CIO, ASK Investment Managers
Over the past two months, there has been a big focus on NBFCs. If you ask whether there is a systemic risk to the system, I believe the peak period of renewal of commercial papers was in the first half of November and that period has passed. The key period to watch for is when corporates pay taxes and liquidity reduces.
What steps are being taken to avoid repeat of the problem?
The problem has arisen because of asset liability mismatch. NBFCs borrow short term and lend longer term. This strategy works till the interest rate scenario is benign but hurts when rates start to climb. It is a risky strategy. The problem has arisen because rating agencies have probably given more importance to the business house sponsoring the NBFC rather than the business of NBFC itself.
• I believe in future rating agencies would give more importance to ALM.
• Leverage may have to be cut, that is have higher equity/and or have some money kept with the regulator similar to CRR of banks. This is already being done for deposit taking NBFCs. This may be extended to all NBFCs.
What is the growth outlook?
The growth outlook for NBFCs has become impaired due to several reasons.
• Banks are more competitive in the market place as avenues of low-cost funds which allowed NBFCs to compete with banks have reduced. When mutual funds inflows were strong, it was possible for NBFCs to raise medium-term money at competitive rates and compete with banks on an all-inclusive cost basis. Similarly, strong FII inflows into the debt market and the ECB market also allowed cheaper liquidity on a fully-hedged basis when the rupee was stable. This is changing. Cost of funds have increased. PSU banks are now more competitive than NBFCs for giving loans.
• PSU banks, with a large branch network, are competitors to NBFCs. However, they have not been aggressive on account of balance sheet issues. While this issue persists, on the margin things have improved. Banks are are now buying assets and increasing their market share.
I believe that banks would gain market share in this period.
Are NBFCs good investments?
NBFCs increase the equity percentage in the total lending business. For example, if a bank lends directly to an entity, it would keep just say 10% of the loan amount as equity. However, if the bank lends to an NBFC and the NBFC lends to the entity, the overall equity backing the loan goes up because both entities — the bank and NBFC –keep the requisite equity. To avoid recurrence of the NBFC problem, the best way would be to have them share on a continuous basis their ALM and having rating agencies give a high weightage to ALM.
In case the regulators focus on ALM matching, except for HFCs and financiers of capex, other NBFCs which finance micro loans, gold loans, two-wheeler loans, CV loans etc. would be all fine. These NBFCs have short duration loan books and have a good ALM match.
Since long term credit is not available in India, NBFCs which lend to spaces such as housing finance and infrastructure finance may need to either provide more capital or maintain minimum liquidity. The overall scenario has not changed. PSU banks are still starved of capital. Many banks are under PCA and hence can’t expand their balance sheets.
Presently, banks lending to NBFCs have RWA of 100%. This induces banks to lend to entities which offer higher yields versus which are safer. It seems RBI is not in favour of banks sponsoring risk-bearing entities like insurance businesses or NBFCs. Such entities may have to be reorganised so that the risk on banking business itself is minimised.
Regulations would hence need to be watched closely.
Least risky and best positioned would be NBFCs rated A- or above and focussed on segments like gold finance, micro finance, twowheeler finance, consumer finance, and CV finance. These segments are higher yielding and shorter duration and permit ALM match. Some of these segments which qualify for priority sector lending have an advantage. With these segments as core, an NBFC could build a relatively smaller housing or infrastructure financing segment. However, infrastructure and housing would need to have longer term funding to be less risky.
In the near term, some slowdown in growth and some compression in NIM should be expected. However, over the medium term, the growth prospects may change.
Source: Economic Times