The contagious effect of IL&FS downfall on NBFCs because of liquidity constraints became far more critical for the government and the Reserve Bank.
In retrospect, last 15 years Non-Bank Finance Companies (NBFCs) have grown to occupy a pivotal position in the financial sector in India- ‘serving the unserved’. Today, NBFCs holds 9% of financial assets as per a recent report of Investec. These have grown 18-20% per annum over last five years. In comparison to banks their share in incremental lending was more than 30% in FY18. It this liquidity crisis was no surprise.
Over the years the RBI has done well to discipline the conduct and affairs of NBFCs through prescribing dos & donts and setting the boundaries there-of. In deficit, however, is quality of governance and compliance. NBFCs often adopt structures and practices against the spirit behind the RBI norms.
RBI norms for Asset and Liability Mismatch are suggestive in nature and left to be decided by the management or board. Actual ALM in most of the NBFCs remained in the range of 25-30% to increase spread and profit ignoring the inherent risks involved.
NBFCs took advantage of commercial papers or short term bond rates citing available limits of sanctioned loans or short term paper as adequate safeguard. By any standard of financial prudence such an approach was a recipe for impending catastrophe -ironically remained unnoticed by rating agencies, bond market and analysts.
The problem in infrastructure finance companies and core investment companies is far more acute as these lend for 17-20 years but on the liabilities side borrow from less than 3 months to 12-13 years.
The problem is exacerbated by excessive leverage and use of exotic corporate loans or securitisation and like debt instruments at multiple levels and use of that as equity contribution in maze of Special Purpose Vehicles.
On the other, inadequate provisioning for poor quality of loan portfolio masked effective erosion in capital adequacy. Mammoth size of IL&FS triggered the inevitable crisis as the excessive leveraging coupled with ALM in short term bucket became highly unsustainable.
Priority of the government and the RBI is to avert massive default in debt redemption estimated to be Rs 1.2 to 1.5 lakh crores by March 2019 with Rs 50, 000 crores as reported to be redeemed by 9th November 2018.
The measures taken for easing liquidity through Open Market Operations, SBI’s scheme for buying loan portfolio from beleaguered NBFCs, increasing single NBFC exposure limit for banks, and the like are not sufficient to match the size of the crisis.
ALM norms needs to be made more stringent with zero tolerance level up to 3 month bucket and 10% in three to six month bucket.Ashok Haldia, Former CEO & MD PTC India Financial Services Ltd
Situation currently is too precarious to meet normal credit demand for festive season and for SMEs,and the industry alike. NBFCs source more than 75% of their fund requirement from banks or through CP or non-convertible debentures which have since dried up.
Banks are currently not making disbursements against committed sanctions.
The gravity of the crisis can be gauged from government’s action in issuing directions to RBI invoking for the first time Section 7 of the RBI Act.
What is aimed at is further easing liquidity through calibrated relaxation in norms for capital requirements and allowing lending by 11 PSBs under Prompt Corrective Action.These measures should not however lead to indiscreet support to NBFCs for debt redemption or imprudent lending as in the past- otherwise the current crisis would only shift to emerge later with more severity.
NBFCs with unsustainable balance sheet should not be rescued and rather subjected to PCA type measures.Insolvency and Bankruptcy Code for NBFCs on the lines of other corporate entities should be put in place without any further delay.
NBFCs are no more meagre alternative source of funding and are now indispensable for serving the unserviced. Their significant share in lending makes the financial sector vulnerable to their health hazards.
This calls for structural,policy and regulatory changes to make at least large NBFCs at par with banks and closer monitoring by RBI both at the aggregate and the NBFC level.
Further, the RBI needs to introduce infrastructure banks which source their funds from large and long term deposits. The ALM norms needs to be made more stringent with zero tolerance level up to 3 month bucket and 10% in three to six month bucket.
Also debt to equity percentage in NBFCs including at holding company level should not be allowed to exceed 80:20 and at any time short term fund should not exceed 10% of the portfolio.
NBFCs exceeding these norms should be subjected to PCA. These rigour are consistent with new rating norms for two to three notch downgrade in case of default even for a day -as has been the case in ILFS. The board of NBFC should be held accountable ,individually and collectively, for breach of ALM and other prudential norms.
About the author: Ashok Haldia is the former Chief Executive Officer and Managing Director of PTC India Financial Services Ltd an non-banking financial institution and has also served as the CFO in the same organisation.
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