Tough life ahead for NBFCs as RBI set to tighten liquidity mismatch limits

The Reserve Bank of India (RBI) is set to impose new limits on the liquidity mismatches that non-banking financial companies (NBFCs) operate with as part of its plan to nudge them towards more stable sources of funding. 

The new guidelines, expected to be introduced in a phased manner, will cover both systemically important non-deposit taking, and all deposit taking entities, and take into account the sectors they operate in. The regulator will thus align NBFCs’ asset-liability mismatch norms with those of banks, which are stricter. 

A relook is underway into the cumulative mismatches, or the negative gap (the difference between outflows and inflows of funds), of NBFCs in the one-day to a year time-frame now set at 10 per cent, and in the one-day to a month’s duration at 15 per cent. Simply put, if an NBFC has to repay Rs 100, it can only borrow Rs 10 in the first case from the market and the remaining Rs 90 must come from its business operations. 

While well-run NBFCs and housing finance companies with a strong asset-liability management policy adhere to the norms, there is room for exceptions too.

These practices are up for a review and Mint Road is to issue a fresh set of standardised guidelines; and of particular import will be a cap on NBFCs’ reliance on commercial papers to fund the gaps. The new norms, a highly placed source said, is also expected to take into account the sectors in which NBFCs operate. For instance, in the case of NBFCs that operate in the infrastructure area, liquidity becomes an issue when government agencies don’t release funds on time. 

It is also learnt that chief executives and senior officials of NBFCs in their interaction with the central bank while appreciating the regulator’s concerns put forward the view that they be given time to transition to a new regime.

Systemically important NBFCs are defined as those with an asset size of Rs 500 crore, and it was pointed out that one of the reasons their entire universe would not be brought under stricter oversight immediately was to ensure that these entities and the sectors serviced by them were not put under hardship. 

The latter point was stressed when NBFCs met with Governor Shaktikanta Das earlier this year.

The move to cover deposit taking NBFCs right away is to protect the interest of depositors given that deposit insurance facility of the Deposit Insurance and Credit Guarantee Corporation (DICGC) — a subsidiary of the RBI — is not available for NBFC depositors.

An internal Mint Road study based on the supervisory data of 76 loan companies, a category of NBFCs, for the period Q3 FY15 to FY18, notes that NBFCs operate a passive strategy for managing asset-liability mismatches (ALM) by covering the gaps in the wholesale funding markets, rendering them vulnerable to liquidity risks.

The study focused on these firms for three reasons: they were among the largest components of the systemically important non-deposit NBFC sector with a share of 38.5 per cent in credit; the decline in the share of banks in the credit given to real estate, consumer durables and vehicle loans to 74.6 per cent at the end of FY18 from 88.1 per cent in Q3 FY15 was almost entirely explained by the increase in the share of loan companies to 25.4 per cent from 11.9 per cent; and that both banks and loan companies have similar business models and vie for the same clientele, especially in retail loans.

In the case of banks, the net cumulative negative mismatches during day 1, 2-7 days, 8-14 days and 15-28 days buckets cannot exceed a prudential limit of 5 per cent, 10 per cent, 15 per cent, and 20 per cent, respectively, of the cumulative cash outflows.

Banks have to show how they propose to finance the gap to bring the mismatch within the prescribed limits. The gap can be financed from market borrowings (call or term), bill rediscounting, repos, liquidity adjustment facility and deployment of foreign currency resources after conversion into rupees. While it is clear that the new norms for NBFCs will not be the same as for banks, in principle, they will mirror them, but it is not clear how the gaps are to be funded. NBFCs do not have the same access to funds as banks, which can borrow in the call money market and the RBI’s repo window.

Tough life ahead
| Current liquidity gaps of 10% and 15% to be tightened
| NBFC boards will not be allowed to make exceptions
| Dependence on commercial papers to be reduced
| New norms will take into account sectors in which NBFCs operate
| To cover systemically important non-deposit and all deposit 
taking entities
| Will align NBFCs’ asset-liability mismatch norms with those of banks

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