The Reserve Bank of India’s (RBI’s) proposal to introduce liquidity buffers for non-banking financial companies (NBFCs) may restrict their ability to lend, but this short-term pain is necessary to make the sector more responsible. NBFCs
did play a critical role by partially filling the vacuum created by the trouble in public sector banks
(PSBs) and increasing their geographical reach via swift adoption of new technologies. As a result, the share of NBFCs
in total loans rose to 23 per cent in FY19 from just 13 per cent in FY12 — a period that saw a sharp erosion in PSB
lending. However, reckless lending practices and wide asset-liability mismatch (ALM) due to borrowing short-term and lending long-term have caused a huge liquidity shortage. The stringent guidelines, which are expected to improve liquidity management in NBFCs
and cushion them against crises that arise from asset-liability mismatches, are necessary as the IL&FS crisis
caused a lot of pain, especially among banks and mutual funds.
For debt mutual funds, defaults in repayments have led to erosion in net asset values. With another Rs 1.3 trillion NBFC papers set to mature in the next few months, mutual funds
are expected to reduce their exposure to the sector significantly. Against this backdrop, cleaning up of books and a clear idea of the asset-liability situation will give more confidence to lenders and make the sector healthy in the long run.
RBI’s proposals include maintaining a liquidity coverage ratio (LCR) equal to 30 days of net cash outflows for all systemically important NBFCs. LCR, maintained in high-quality liquid assets, ensures that financial institutions have enough liquidity to fall back on for 30 days in case of a significant liquidity stress. If implemented, the process will start from 2020 with LCR at 60 per cent, and end in 2024 at 100 per cent. The central bank has also granulated the one- to 30-day maturity bucket into three buckets — one to seven days, eight to 14 days, and 15-30 days buckets. This maximum ALM has been capped at 10-20 per cent in the buckets running up to a year — a relief as ALM guidelines were expected to be more stringent at 5 per cent from the current 15 per cent.
The move has its detractors, too, who say the central bank is proposing “liquidity management” at a time when there is no liquidity in the system. Also, the LCR requirement margin will impact NBFCs with longer-term products. For example, commercial and other vehicle financiers with product durations of three to five years would feel the pinch, and housing finance companies
will be impacted the most, as their asset maturity is the highest at seven to eight years. They also argue that credit is likely to slow down in the medium-term and margins will get crimped due to investments in low-yielding assets, thereby hitting profits.
A possible consequence of these measures is that weaker NBFCs with poor liquidity management will get absorbed into their larger counterparts to comply with the RBI’s liquidity buffer norms. This is not necessarily a bad thing as the NBFC sector has too many players without the required scale. In a way, this is inevitable as even the staunchest supporters of NBFCs can’t deny the fact that a large number of such companies have been slipshod in implementing prudential norms or risk mitigation standards.