Story Of The Week

NON-BANKING FINANCIAL COMPANIES in INDIA- A BIRD’S VIEW

Largely it (NBFC crisis) has reached a peak in terms of challenges that they are facing. … the deteriorating situation has reached its bottom … now it has bottomed out” 

-Ms.Nirmala Sitharaman, Current Finance Minister

In a mere span of two years, Indian Shadow Banks a.k.a NBFCs are believed to have been swung by 180 Degrees. The sector is in the midst of not just liquidity squeeze but also a solvency crisis (as highlighted by this year’s Budget) which is indicative of a deferred full-blown crisis.

However, before we delve deeper into this situation of ‘Stressed NBFCs’, a quick recap awaits!

Brushing up basics- NBFCs:

NBFCs are financial institutions that are involved in a variety of banking services, but they do not possess a banking license. Some of the banking services they offer include loan provision, retirement plans, underwriting, merger activities etc. Then how different is NBFC from a traditional bank? These companies are not allowed to take traditional Demand Deposits (unlike Savings Bank/Current Bank accounts) from the general public. Technically, any institution where more than 85% of the revenue is realised through financial activities and is not in the ambit of banks, can be deemed an NBFC. As the number of NBFCs in India is increasing rapidly, securing a loan gets easier, thus acting as better alternatives to banks. 

In simple terms, if a retail customer, say X, were to secure a housing loan from a bank, he must undergo the sweat and toil of all the procedures/norms that the bank expects him to follow. To add salt to the wound, there are various limitations that the bank poses on the amount of credit that can be approved to X, based on his salary and paying abilities. In such a scenario, if X expects to procure a loan with slightly more flexible norms, he can get it done from an NBFC, maybe at a higher interest rate (a trade-off is always factored-in).

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Source: www.slideshare.net

Some NBFCs are specialised in a specific sector such that they cater the sector-specific demands exclusively.

 

Opportunities and obstacles:

Upholders of NBFCs say that they play a crucial role in meeting the rising demand for credit in the market. The customers can be both Businesses and Individuals, mostly who have trouble qualifying under the stringent norms set by traditional banks. The business model of NBFCs provides certain perks- they eliminate the middleman and facilitate direct client interaction, act as an alternative source of funding to the customers and yields a higher return for investors.

 On the other hand, the regulation on NBFC is still maturing and the model is more vulnerable to systemic risk to the economy than banks. The operations are less transparent than it is in banks.

The NBFC Liquidity crisis:

A few months ago, IL&FS defaulted on some of their obligations in the market. So, the lenders became reluctant to lend money to other NBFCs as well, thinking that they might as well default on their obligations. This concern of the lenders was genuine, but it caused a liquidity crunch in the market for NBFCs. As we can see from the below graph, the main sources of funds for NBFCs are from banks and mutual funds (around 77% of the money comes from these two sources). There were large redemptions from MFs and they suddenly wanted to withdraw investments from various NBFCs.

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Source: www.moneycontrol.com

 Similarly, banks also didn’t have enough wherewithal (cash) to lend money to NBFCs. Because of this the NBFCs, who were borrowing money from the short-term market and lending the same in the long-term market, faced a mismatch in the assets and liabilities. Now there is a fear that the liquidity crunch could hamper the business model of NBFCs, leading to a solvency crisis.

 Now if you are wondering why should I care about the crisis?  There are several reasons for you to worry about.

  1. Due to the increased penetration of NBFCs in the lending market, they have a significant share of credit in the economy. They have catered to many sectors where banks have not even started exploring. So, the impacts due to the crisis are far-reaching.
  2. The cost of borrowings may go up. If the cost goes up, the NBFCs might cut back on their lending. There are some sectors (such as commercial real estate) that are credit-thirsty throughout the year. If these sectors are made to starve for credit, they might as well default, leading to NPAs, which further pulls the market down.
  3. The flow of credit to the economy comes down, ultimately leading to slower economic growth. The repercussions of such a situation are already well-informed.

Mending the ways- Government and RBI:

The Government of India, RBI/SEBI has a crucial role in revitalising the health of NBFCs. They came up with the following measures:

  1. National Housing Bank (NHB) increased its refinance* limit from 24,000 crores to 30,000 crores.
  2. RBI eased the mandatory Liquidity coverage ratio*(LCR) of banks so that they can improve on lending to NBFCs.
  3. It also allows the banks to use 15% of their capital funds to lend to non-infrastructure funding NBFCs. The figure was 10% earlier.
  4. The Government will provide a one-time 6-month’s partial credit guarantee to PSBs to buy high rated pooled assets worth Rs 1 lakh crore from NBFCs

*The liquidity coverage ratio (LCR) refers to the proportion of highly liquid assets held by financial institutions, to ensure their ongoing ability to meet short-term obligations

*Refinancing is the replacement of an existing debt obligation with some other debt obligation under different terms. 

Added expectations of GoI from the Banker’s Bank:

  • Dilute the norms of banks under PCA (Preventive and corrective measures) so that they can increase the lending to NBFCs.
  • GoI wants RBI to open a special refinance window for NBFCs.
  • Increase the refinance limit of NHB further. This might provide relief to at least one section of NBFC- the Housing Finance companies.

But the real question is, are these measures enough to recoup market sentiments? 

Well! The market sentiments can only be controlled as much as the efficiency of measures taken. We might have to wait and watch how the aforementioned measures make or break the deal. But calling the crisis as India’s own Lehman movement may be an exaggeration.

References:

  1. https://www.slideshare.net/sumit235/nbfc-42526965
  2. https://www.investopedia.com/terms/n/nbfcs.asp
  3. https://qz.com/india/1401032/why-the-ilfs-default-is-spooking-india/
  4. https://qz.com/india/1659095/what-nirmala-sitharamans-union-budget-did-for-aviation-nbfcs/
  5. https://www.businesstoday.in/union-budget-2019/news/budget-2019-government-steps-in-to-ease-nbfc-liquidity-crisis/story/362045.html
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