New NBFC norms may affect credit growth, trigger consolidation

The Reserve Bank of India (RBI) on 24 May said it planned to implement liquidity coverage ratio (LCR) in a phased manner over four years starting April 2020. Setting aside 60% of NBFCs’ net cash outflows, as envisaged in the initial phase, in so-called high-quality liquid assets such as government securities and cash will prevent them from deploying these funds for lending.

A possible consequence of the norms is that weaker NBFCs with poor liquidity management will get absorbed into their larger counterparts to comply with RBI’s liquidity buffer norms.

Leena Chacko, partner at law firm Cyril Amarchand Mangaldas, said, “There is likely to be consolidation because NBFCs with higher liabilities and lower liquid assets will have to consolidate in order to meet the regulatory requirement. This should help improve the creditworthiness of the NBFCs and ensure that they are able to meet their liabilities."

The norms could lead to a credit slowdown for NBFCs that do not have a well-managed asset-liability situation, said Madan Sabnavis, chief economist of CARE Ratings. “Once these lenders start maintaining LCR, they might end up with less cash to lend. While the large NBFCs are better managed in terms of liquidity, even they are unlikely to have 100% LCR," said Sabnavis.

To be sure, these suggestions are still part of RBI’s draft guidelines and the final one will be prepared after receiving responses from the stakeholders.

Although NBFCs will need to maintain LCR of 60% from April 2020, they will gradually have to move towards 100% LCR by April 2024.

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.

Sabnavis added that since most non-banks do not have access to low-cost deposits, they have to depend on market borrowings for funds. This, he said, leads to a higher cost of funds for non-banks compared to banks, and with LCR expected to shrink their margins, some could resort to raising lending rates. “Whether or not they are able to raise rates in such a competitive market is to be seen," he added.

The slowdown, if it happens, could affect overall credit growth since NBFCs play a significant role in the lending market. They have been gradually bolstering their market share in total loans, as banks have turned risk-averse. For instance, NBFCs, which accounted for 13% of the total loans in fiscal year (FY) 2012, now account for 23% in FY19. Consequently, the share of banks has been declining from 87% in FY12 to 77% in FY19, according to data compiled by Emkay Global, a Mumbai-based brokerage.

A report by Kotak Institutional Equities pointed out that the share of NBFCs has increased in most products between 2016 and 2018, with the rise sharper for business loans and home loans. “NBFCs have additionally gained market share in small-ticket consumer loans. With a gradual slowdown in disbursements of most NBFCs since September 2018, and revival in retail lending by public sector banks, the share of NBFCs will decline marginally going ahead," the report added.

While some NBFCs could see their margins shrink in the short-run, the long-term benefits will eventually offset this, experts said. A note by Jefferies said that LCR norms would affect margins and returns in the medium term, especially for housing finance companies (HFCs), given their higher asset liability management (ALM) mismatch.

“Deposit-taking NBFCs are required to hold 15% of deposits in liquid assets, but this may not be adequate. Note, most HFCs and NBFCs have reduced their ALM gap in shorter-maturity buckets in recent months and are also maintaining higher liquidity buffers at present," the report added.

Some experts say that apart from debt market investors, these guidelines will also help calm the nerves of banks that have been reluctant towards additional NBFC exposure ever since the defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS) happened last year. They feel that while the liquidity crunch is real, it is affecting the smaller non-banks even worse since the ones with good parentage are able to raise funds even in this market.

“These regulations have removed speculation and rumours in the market about the liquidity situation of NBFCs. It also gives comfort to banks for lending to NBFCs. RBI should now look at creating a separate category for NBFCs with asset size above ₹5,000 crore. The top 15-25 companies are already following these liquidity criteria, hence they won’t be affected," said R. Sridhar, executive vice-chairman and chief executive, IndoStar Capital.

Following a series of defaults by IL&FS last year, mutual funds with exposure to debt papers of the company had to write off a chunk of their holdings.

This, and the ensuing defaults by some NBFCs, had led to a liquidity crisis. Since then, mutual funds have largely avoided investing in commercial papers of non-banks, worsening the liquidity crunch.

“People are moving away from specific names which have a stressed situation. There is a kind of rush to quality. RBI open market operations (OMOs) improve overall liquidity but do not completely address the issues faced by the troubled NBFCs," said Avnish Jain, head (fixed income), Canara Robeco Mutual Fund.

*Neil Borate contributed to this story