The Union Budget 2019 announced that only solvent NBFCs can sell their high-rated (AA) pooled assets (of Rs 1 lakh crore) to public sector banks and the government can extend a partial credit guarantee cover to PSBs in the case of first-loss up to 10%.
By Kushankur Dey
NBFC crisis is looming large following the failure of a few systemically important financial institutions in infrastructure, financial leasing, and housing. NBFCs leverage on low transaction costs, financial innovation, and regulatory arbitrage (RBI, 2014). Thus, the on-going crisis has received a considerable attention of the regulator and the government.
The Union Budget 2019 announced that only solvent NBFCs can sell their high-rated (AA) pooled assets (of Rs 1 lakh crore) to public sector banks and the government can extend a partial credit guarantee cover to PSBs in the case of first-loss up to 10%. While this measure was sought to facilitate fund-raising opportunity for cash strapped NBFCs in the short-run, liquidity problems remain unaddressed.
Prudential framework of stressed asset management and asset liability management have already caught RBI’s attention. These are applicable for systemically important NBFCs, NBFCs–ND with asset size of Rs 100 crore and above, NBFCs–D (irrespective of asset size) and Core Investment Companies.
Besides this following measures can be considered.
Basel accord: RBI should implement the Basel-IV accord for NBFCs/FIs. The regulatory architecture needs to incorporate market-based indicators attributed to the three important pillars of Basel accord, namely capital requirement, market discipline, and supervisory review.
Consideration of CAMELS approach for systemically important NBFCs can help with Basel-IV implementation.
Further, capital requirement can be reduced—9-12% (6-8% of Tier I plus 3-4% of Tier II capital) from 15% current level—from source of funding point of view. The amount of discretionary financing needed will also be reduced as NBFCs can use their surplus or retained earnings for internal financing putting an end to current fund-raising problems both from money and capital markets.
Investment maturity: NBFCs need to shift their interest sensitive assets or change the blending of investment maturities as interest-rate expectations change (riding the yield curve). For example, investment portfolio can shift toward long-term maturities when interest rate is expected to fall (as can be seen from a downward sloping yield curve). They can bucket interest sensitive assets to short-term maturities if interest rates are expected to rise (from an upward sloping yield curve).
NBFCs can improve their liquidity position and avoid a large capital loss in case of upward movement of interest-rates, by adopting a front-end load maturity policy. They can maximise their earnings through a back-end load maturity in case interest rates fall. Both strategies can improve earnings potential.
Interest rate risk management: NBFCs have more long-duration assets than liabilities. Hence, they need to finance their fixed-rate assets with floating-rate liabilities. However, as NBFC’s credit-rating has already plunged, they are likely to pay a fixed-rate interest on deposits and receive a floating-rate interest on loans and advances. Thus, using interest-rate collars (combination of cap-rate and floor-rate) similar to long-call and long-put options can help NBFCs.
More importantly, as a one-size-fits-all is not applicable, RBI should appoint a dedicated advisory committee. Periodic review of their operations, financial disclosure can help take ex-ante corrective measures. The committee can refer to terms of reference and conduct a bi-monthly meeting to discuss the state of NBFCs in financial landscape—lending and borrowing quantum, external benchmarking, product-market mix and asset securitisation.
While the virtue of regulatory arbitrage has pushed several NBFCs to face headwinds of shadow banking, lack of due diligence and poor asset transformation strategies has moved net-NPAs to 6.6% in FY19 from 5.0% in FY18. Therefore, any short-term stimulus will not heal the wounds of the sector. Instead, RBI should have more bandwidth and autonomy to regulate the number of debilitating NBFCs. This is a strip-down version of an article communicated to Mumbai World Trade Centre for a panel discussion: ‘Strengthening the NBFC sector’ held in August 2019.
The author is Faculty, IIM Lucknow.
Views are personal