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UPDATE 1-India c.bank to regulate housing finance firms, review assets - sources

Swati Bhat and Aftab Ahmed

sources@

* HFCs to come under more stringent asset quality reviews-sources

* Move will give authorities more control over shadow banking-sources

* C.bank wants to be more effective in managing liquidity crunches (Updates with details, quotes)

MUMBAI/NEW DELHI, July 3 (Reuters) - India will soon give its central bank power to regulate housing finance companies (HFCs), which will almost certainly lead to the lenders facing stringent asset quality reviews, two sources with direct knowledge of the matter said.

That could have major repercussions for about 80 HFCs, the largest of which include Indiabulls Housing Finance Ltd , Housing Development Finance Corporation and Dewan Housing Finance Corporation, leading to them facing unprecedented scrutiny and the potential for major financial penalties and restriction on their activities if improper practices are discovered.

In late 2015, the Reserve Bank of India (RBI) started a similar review of bank assets amid allegations that lenders were hiding the extent of the bad debts on their books.

During multiple asset quality reviews of banks, the RBI revealed a plethora of areas where lenders were under reporting their bad loans. It initially led to financial penalties for some lenders and eventually fed into decisions to impose tougher restrictions on their loan books while their bad debts remained high.

The housing finance companies, which are part of the broader shadow banking sector known as non-banking finance companies (NBFCs), are currently regulated by the National Housing Board, and the central bank has no direct authority over them.

The other NBFCs are very loosely regulated, with various regulators including the RBI having some role but no one being fully accountable.

The RBI's oversight of HFCs will be a step towards the Indian authorities getting a firmer grip on the risky shadow banking sector that will help to contain any systemic problems.

A series of debt defaults last year by major infrastructure financing group, Infrastructure Leasing and Financial Services (IL&FS), showed that much of the sector was highly leveraged.

"There will be substantial improvement in regulation and supervision of all entities including NBFCs and HFCs once RBI has direct control over the housing finance firms," one of the sources said.

On Monday, Finance Minister Nirmala Sitharaman said the government was considering giving more powers to the central bank to regulate the struggling shadow banking sector, though she was not specific.

A government official, who did not wish to be named, was more explicit in comments on Wednesday. "The government is planning to give more regulatory powers to the RBI to regulate housing finance companies. Right now they do not have that."

One of the sources said the central bank sought more regulatory powers so that it could be more effective in handling liquidity crunches in the sector, which have hit lending and the overall economy.

The Reserve Bank of India declined to comment on the development.

As credit rating firms have downgraded the ratings of some of the housing finance companies it has stoked credit-risk fears and hurt their ability to raise funds for more lending. That in turn has made it difficult for consumers and small businesses to get loans and hurt car and motorbike sales, among other things.

The failure of a large Indian non-banking financial company could cause as much damage as the collapse of a big commercial lender, the RBI said last week, stressing the need for greater surveillance of these firms.

Both the government and RBI have declined to provide direct financial support to financially troubled NBFCs so far. But having regulatory powers over the HFCs might make it easier for the RBI to open credit lines for these firms if necessary, two of the three sources said.

The National Housing Board was controlled by the RBI before the government took over the housing finance regulator on April 29. Shifting the regulatory powers to the RBI will, however, take place later in the year as it will require a change to the RBI Act, the government official said. (Reporting by Swati Bhat and Aftab Ahmed Editing by Martin Howell and Jacqueline Wong)