By YS Chakravarti

Non-Banking Financial Companies (NBFCs) play a critical role in the Indian economy by providing access to funds to the last-mile customer. NBFCs provided credit of a sizable nature, amounting to over `26 lakh crore to individuals and various industries as of September 2021. Credit growth, at under 10% as of Decemeber 2021, indicates languishing credit demand. While the green shoots of recovery are visible in some sectors, small businesses are not out of the woods yet.

The government and RBI have taken several steps like the interest subvention and credit guarantee schemes, special liquidity windows and long term-repo operations to support the MSME sector. However, such sectors need continued regulatory support, including easy access to cheap credit, to help them tide over cash-flow disruptions.

Against this backdrop, RBI’s decision to extend the deadline for implementation of its November 2021 circular on the recognition of non-performing loans by NBFCs is a relief. This will give a breather to NBFCs’ bottom line, give them more time to put the new systems and processes in place, and also put less pressure on borrowers’ credit profile. As per the circular, NBFCs need to recognise NPAs on a daily due-date basis. They can upgrade an account from ‘NPA’ to ‘standard’ only on payment of entire arrears, including interest. This will align the norms for NBFCs with those for banks. The deadline has now been extended to September 30, 2022.

RBI also specified that the exact due date for repayment, the frequency of repayment , breakup between principal and interest, and examples of special mention or NPA classification dates must be clearly specified in the loan agreement. Further, in the case of loan facilities with moratorium on payment of principal and/or interest, the exact date of commencement of repayment shall also be specified.

Earlier, the industry practice was to recognise stressed loans on a period-end basis and upgrade loans even on partial payment. The combination of day-end recognition and stricter norms for loan upgradation implies that stressed loans of NBFCs are likely to get classified as NPAs quicker and stay as NPAs longer, until the new collection mechanism is put in place.

The recent extension is a positive move both for borrowers and lenders; however, the extension would have been a lot more helpful had it come along with RBI’s November 2021 circular, where RBI revised the framework for NBFCs to classify loans as ‘standard’ or ‘NPA’ as per Income Recognition and Asset Classification (IRAC) norms.

In Q3FY22 most NBFCs absorbed the impact of the RBI norms, taking a hit of ~100-300 bps on their GNPAs; thus, the clarification only defers the adoption of the new norms. Further, NBFCs are unlikely to reverse the provisions already existing, due to accounting complexities. Until the gap between the old and new NPA methodology is reduced, reversing the provisions will not seem fit. The hit from the revised norms has been higher for NBFCs that lend to economically weaker individuals, small businesses ,and vehicle financiers, due to the irregular repayment behaviour of small borrowers and cash-flow disruptions.

On the customer front, individual entrepreneurs and MSMEs, below a certain outstanding exposure, should be totally exempt from the new classification norms as their cash-flow mismatches are usually long-term.

Further, the norms have come just as NBFCs were seeing regularisation in cash-flows led by gradual economic recovery Even as collection efficiency is improving across the sector, these norms may offset the gains in portfolio quality and provisioning requirements, leading to stagnant or marginally higher NPAs industrially in the short-term. However, six months from now, owing to the positive rub off from the budget’s capex, the economy could be in a much better place and delinquencies could start to drop.

The NBFC industry has requested a further extension till March 2023, exemption of MSME loans, vehicle loans of up to 25 lakh, and retail loans of up to 2 crore, at least until economic conditions revert to the pre-pandemic state. Any softening in stance will lead to a healthy overall revival for the industry. As such, provisioning requirements for most lenders are not likely to increase as NBFCs follow the Ind-As accounting standard, wherein provisions are based on expected credit loss.

However, the gap between stage-3 assets and NPA ratios could take some time to narrow given the short-term surge in bad loans. The NBFC industry will work on strengthening of the collection efforts and processes in the 0-30 and 31-60 days-past-due buckets to avoid account downgrades and keep asset quality in check. This will be beneficial in the long term as it will enable overall better portfolio quality for individual companies and the sector, increase focus on and innovation in collection processes, and encourage better credit discipline from borrowers.

The author is MD and CEO, Shriram City Union Finance