NBFIs and the level of regulatory oversight and conditions imposed upon them.

The lending NBFCs include investment finance companies (IFCs), leasing companies, housing finance and discount houses. The concept of micro lending has also been introduced

In case lending NBFCs take deposits, the minimum equity requirement is higher. The highest minimum equity of Rs1bn is for a deposit-taking IFC; for non-deposit taking ones, it reduces to Rs0.5bn.

In the case of non-deposit-taking lending NBFCs, the minimum equity has been set at a lower level.

Adjustments have also been made for asset management and advisory NBFCs. In line with the re-grouping of activities, lending and deposit-taking functions have been shifted appropriately within the regulatory document.

Overall, the proposed regulatory amendments are positive, but sadly appear not to have tackled the issues related to lending NBFCs presented in the report of the Non-Bank Financial Sector Reform Committee earlier constituted by the SECP.

The committee had pointed out the NBFCs’ lacklustre performance for various reasons, including: limited resource-mobilisation, non-availability of credit lines from financial institutions and limited ability for deposit-taking; absence of level playing field as commercial banks, brokerage houses and chartered accountancy firms are also performing similar activities; and no regulatory support in case of financial distress, as the SECP is not ‘the lender of last resort’.

The committee had noted that the condition of lending NBFCs had deteriorated from 2003 to 2012. In 2003, there were 29 leasing companies, which had dwindled to eight by 2012. Of the 12 IFCs in 2003, only seven were operational in 2012. And there were no housing finance companies in 2012, against two in 2003.

During this period, the total assets of these companies also decreased considerably.

One is surprised at the deep discount at which a majority of shares of listed investment banks and leasing companies are quoted on the stock exchanges. The number of listed companies is also excessively low.

It appears that the NBFC sector is far from healthy and needs a closer look by the stakeholders to ascertain the real reasons for its present condition.

Most lending NBFCs may perhaps require possible solutions from the SBP, the finance ministry (or both), besides other stakeholders.

Some of the proposed changes in the regulations need to be rationalised, as suggested below.

Existing regulation 16 — creation of reserve fund — requires an NBFC to create a reserve fund that is credited with at least 20pc of its after-tax profits till the time that the fund equals the NBFC’s paid-up capital. Thereafter, a sum not less than 5pc of its after-tax profits shall be credited to the fund.

Under proposed amendments, the requirement of creation of a reserve fund is being deleted, keeping in view the minimum equity and risk-based capital adequacy requirements.

Looking at the prevailing conditions of most existing NBFCs, one is disappointed at the deteriorating level of regulatory compliance. It is urged that it is not the proper time to delete the existing requirement of the reserve fund.

The SECP requires lending NBFCs seeking public deposits to safeguard the interest of the general public.

Besides other requirements, all advertisements must contain a disclaimer advising customers that “deposits raised by an NBFC are subject to credit risk and are not comparable to deposits placed with a banking company” and that they should do a risk analysis.

However, individual depositors are not in a position to carry out such an analysis. Therefore, it is proposed that the NBFCs may not be allowed to raise deposits from individuals for the time being.

Small bank deposits have implied deposit insurance from the SBP/GoP; such protection would not be there in the case of NBFC deposits.

Meanwhile, lending is a specialised business. Institutions like PICIC and the NDFC — with all their resources and success stories — could not survive for long and eventually had to be merged with commercial banks.

In such a scenario, will the lending NBFCs be able to survive in the face of real world challenges?

They are not proper institutions like PICIC and NDFC, and therefore should never consider lending or participation in high-ticket projects. SMEs and micro businesses should be their focus.

Existing regulation 17 — maximum exposure of an NBFC to a single person or group —provides that the total outstanding exposure (fund-based and non-fund based) of an NBFC to a person shall not at any time exceed 30pc of the NBFC’s equity (as disclosed in the latest financial statements).

This exposure limit is being revised to 15pc. For a group, the existing limit is 50pc, which has been proposed to be reduced to 25pc.

The proposed lower limits are still over-generous and must be brought down.

No NBFC may survive for long if only 4-7 people can avail the exposure that is equal to the NBFC’s equity. In case of a person, the upper exposure limit should be 2pc of the NBFC’s equity. Similarly, in the case of groups, the maximum exposure should not exceed 5pc of the NBFC’s equity.

Published in Dawn, Economic & Business, March 16th, 2015

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