NBFCs face double whammy of liquidity bind and tighter regulations

Illustration: Binay Sinha
Ask Keki Mistry if the wariness towards non-banking finance companies (NBFCs) in the aftermath of the Infrastructure Leasing & Financial Services (IL&FS) fiasco is an over-reaction and he readily says: “Yes. On the unfounded belief that other NBFCs would default as well,” says the vice-chairman and CEO of Housing Development Finance Corporation (HDFC). 

His view is echoed by Umesh Revankar, managing director and CEO of Shriram Transport Finance, who disagrees with the false equivalence being created: “Trying to link IL&FS with NBFCs may not be appropriate as most have their own core segment. Creating a bank vs NBFC analysis, and market share game is not a proper analogy, or the right approach.” 

 There are scores of people who share this view but the din over IL&FS drowns them out. Make no mistake: NBFCs are once again seen as ogres. The regulatory topography for them is set for a major revisit. The past holds a clue to the present.  

Bracing for the music

The 2012 Usha Thorat Committee held back from ringing in bank-like policies for NBFCs on their capital market and real-estate exposure; or to load on priority sector norms, and liquidity buffers. But since the financial flu of 2008, Mint Road has slammed its regulatory brakes on NBFCs—for both the systemically important non-deposit and deposit-taking entities. 

The last comprehensive review of NBFC regulations was in 2014. The revised framework put the spotlight on entities which could trigger a contagion even as it gave operational freedom to the smaller players. The significant change in design was to revise the threshold for systemic importance to Rs 5 billion from Rs 1 billion. Non-deposit accepting NBFCs (ND-NBFCs) with assets less than Rs 5 billion had feather-touch supervision while the larger ones were subjected to stringent oversight. 

What’s likely in the new plot being scripted? Capital adequacy and credit concentration norms which had been waived for ND-NBFCs may be written in again, plus those  on asset-liability mismatches (ALM), and also a cap on the number of subsidiaries an entity can spawn—IL&FS had 348 said the government-appointed board headed by Uday Kotak as non-executive chairman. 

Access to the commercial paper (CP) mart may be crimped. During FY16 to FY18, its share in the resource mix of NBFCs went up by 500 basis points (bps) to 15 per cent, double the 2014 levels; the same for housing finance companies stood at 10 per cent (8 per cent in FY18). “It is important to maintain adequate liquidity cushion to offset the potential risk in CPs which emanates from high dependence on rollovers and refinancing on maturity. The ability to do so is very sensitive to the confidence levels in the market, especially amongst investors like mutual funds (MFs)”, says Krishnan Sitaraman, senior director at CRISIL. It’s understandable, therefore, if a few were to view cause and effect differently. 

 “The inability of IL&FS to repay its CPs triggered a run on debt mutual funds. The interest rate cycle has been impacting their yields adversely for the past few months leading to redemption pressure. The IL&FS default added fuel to this fire. Consequently, the money has been moving out from MFs, impacting the money availability for CPs”, explains Kailash 

Baheti, chief financial officer at Magma Fincorp.

Mahesh Thakkar, director-general of the Finance Industry Development Council (a self-regulatory body of NBFCs registered with the central bank) struck a sarcastic note: “IL&FS was in a space of its own. There is now talk that the capital adequacy ratio will be hiked. Some NBFCs already maintain 15 per cent. Just how high do you want it to be? Make it 21 per cent!” 

The liquidity game

It may appear that NBFCs are reading the tea leaves right on funding: that banks will not be on tap. Sitaraman points to the “securitisation of the non-priority lending book at Rs 315 billion in the first quarter of 2017-18, which makes up for 64 per cent of such volumes”. 

He expects this route to pick up, but adds this is also due, to the clarification by the Goods and Services Tax Council that such transactions will not attract tax. Large mortgage players tapped the market again after this.  

The importance of stand-by bank credit lines is being stressed (or in quasi-form via portfolio buyouts as announced by the State Bank of India), but this needs to be read in the context of the capital constraints faced by state-run banks, especially those under the Reserve Bank of India’s (RBI) Prompt Corrective Action framework. It is possible that in some cases, the drawing down of unutilised lines may take time, not to mention the higher commitment charge by banks to keep these open. 

Revankar appears to allude to this when he says:  “I do not know of an instance where bankers refused to honour the unutilised lines of an NBFC… If there is some delay, it could be mainly because of the current situation where banks would like to re-price their offering.”

 There are no easy answers as to how NBFCs are to address the issue of ALM – of perpetually rolling over short-term funds to finance long-duration assets; it’s a variable which is not specific to the sector, but affects wider India Inc as well. The move by the Securities and Exchange Board of India to have large corporates tap a quarter of their fund-raising from the corporate bond market is seen as a way out. 

“Of course, they can tap into the bond market. Indeed, some of the larger NBFCs are accessing it. There are also other instruments such as masala bonds or external commercial borrowings, subject to RBI approval,” said  Mistry.

This comes with its own share of headaches. The bigger, top-rated NBFCs can tap it. But remember bonds react immediately to a change in interest rates unlike the bank credit which does so with a lag. The point is that raising funds via bonds can affect net interest margins (NIMs) faster – and is not a hatch to get out of the current woes facing NBFCs.

There is already chatter that disbursements by some NBFCs over the past month have fallen by as much as 30 per cent. One banker to NBFCs said on the condition of anonymity: “Wait for the credit disbursal numbers of NBFCs in the quarter’s results. Their NIMs will also be hit. My rate for NBFCs is up 100 basis points (bps). I quoted a price of nine per cent last week.” 

An NBFC official pointed out that CP money was available at roughly 150 bps lower than the long-term rate. “If the route is affected, and this transition were to happen for 10-15 per cent of the borrowings, the cost of funds is likely to go up by 20 bps. And this is over and above the normal increase which has happened (or would happen) due to interest rates moving up,” he explains. 

It looks like a slippery slope for a host of NBFCs. The only certainty is that of living in interesting times.

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