RBI Ladder-Based Regulation (SBR): A revised regulatory framework for NBFCs mandates a Basic Banking Solution (CBS) for all NBFCs with more than 10 branches
For small NBFCs, including fintech startups in the space, such requirements can result in huge and unnecessary costs.
Most well-run NBFCs have already adopted sophisticated IT systems that rival many banks, but it is questionable whether “CBS†mandates will benefit the ecosystem.
In 2021, the Reserve Bank of India (RBI), through several advisory documents, has indicated that the non-bank financial corporations (NBFC) sector may undergo significant regulatory changes. While some proposed changes make lending easier for NBFCs, others come with additional costs. One such proposal, made in the RBI Discussion Paper on the Revised Regulatory Framework for NBFCs – A Ladder Based Approach, is to impose a Basic Banking Solution (CBS) for all NBFCs with more of 10 branches.
A CBS, at the heart of the proposal, is a complete, ready-to-use product intended for all back-office operations of commercial banks. Such a “bank-in-a-box” product integrates several modules covering deposits, loans, clearing, payments, guarantees, treasury operations, teller functions and ATM integration, among others. . With this in mind, to understand the implications of this proposition, we present our arguments under three aspects: relevance, cost and applicability.
Figure 1: Components of a CBS
Source: McKinsey & Company
At Relevance, as the definition clearly shows, CBSs meet the diverse needs of banks. However, they tend to be rigid in most aspects and the complexities involved often make customizations difficult. Business processes, defining flexible deadlines, repayment frequency, method of accruing interest, moratorium changes, among others, are a few examples where undertaking changes in CBS are complex. In contrast, other systems, such as Loan Management Systems (LMS), provide more flexibility without overloading the lender with unnecessary modules.
This difference in functionality becomes very important for NBFCs, as they are prohibited from offering sight deposit accounts, accessing payment and settlement systems (PSS), among others. Therefore, NBFCs need and tend to opt for specialized systems that meet their needs. For example, they have systems tailored to their business for different stages of the loan journey, such as loan origination, credit underwriting, loan management, collections, monitoring, and more. These systems not only provide personalized functionality, but also provide the flexibility to make changes as the business evolves. Thus, a rigid “bank-in-a-box†product is unsuitable for the needs of NBFCs.
Costs associated with a CBS are another major hurdle. NBFCs are highly specialized lenders, often focusing on selected product segments. They generally need more personalized LMSs with sophisticated integrated loan creation (LOS) systems. Thus, the RBI’s decision to mandate CBS for NBFCs is redundant at best, and counterproductive at worst, as NBFCs will be forced to ship expensive CBSs while retaining their custom LMSs.
In addition, the Total cost of ownership (TCO) of a CBS ranges from 0.50% AUM for a typical bank to around 3% AUM for NBFC (with INR 100 crores (Cr) in AUM). In contrast, the cost of custom, feature-rich LOS and LMS modules tends to hover between 0.20% and 0.30% of NBFC AUM. So, without the oversight of the RBI or the cost control of the CBS, a small NBFC with assets of INR 100 in assets, spread over 10 branches, has to spend an astronomical INR of 3 Cr to own a CBS, vis-Ã -vis screw integration of LOS and LMS in one go. – one-fifth of the cost.
Essential and interesting features of LMS
For the management of the loan account:
| Essential | Flexible Product Definition: The flexible product definition is a key requirement, and the following are essential to provide this flexibility:
1. Calculation methods (30/360, real / real, etc.) |
| Essential | Complete lifecycle management – disbursement, collection, accumulation, penalty, provisioning, write-off, postcode, etc.
1. Loan Accounting – Automated processing of all accounting resulting from various life cycle events |
| Not essential | 1. Co-lending capacities 2. Digital collections 3. E-Sign, E-NACH and E-Stamping capabilities |
For branch management:
| Essential | 1. Cash management capacities 2. All branch cash transactions should be recorded, tracked and accounted for immediately. 3. Cash control measures such as physical money counting 4. Inventory management 5. Document management |
For the GIS, Analytics and Internal Audit functions:
| Essential | 1. Standard reports on PAR, POS, disbursement, submission to credit bureaus and collections 2. Potential integration of Data Warehouses (essential if the volume increases) 3. Basic analytical skills on PAR / POS demography |
| Not essential | 1. Modeling and credit decision based on AI / ML 2. Automation / Digitization of the entire audit process |
For customer self-service modules (depending on the nature of the activity)
| As requested | 1. Multichannel origin 2. Digital collections and loan service |
The next natural question is “why can’t an NBFC choose the features they want from the CBS offering?” “. To answer it, we need to discuss current market practices. Currently, most manufacturers of CBS offer them as a commodity, akin to a minimum viable product. Technically, CBS providers can turn off some unnecessary features, but this does not proportionately reduce costs. Moreover, if one thinks semantically, deactivating the functionalities of a CBS no longer makes it a “bank-in-a-box†product but increases its similarity to an LMS.
This does not mean that the RBI should instead mandate an LMS. Rather, the RBI could set general guidelines on the minimum functionality of NBFC computer systems. This is in line with the past approach of the RBI, where it published the “Information Security (IS) Framework for NBFCs” in 2017, which unfortunately only applies to NBFCs with over 500 INR Cr in assets. Smaller NBFCs, serving several thousand customers, are not required to have computer systems. This leads to a lack or de-prioritization of features such as integrated loan management, automated reporting, Maker-Checker for all transactions, integrated accounting and integrated grievance systems.
In such cases, NBFCs do not have the adequate technical capacity to ensure customer protection and transparent regulatory reporting.
The last aspect is applicability. Has the 10-branch criterion been verified? We think not. In the age of fintech powered by tech-driven startups, NBFCs can operate exclusively through online channels, serving thousands of customers without any physical “branchâ€. Therefore, the RBI should mandate all NBFCs with lending operations to adopt appropriate IT systems.
However, the significant scope of the interpretation results given that the RBI mandated a specific type of system instead of mandating a minimum feature set. As a result, there may be a discrepancy between the objectives of the RBI and the results achieved by it and the NBFC. In conclusion, NBFCs must adopt robust IT systems to increase their efficiency and improve controls. Most well-run NBFCs have already adopted sophisticated computer systems that rival many banks. Now, whether such systems are called CBS, or LMS, or whatever acronym is, is less important.
The most important questions are whether such systems facilitate NBFC’s business operations, help better serve clients, and allow the RBI to carry out its regulatory mandate in a transparent manner. In light of these concerns, we suggest that the RBI reconsider its decision and instead consider imposing the minimum technical characteristics it wishes to see in one of the NBFC’s computer systems, rather than specific products.
The article is co-authored by Arun Kumar D is the Business Development Manager at Dvara Solutions.