What seemed to be a debt default by a single large non-banking financial company (NBFC)Infrastructure Leasing and Financial Services (IL&FS) has assumed such large proportions that it threatens to derail the entire sector and throw into jeopardy a clutch of companies involved in asset financing and personal loans. The crisis in India’s NBFCs, triggered by the IL&FS debacle, has taken centre stage in the economic debate even as the tussle between the Union government and the Reserve Bank of India (RBI) on a host of issues, including refinancing for NBFCs, is heading for a climactic showdown at the central bank’s next board meeting scheduled on November 19.
The threat looms large, but sources indicate that the panic buttons haven’t been pressed yet on India’s thriving EMI economy which funds everything from cars to homes to gold purchases in manageable equated monthly installments, and even small businesses and there’s optimism that the RBI will come up with new ways to pump more money into NBFCs. NBFCs are currently not only in a crisis of liquidity but also of confidence, says Abizer Diwanji, partner (financial services) at consulting firm EY India.
Until just about a decade ago, Indians thought of EMIs for homes and vehicles, but in the past five years, more and more have become cheerful participants in a deepening retail economy to buy jewelry, smartphones, luxury handbags, air tickets, furniture, etc. and a lot of that boom has been funded by NBFCs big and small. You want it, you buy it. If the price looks steep for a straight purchase, an NBFC will finance it for you. You just pay an EMI often interest-free. NBFCs aren’t as strict about creditworthiness and documentation before financing you. They aren’t as stringent as banks. They lend to segments that wouldn’t make the cut for a banking institution, they take on more risk and often lend without due diligence checks on the borrower. But they fund small businesses, which fuel the economy from small transporters to traders or contractors.
There are over 11,000 NBFCs registered with the RBI across the country, which has revved up India’s consumer economy as retailers across sectors have latched onto the EMI bandwagon to lure the consumer. After IL&FS defaulted on payments to lenders and triggered panic in the markets, there is now speculation that the entire sector might cave in unless desperate measures are taken to keep it afloat. Several questions have been raised on the viability of this shadow banking sector, which has grown at around 20 percent and now has a fat aggregate book of Rs 26 lakh crore.
The RBI has since tightened regulations and now, depending on who you speak with, you are warned or comforted about the state of NBFCs. These institutions work on short-term credit and nearly Rs 1.5 lakh crore is up for redemption this month. There is a clamor for the RBI to bail out the NBFCs. As Nilesh Shah, managing director of Kotak Mahindra Asset Management Company, says, If a child jumps off the first floor, will you help the child heal first or slap him? Now is the time to bandage the child, then you can rap him.
How the crisis unfolded
Like every other business, NBFCs have short-term and long-term cash requirements. They take long-term loans from banks as well as institutions by raising debentures. These loans mature, and additional loan disbursements need to take place. NBFCs’ asset-liability management is tougher than of banks, says Diwanji. They don’t necessarily match cash flows and there are always gaps. They don’t have fixed period receivables and fixed period payables, unlike banks who have savings accounts, which is floating cash. As part of their regular business, these NBFCs keep borrowing short-term money through commercial papers (CPs) of three or six months from mutual funds. With the IL&FS default, some mutual funds were left cash-strapped. With the stock market going down, there have been more withdrawals from mutual funds. They have been trying to curtail more and more cash, and hence not giving out CPs, adds Diwanji. This choked NBFCs of funds, and their disbursements slowed down. Growth suffered and owing to liquidity fears, the stock prices of these firms took a hit. Companies then began to sell subsidiaries to raise cash.
Shah says the banking system needs Rs 90,000 crore more to maintain its liquidity. And some NBFCs could be in trouble because of an asset-liability mismatch, where short-term funding is used to finance long-term assets. It will be stupid to assume that the entire Rs 28 lakh crore will be impacted, says a Mumbai-based analyst. While the government presented a grimmer picture, an RBI source clarified that system-wise, there is excess liquidity.
A Crisil analysis of the liquidity position of the large non-banks NBFCs and housing finance companies it rates shows that they are maintaining adequate liquidity buffer to manage mismatches, if any, in their asset-liability maturity profiles. Says Krishnan Sitharaman, senior director, Crisil Ratings: In an environment where access to funding has become a function of market confidence, the quantum and quality of such liquidity cushion will be the key differentiator. The business fundamentals of non-banks, such as growth potential, asset quality, and capitalization, still look solid. But having said that, it’s worth noting that IL&FS continued to get star ratings even days before its default.
The IL&FS fiasco has made investors wary. The RBI has allowed portfolio sale by NBFCs and several of them are resorting to it to maintain liquidity. Some of them are even lobbying for a special liquidity window for NBFCs from the RBI, apart from banks honoring previously sanctioned credit lines. The government too wants the RBI to consider the suggestion. However, Shah and several analysts India today spoke to say that a separate window should be the last option. The RBI and the government can work together to address transmission of liquidity by adjusting the prompt corrective action (PCA) framework and improving market depth for the needy sectors, says Shah.
Meanwhile, institutional investors have shuffled their holdings in the NBFC sector. In September, for instance, foreign investors used the fall in share prices of NBFCs to buy stakes in about 11 major NBFCs, such as Repco Home Finance, Shriram Transport Finance Company, Dewan Housing, and Muthoot Finance, and reduced stake in about 13 of them, media reports said.
The RBI has infused about Rs 80,000 crore through open market operations in October and November. But evidently, the central bank is not open to providing sector-specific dispensation whether it is power companies or NBFCs. Policies are policies for everyone and it is a philosophical debate. Central banking literature suggests that there should not be specific provisions for specific things. Special dispensation should be used more selectively. I would rather wait for more confirmation when the asset growth data is released for October to December. Without that, acting in a hurry will make you look foolish, says the Mumbai-based analyst.
Finding a solution
Even as the RBI and the government fight it out, several issues, including easier norms and more liquidity for small and medium enterprises, easing of norms for non-performing assets (NPAs) and getting banks out of the PCA framework, and a special window for NBFCs are expected to be on the agenda for the November 19 meet. A crisis can be averted if the RBI decides in its meeting to open a window for NBFCs, says Diwanji. I don’t think the RBI will lend against portfolio directly, but it can give a liquidity window to banks to acquire higher portfolios from NBFCs, given that banks have a better understanding on how to manage and monitor those portfolios. They may also make an exemption for banks under the PCA framework. These measures can provide some relief to NBFCs and keep the EMI economy alive and kicking, say experts.
The State Bank of India has offered to bail out liquidity-starved NBFCs with its proposal to buy from them quality assets worth Rs 45,000 crore. Earlier, SBI had planned to buy only assets worth Rs 15,000 crore.
All eyes are now on the RBI board meeting. There are, however, some experts who argue that the RBI should not open a lending window as mutual funds are not facing a panicky repayment situation and are only cutting exposure to NBFCs. Also, it is uncertain if, despite more liquidity being introduced, the flow of funds from mutual funds to NBFCs will get back to levels seen before September. Others say the RBI did not intervene when NBFCs were growing fast using short-term financing and should ideally leave it to the latter to manage their own crisis. The risks, it is argued, are too many. When the RBI lends to banks, they do it against government securities, which is stable, says Diwanji. That’s not the case with NBFCs, as the lending would happen against their own portfolios, and hence the risks. Although this makes the job of the RBI a lot tougher, it has no way out but to come up with a plan to address the NBFC crisis, considering its scale and impact.