In a move to improve liquidity flow to non-banking financial companies (NBFCs) in the country, the Reserve Bank of India (RBI) on Thursday announced that banks assign differential risk-weights to their exposures to NBFCs, based on ratings assigned by credit rating agencies, as against the existing practice of a uniform risk weight of 100%.
Prevailing regulations require uniform 100% risk weights on bank exposure to rated, as well as unrated, systemically important NBFCs that don’t take deposits. The move will not only free up capital for banks for further lending—both directly and indirectly—but will also help reduce borrowing costs for well-rated NBFCs, which have been grappling with a systemic liquidity crisis triggered by a series of defaults by Infrastructure Lease and Financial Services Ltd (IL&FS), and its subsidiaries.
The alignment of risk weights with credit ratings will “facilitate credit flow to better-rated NBFCs, lower the cost of bank borrowings for NBFCs and for the end users, particularly the borrowers of micro finance institutions," RBI governor Shaktikanta Das said, while addressing the press.
“PSU banks have been keen to lend to highly rated housing finance companies and asset finance companies due to the benefit of lower risk weights, but were not too keen to lend to even highly-rated loan companies due to 100% risk weight," said Renu Sud Karnad, managing director, HDFC Ltd. The relaxation will also make banks more amenable to lend to NBFCs.
While it is not clear yet if the new guidelines will be applicable retrospectively as well, or fresh loans alone, the move is likely to free up around ₹15,000 crore worth of capital for banks, said Karthik Srinivasan, group head, financial sector ratings, ICRA Ltd. “In a way this (alignment of risk weights with credit ratings for NBFCs) is indirect capitalization of banks."
Guidelines pertaining to risk weights for bank exposures to NBFCs will be released by the end of February. The regulator also clarified that the risk weight for core investment companies will continue to remain 100%.
“So far, banks were given flexibility to assign risk weights for only a few categories of NBFCs, such as asset finance companies and housing finance companies. In my view, this needed correction. A firm financing SMEs is as important as a firm financing cars, as both are critical to growth. The move to bring all NBFCs and corporates at par, in terms of how risk weights are assigned, is a huge positive," said Sumit Bali, chief executive, IIFL Finance.
Bali added that the flexibility provided will also allow banks to improve their return on capital and pass on the benefits to borrowers as lesser capital will have to be set aside against the loans to NBFCs.
Although bank lending to NBFCs during the first half of 2018 remained robust, the IL&FS crisis in September dried up bank lending, forcing NBFCs to scout for alternate sources of funding, like non-convertible debentures.
The central bank also said that it will be merging three categories of NBFCs—asset finance companies, loan companies and investment companies—into a single category, namely NBFC investment and credit company, in line with its efforts to harmonize various classes of NBFCs, and the regulations for the sector on the whole.
“There are too many categories of NBFCs currently and every time the regulator comes out with some policy changes, they get applied only to some categories of NBFCs and others are left out. So harmonization will help in getting the policies applied uniformly across various categories," said Karnad of HDFC.
The three categories cover nearly 99% of the NBFCs by number. “The Reserve Bank is committed to such harmonization and to move towards activity-based regulation replacing the current entity-based regulation for the NBFC sector…The proposed merger of existing categories would reduce to a large extent the complexities arising from multiple categories and also provide the NBFCs greater flexibility in their operations," the regulator stated in the press release.