Tough road ahead for NBFCs

The non-Banking financial companies (NBFC) sector has seen several downgrades in the aftermath of the default by IL&FS in September 2018. Corporate Affairs Secretary Injeti Srinivas said recently in an interview that there is an “imminent crisis in the sector due to over-leveraging and misadventure by very large entities which is a perfect recipe for disaster.” It is a defining moment for the NBFC sector.

But while it is a day of reckoning for some companies, it’s business as usual for those that have managed the risks well.

The NBFCs, or shadow banks, had evolved their operations and reach in the last decade or so and had taken on the mantle of banks at a time when banks had their own problems like asset quality concerns, etc.

Borrowers, whether they were MSME or retail, preferred them to banks due to their faster decision-making ability, prompt provision of services and expertise in niche segments like truck finance, consumer durables or gold loans. Now, the NBFCs are staring down the barrel and going through a turbulent time.

NBFCs have been facing multiple crises – a crisis of confidence, and crises arising from regulatory, liquidity and solvency issues. However, liquidity has not been an issue with all NBFCs. It has not been an issue at least with those NBFCs that lend short-term loans for purchase of vehicles, consumer durables or gold.

However, it has been a serious issue with those NBFCs that finance real estate and infrastructure projects. These NBFCs had given long-term loans to infra and real estate projects with repayment of 20 years and more, funded by short-term borrowings, resulting in serious asset-liability mismatches. The classic example is IL&FS itself.

It was not the way they did business but how they funded their business that was the reason for the crisis. The liquidity crisis was also compounded as banks that were funding them stopped lending to them. NBFCs do not have access to RBI’s liquidity window, like Liquidity Adjustment Facility or a Marginal Standing Facility, and so they have to fend for themselves to tide over the cash crunch.

Historically, NBFCs have been raising funds through many routes — public issue, bank loans, public deposits. Mutual funds have been a huge source of funding as well as they have been investing in the instruments of NBFCs and Housing Finance Companies (HFCs).

The proposal in the Budget to provide a one-time Rs 1 lakh crore partial credit guarantee to public sector banks for purchase of high-rated pooled assets of financially sound NBFCs will provide a big relief to NBFCs by providing them much needed liquidity.

More importantly, it will restore confidence among NBFCs. However, the flip side is that PSBs may buy only the “high-rated assets of financially sound NBFCs.” And those NBFCs may not need any liquidity in the first place.

Improving liquidity

Under the ‘Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR)’, the RBI has proposed to give banks an option to generate additional liquidity of up to 1% of the deposit base, linked to the incremental lending to NBFCs and HFCs. This facility will be introduced in two stages, in August and December. This provision for additional liquidity will now be front-loaded.

The proposal to tax interest on bad and doubtful debts only when they are received and not on accrual basis will provide some relief to NBFCs. In addition, the scrapping of debenture redemption reserve for NBFCs when they raise debt through public issues will lead to improving their liquidity.

With a need to augment risk management practices, RBI has issued guidelines in May 2019 that NBFCs with asset size of more than Rs 5,000 crore should appoint a Chief Risk Officer with clearly specified role and responsibilities.

To address the regulatory issues, the HFCs will come under the regulation of RBI and under the National Housing Board. This will strengthen RBI’s authority over them. RBI now has been given the power to supersede the boards and remove directors if they act in a manner that is detrimental to the interests of the companies.

In the final analysis, while all these measures may not be adequate to revive the sector, these are steps in the right direction as the government realises the role and importance of NBFCs in credit intermediation in the economy.

The prolonged stress in the NBFC sector will have a serious impact on the economy. The impact will be humongous as NBFCs provide nearly 20% of the total credit requirements of the economy and have been playing a supplemental role to banks in the growth of our economy.

The worry in the short term will be that due to the crisis, lending by NBFCs to different segments of the economy will slow down as evidenced, for example, by the fall in the sales of vehicles in the last few months by automakers.

Banks saddled with bad loans and having their own share of problems may not step in immediately to address the credit requirements of the economy.

(The writer is with Manipal Academy of Banking, Benga­luru)