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Enable NBFCs to surge. If they shrink, a few will sink and raise a stink for entire system

The government has been very supportive of the NBFC sector. All it needs is to take other public institutions along and ensure no loss of intent in execution.

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A ‘thick snake’ would repulse and rage you, while a ‘pillar’ would give you a feeling of security and strength. What if it’s the same animal viewed from different angles, as in the ‘Blind Men and an Elephant’ parable? 

Non-banking financial companies (NBFCs) evoke varied sentiments, not just from a person on the street but even from people with powers to form policies and regulations. There are some who view NBFCs as doing an altruistic job of delivering credit to the underprivileged, under-served segments of society, and there are some others who view them as an avoidable annoyance, with questionable governance, posing threats to the financial system’s stability. Let credit be delivered by the banks alone. 

There are many with in-between views. Whatever be your view, the NBFC sector is a big elephant in the economy. Private NBFCs (excluding government-owned REC, PFC etc) have outstanding credit of Rs 25 lakh crore. In this article, my reference to NBFCs includes housing finance companies (HFCs) and microfinance institutions (MFIs) as well.


Also Read: MSMEs, NBFCs get priority in Modi govt’s big stimulus, but it’s heavily credit focused


Why liquidity for NBFCs gets diverted, and denied

To be fair, the government and the RBI have announced a slew of schemes, more than ever before, to infuse liquidity in NBFCs since the collapse of IL&FS. It seems clear that policymakers see merit in supporting NBFCs. 

They want to provide liquidity, and ensure liquidity should not cause solvency issues. Yet, the drafting and execution of these policies pass through many layers with their own views of the world and the NBFCs’ place in it. 

As a result, NBFCs, in need of liquidity support, are getting a small part of the actual funds released. They are surviving but not able to resume normal lending to support economic growth.  

Let us evaluate the key initiatives for liquidity infusion in NBFCs, and the flaws in execution that cause a major part of the funds to be diverted, and denied to the deserving ones: 

  1. Recently, as part of a mega stimulus, the government provided Rs 30,000 crore of liquidity for NBFCs, to be invested in their debt papers. The devil is in the detail, as this investment can be through primary or secondary purchase of these bonds. In practice, mutual funds will get rid of their NBFC bonds by selling to banks under this scheme. The government is guaranteeing these securities. The net effect is government taking over risk from mutual funds for decisions taken even before the crisis, and funds do not go to the NBFCs.
  2. Last month, the RBI provided liquidity to banks at a low cost under the Targeted Long Term Repo Operations or TLTRO scheme (Rs 1 lakh crore was the first tranche), with the stated objective of “bank credit flows on easier terms .. to those affected by the pandemic”. However, banks ended up lending to AAA-rated, very large corporates that have no liquidity issues and can easily borrow from non-bank lenders, including foreign investors. Then, in the second tranche, banks invested a significant part of funds in the secondary purchase of bonds, providing liquidity to large mutual funds and insurance companies that held NBFC bonds. NBFCs, which were in dire need of liquidity, received a pittance.
  3. The government announced the Partial Credit Guarantee Scheme of Rs 1 lakh crore to ease liquidity for NBFCs by guaranteeing their securitised loans bought by banks. The scheme had very stringent terms and a cumbersome process, undermining its efficacy. It offered guarantee only for two years, whereas underlying securities typically have a much longer tenure, providing little incentive to banks to provide liquidity under the scheme. Further, it required a rating agency’s AA rating, approval of government through the Small Industries Development Bank of India (SIDBI), and cost of insurance.
  4. The government set up a fund of Rs 25,000 crore for real estate to provide last-mile funding. The conditions include first charge and escrowing all cash flows to first repay this last-mile loan. This will make sure that the existing lender of much larger amount will not get its interest or repayment instalments serviced, making such loans NPAs on its book. Understandably, the response was tepid, and the woes of real estate developers and their lender NBFCs continue to get accentuated. 

Also Read: Global investors have no fear lending to these Indian NBFCs


A deeper dive into risk aversion by banks

Of late, many banks have been asking for guarantees or some sort of risk transfer to the government for lending to NBFCs. The banks refused to give a moratorium to NBFCs, which, in turn, were practically compelled to give a three-month moratorium to their borrowers following the RBI’s direction. 

It is a situation where a water tank, however strong, has its inlet closed and outlet open. Currently, only banks are flush with liquidity and in a position to provide fresh credit. The banking system has Rs 8.5 lakh-crore surplus deposited with the RBI at a reverse repo rate of 3.75 per cent. In April 2020, SBI saw an 800 per cent surge in its deposit on a year-on-year basis. People with savings are now risk-averse and consider their funds safe with banks, with a perceived RBI guarantee. The risk aversion is a self-fulfilling prophecy. The strongest bank in the world cannot survive a day if its deposit-holders perceive risk with the safety of their money. In the last 18 months, NBFCs have been fighting the spectre of perception, aggravating their woes. 

