By Deepak Aggarwal
Credit and Finance for MSMEs: The number of non-banking financial companies (NBFCs) has grown exponentially in India. They have emerged as important players in the country’s economy for financial stability and inclusion. Their significance can be simply gauged from the fact that they have expanded the reach of financial inclusion by bringing MSMEs under their umbrella—a sector that is a crucial growth engine but has largely remained underserved.
Over the years, small businesses have found it difficult to avail loans owing to complexities and limitations. Here the NBFCs have aided them by putting their weight behind them through MSME lending. This is great support, especially in a sector whose only 8 per cent is served by formal credit channels, as per a report. The NBFCs have gained an edge here by being credit providers, especially at the bottom levels across locations. The smaller businesses also find them viable for quick disbursal of loans, flexible rates and lenient eligibility criteria. Additionally, NBFCs have utilised innovation in lending to the MSMEs which has resulted in greater outreach and notably accessible, reliable and smooth gateway to loans for small businesses which was earlier very limited.
Undoubtedly, NBFCs have been significant in strengthening this sector however, they still face many roadblocks in terms of scalability, and raising equity and debt capital. Here, asset classification at par with banks will bring higher transparency and comparable accounting practices will improve the flow of equity and debt capital to NBFCs. Thus, the Reserve Bank of India (RBI) has just taken the right step in this direction.
How NPA classification norms by RBI bring NBFCs at par with banks
The RBI has come out with asset classification norms for NBFCs which will put them at par with banks. Under new NPA classification norms, firstly, the country’s central bank has mandated that all NBFCs would be required to collect the entire arrears of interest and principal to reclassify a non-performing asset to standard asset in line with banks. Secondly, all NBFCs have to classify their account as NPA exactly after 90 days from the overdue date unlike the present practice of starting 90 days from the end of the month in which the account becomes overdue.
This will remove the cushion available to NBFCs in upgrading the NPA accounts to standard assets by collecting part overdue. Additionally, SMA and NPA recognition for NBFCs will now be at par with banks. As a one-time impact, this will result in higher NPAs for most NBFCs and may lead to higher provisioning and lower profitability for NBFCs practising aggressive accounting. However, this is a welcome move and will ensure transparency, a high degree of corporate governance and improved consistency in accounting not just with banks but also among various NBFCs.
Here, it becomes important to know why this move is significant. An account is declared an NPA if the principal or interest repayment on the loan remains overdue over a fixed period. While, on the other hand, standard assets are the assets which don’t carry more than normal risks attached to a business. Knowing the numbers of NPAs of a financial institution is crucial as it depicts the health of the portfolio and the quality of underwriting. The high NPA ratio reflects not only the flawed underwriting and recovery management but also raises a concern about the business model. The latest NPA classification norms come after RBI’s observations on some lending institutions that upgraded accounts to standard category upon payment of only interest overdue, partial overdue or others.
Additionally, the current norms say that the amount will be treated as overdue if it is not paid on the due date fixed by the bank. This will bring more transparency as in many loan agreements, the fixed due dates are not clearly specified which earlier left scope for different interpretations. This move is to bring improved consistency in accounting among NBFCs.
Why is it important?
Currently, many NBFCs are trying to reinvent themselves to become full-fledged banks to stay ahead in the financial markets. An NBFC carries better loan origination capability and lowers the cost of operations. As the central bank has supported innovation for financial inclusion, the idea of bringing NBFCs at par with banks can be beneficial in the long run and also for financial stability.
Additionally, in recent times, not just new-age digital lenders, but even larger NBFCs are looking to have partnership models with banks, most importantly co-lending model (CLM). Under CLM, mostly 80 per cent of loans are booked in banks while 20 per cent are in the books of NBFCs. It makes so much more sense to have similar asset-classification norms so that the same loan is not recognised as NPA in a bank while it is recognised as an SMA account in NBFC.
Similarly, many banks now have a higher focus on retail loans similar to NBFCs, thus again bringing the need to have a level playing field. The RBI has given a leeway to NBFCs till September 2022 to put the revised norms in place. After this move, the NPAs of NBFCs are expected to rise marginally as a result of the revised rules for recognising and upgrading bad debts.
The RBI is watching the space closely and has even come up with scale-based regulations for the sector. This can also be the step to allow larger NBFCs entry into banking as they would already be complying with stricter norms similar to banks. Similar norms among banks and NBFCs will definitely increase higher collaboration over the medium and long-term and will be a shot in the arm for MSMEs.
Deepak Aggarwal is the Co-Founder of Moneyboxx Finance. Views expressed are the author’s own.