Is the NBFC crisis imminent?

Published: May 17, 2019 1:54:16 AM

NBFCs’ capital adequacy ratio (CRAR) notched up from 22% in 2016-17 to 22.9% in 2017-18, but decreased from 27.5% in 2013-14.

NBFCs have been plagued with liquidity, maturity problems, but they have reportedly a high capital adequacy ratioNBFCs have been plagued with liquidity, maturity problems, but they have reportedly a high capital adequacy ratio

By Kushankur Dey

RBI and SEBI have to tighten regulatory supervision as NBFCs are going to face an impending crisis. That is attributed to liquidity crunch in the NBFC sector and can potentially retard the pace of financial intermediation and induce systematic risk in the financial system. MCA states that overleveraging, squeezed credit flow, asset-liability mismatch and misadventures by a few large entities are some causes serving a recipe for this disaster. Can we make a systematic attempt to understand the crisis?

RBI’s FSR (June 2018) mentions that NBFC sector aggregate balance sheet size stood at `22.1 trillion. But there is a stark decline in share capital growth of NBFCs in 2017-18—a negative growth rate of 58% between 2017-18 and 2016-17, while borrowings grew at 19.1%. It implies that the capital structure mix of NBFCs is likely to be overleveraged. Loans and advances of the sector have increased by 21.2% with investments growing by 13.4%. Net income showed a positive growth of 30.8% in 2017-18. Return on Assets and Return on Equity were 1.9% and 8.4% in 2017-18, respectively.

From asset quality and capital adequacy viewpoint, GNPAs of the NBFC sector as a percentage of total advances had gone down from 6.1% in 2016-17 to 5.8% in 2017-18. NBFCs’ capital adequacy ratio (CRAR) notched up from 22% in 2016-17 to 22.9% in 2017-18, but decreased from 27.5% in 2013-14. NBFC sector had about 15% combined exposure to capital market and real estate in 2017-18.

So, we can infer NBFCs have leveraged their capital structure with more debt and lesser equities. It is understood from FSR 2018 that NBFCs are the largest net borrowers of funds from the financial system with gross payables (current liabilities) of `7,170 billion and gross receivables (current assets) of `419 billion in March 2018. So, the current ratio (current assets/current liabilities), being a yardstick of liquidity, is as low as 0.058 (much below finance industry benchmark).

A breakup of gross payables indicates that NBFCs received 44% of funds from scheduled commercial banks followed by 33% from AMC-MFs, and 19% from insurance companies. Long-term debt funds followed by long-term loans and CPs were major sources of fund raising for NBFCs in 2017-18.

NBFCs are facing a maturity problem between their rate-sensitive assets and liabilities arising from assets (long-term loans) and liabilities (short-term borrowings) mismatch. This, coupled with liquidity, poses a threat to their solvency that can show a declining net worth.

RBI had conducted stress tests on the credit risk for NBFC sector and individual NBFCs for 2017-18 and found that under a pessimistic scenario (sudden increase in GNPAs at 99% level of confidence), NBFCs’ capital adequacy ratio/CRAR will decline to 20.4% which is still above the prescribed level of 15% for tier-I & II capital. For individual NBFCs, around 10% of companies would not be able to comply with the minimum regulatory norms under the said pessimistic scenario.

Can the crisis be averted? NBFCs have been plagued with liquidity and maturity problems, but they have reportedly a high capital adequacy ratio. So, based on the two indicators, one can only conjecture the likelihood of a crisis. For confirming this phenomenon, we have to look into the FSR (issue 18) likely to be released in a month’s time. Meanwhile, RBI and SEBI must take measures similar to PCA devised for banks in FY17.

NBFCs cannot depend on AMC-MFs or commercial banks for fund raising as the rollover risk has increased and asset-liability mismatch has widened. So, internal financing from reserves and surpluses can be a way out but for a few. Injection of fresh equities from the capital market may not be possible as the market sentiment has been muted post the debacle of a few large players in housing and real estate. Long-term bond market is not mature enough to meet the sector requirement. Bailing out a large number of NBFCs is not a solution due to moral hazard and principal-agent dichotomy. Should commercial banks come forward and take over ailing but systemically important NBFCs? We have no straight answer. Principle-based financial reporting for 2018-19 would give a clear picture where NBFCs stand. A few may survive and many could fall—asset-light NBFCs can withstand the test of time as compared to asset-heavy ones.

The author teaches finance at IIM Bodh Gaya. Views are personal

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