Interestingly, under TLTRO, banks have been comfortable lending to corporates where their NPAs are 12-15 per cent. This is in contrast to banks’ NPAs with NBFC loans, at 2-3 per cent. The banks already have estimated Rs 15 lakh crore exposure to the sector. The sudden risk aversion will be like shooting yourself in the foot. NBFCs, in turn, have slowed, if not stopped, the flow of credit to their customers with higher risk, mostly MSMEs (micro, small & medium enterprises). Our grand vision about the economy, driven by job-givers and not job-seekers, will come to naught if there is no risk capital in the system.


Also Read: NBFC crisis is a big hurdle in India’s path out of the pandemic


Risk riddle – banks fail too, but are bailed out

Since the overhaul of NBFC regulations in 1997, the first major default was IL&FS, followed by DHFL. During this time period, in contrast, the RBI had to help the bailout of 20 scheduled banks, including Global Trust Bank, Bank of Madura, Bank of Punjab, Sangli Bank, Lord Krishna Bank, and, most recently, Yes Bank. Any financial system in the world will have failures and frauds. The regulator tries to mitigate the risk when such events happen despite the best of regulations. Failures occur in all sectors. 

However, in India, no scheduled bank has gone under, with deft bailouts worked out under the aegis of the RBI. That is reputation that inspires confidence of unwritten guarantees to deposit-holders. That is the reputation the RBI has to keep. It is not easy. While the RBI also regulates NBFCs, it would be in no mood to undertake the responsibility of their safety. This leads many commentators to remark that NBFCs are treated like stepchildren. 


Also Read: NBFC crisis is beginning to ease but long way from resolution


Banking licences on tap but no takers — why?

Is there a solution in letting large NBFCs convert to banks? There is an interesting history of banking licences. Since nationalisation some 50 years ago, the RBI has been excessively cagey in giving new licences, perhaps due to the moral responsibility of safety of all banks, as discussed supra. The economy has grown many times during this time period, and the need for banking services even more. 

The existing banks enjoy higher margins than what a free market would allow, and are relatively protected from risks. After waves of liberalisation underpinning the need to free up the sector, the RBI did put banking licences on tap. And lo, there are no takers. Earlier, under a controlled regime, there were many willing to give an arm and a leg to acquire a banking licence. The reason is that licensing guidelines are tilted against new players and favour incumbents in a big way. For instance, new promoters cannot have NBFCs and banks both, but existing banks are allowed to keep their NBFCs and not asked to merge them. 

The new banks, if converting NBFCs, have to meet all statutory requirements from day one but they will build their deposit base only over a period of time. Similarly, new players have arduous conditions for ownership and dilution. The existing players have a vested interest in keeping the sector protected from competition and they are natural sounding boards to policymakers.


Also Read: Relief to NBFCs, stressed borrowers, credit flow to MSMEs: RBI Governor’s full speech


Quō vādis NBFCs?

The policy framework should ideally enable NBFCs to surge and not just survive. Otherwise, they will continue to shrink and a few will sink, raising a stink for the entire system. The RBI and the government, in consultation with the industry, need to take a long-term and holistic view of the sector and challenges that are bound to resurface in any financial system. 

Unlike mutual funds and banks, NBFCs do not have a strong industry association. They need to have one common association and engage with policymakers. 

The RBI and the government both do understand the importance of NBFCs for filling the gaps that banks are not able to service efficiently. It is evident from the increasing partnerships between NBFCs and banks for sourcing and selling assets that they can complement each other. The partnership approach will ensure flow of credit to the underserved sector, without credit losses going beyond acceptable limits. 

The Mudra loans given to MSMEs by banks have a very high default rate in double digits. It’s not surprising then that, despite government push, banks are reluctant to expand Mudra loans. At the same time, many NBFCs are seeing a great profitable opportunity in the MSME sector. 

Our Prime Minister, Mr Modi, himself said in a media interview, “Banks .. are being encouraged to lend to Non-Banking Financial Companies. It is bound to improve availability of credit for the private sector and boost the economy…” 

The government has been very proactive and supportive of the sector. All it needs is to take other public institutions along and ensure no loss of intent in execution. 

The author is the chairman of IIFL Finance

IIFL Finance is an RBI-regulated NBFC with subsidiary HFC and MFI companies. While the author has drawn from his experience of running the NBFC, the views are personal and may not have endorsement of the company.

IIFL founders Nirmal Jain, R. Venkataraman, Karan Bhagat and Yatin Shah are among the distinguished founder-editors of ThePrint. Please click here for details on investors.


Also Read: Need to balance EQ and IQ to be successful today, says IIFL Wealth co-founder Yatin Shah


 

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