The Reserve Bank of India (RBI) on Friday released the much-awaited draft guidelines on liquidity risk management framework for non-banking financial companies (NBFCs) and core investment companies (CICs).
The guidelines come on the back of rating downgrades and debt defaults in the NBFC sector and the need for a stronger asset liability management (ALM) framework. The need has also arisen because many NBFCs have run up serious mismatches in their books by borrowing short-term to find long-term assets.
In its draft guidelines, RBI has proposed to introduce a Liquidity Coverage Ratio (LCR), which is the proportion of high liquid assets set aside to meet short term obligations for all NBFCs with an asset size of more than ₹5000 crore. Starting April 2020, NBFCs will have to maintain a minimum of 60% of LCR as high liquid assets which will be increased in a calibrated manner to 100% by April 2024, RBI said.
The regulator has also proposed to revise the ALM of NBFCs to ensure that the difference between inflows and outflows during the first 7 days is not more than 10% of the total outflows. Similarly over the next 8-14 days and 15-30 days, the cash flow mismatch should be only 10-20% of the cumulative outflows. This is to ensure that NBFCs’ reliance on external debt to repay its maturing debt is reduced, given the current market conditions where funding from banks and mutual funds has become scarce.
RBI has also asked NBFCs to adopt liquidity risk monitoring tools to capture any possible liquidity stress. This will include concentration of funding by counterparty/ instrument/ currency, availability of unencumbered assets that can be used as collateral for raising funds, certain early warning market-based indicators, such as, price-to-book ratio, coupon on debts raised, breaches and regulatory penalties for breaches in regulatory liquidity requirements, RBI said.
The guidelines have also proposed to introduce a stock approach to liquidity—as opposed to a cash flow approach—to ensure asset adequacy to repay debt. For instance, the liquidity ratios being proposed are short-term liability to total assets; short-term liability to long-term assets; commercial papers to total assets; non-convertible debentures(NCDs, with original maturity less than one year) to total assets; short-term liabilities to total liabilities; long-term assets to total assets; etc.
RBI has sought comments from NBFCs, market participants and other stakeholders on the draft framework before June 14, 2019.
The central bank has acknowledged the importance of NBFCs particularly in delivering credit to the last mile, including retail and micro, medium and small scale sectors. “NBFCs’ ability to perform their role effectively and efficiently requires them to be financially resilient, well-regulated and properly governed so that they retain the confidence of all their stakeholders including their lenders and borrowers. The Reserve Bank has always endeavoured to provide and modulate a regulatory architecture consistent with these objectives," said RBI.
The regulator has also assured that it remains committed to promote a robust, vibrant and well functioning NBFC sector.
The problems with NBFC sector started after Infrastructure Leasing and Financial Services Ltd (IL&FS) defaulted on its loan last year, resulting in mutual funds with exposure to debt papers of other NBFCs redeeming their holding in these companies in panic. This led to a series of rating downgrades, which had led to the liquidity crisis.