The Reserve Bank of India (RBI) on Thursday warned non-banking finance companies (NBFCs) against certain systemic risk, complexity and interconnectedness.
Addressing a conference of heads of assurance of NBFCs held in Mumbai, Swaminathan J, Deputy Governor, RBI said that many NBFCs are increasingly turning to rule-based credit engines to accelerate the growth of their lending portfolios.
He added with concern that while automation can enhance efficiency and scalability, NBFCs should not allow themselves to be blinded by these models.
Overreliance on historical data or algorithms may lead to oversights or inaccuracies in credit assessment, particularly in dynamic or evolving market conditions.
Therefore, NBFCs must maintain a clear-eyed perspective on their capabilities and limitations, supplemented by continuous monitoring and validation of credit scoring models, he added.
He highlighted the liquidity risk arising from concentration of funding sources and maturity mismatches adding that overreliance on a few funding sources can worsen liquidity risks for NBFCs, especially during market stress.
Maturity mismatches between assets and liabilities can also increase funding squeezes. Diversification and prudent liquidity management are crucial, he added.
"Customer protection is one of the core elements of policy making at RBI. Given the service-oriented nature of the financial services industry, safeguarding the interests of customers should rank foremost among the priorities of our regulated entities as well, he added during the conference of heads of assurance of NBFCs.
RBI stressed the need to invest in Early Warning Systems, Stress Testing capabilities and Vulnerability Assessments, Monitoring of Cyber Key Risk Indicators.
"To address the issue, solutions like model explainability and visual tools for interpreting credit default risk predictions have been developed. It helps in enhancing transparency and fairness. We believe the optimal way forward for the financial institutions is to integrate AI with traditional scoring methods. This approach ensures that New-To-Credit or underserved segment has a fair chance at availing the required loans," said Arpit Ratan, Co-founder and chief business officer (CBO) at Signzy.
