NBFC crisis: Why the sector needs a macroprudential framework

Published: December 3, 2018 2:45 AM

NBFCs need a macro-prudential framework that instils trust in the sector.

This, along with liquidity deficit in the system (due to increase in government cash balances, RBI’s forex interventions, festive season demand), is worsening the situation.

By Arun Singh

The recent imbroglio in the non-banking financial company (NBFC) sector, following the default of a systemically important NBFC over its short-term debt repayment, has raised concerns regarding the performance of the sector and the risk of contagion, if any. Despite NBFCs robust growth, there has been a deterioration in asset quality of NBFCs over the past few years. The gross non-performing assets (GNPAs) of NBFCs doubled from 2.9% in FY15 to 5.8% in FY18, even though they are at much lower level than GNPAs in the banking sector. The Return on Assets (RoA) of NBFCs shows a declining trend since 2013, with the capital to risk-weighted assets ratio (CRAR) also falling, although it remains higher than the prescribed regulatory level in FY18. Recently, the default in payment by the NBFC entity led to increased uncertainty about prevailing scenario and whether they are being adequately captured or monitored? This is because the NPAs in the banking system are increasing and relevant authorities are struggling to see through an early resolution.

There are three main inferences that must be highlighted. Firstly, the spread of crisis of confidence following the episode of default. Secondly, comprehending the extent of existing risks/structural defaults. Finally, the inadequacy of a strong comprehensive macro-prudential framework covering the entire NBFC segment.

To explain, the inability to repay by a large NBFC and the rating downgrade from AAA to junk has escalated concerns over the efficacy of credit rating agencies in their ability to identify underlying risks in the sector, leading to crisis of confidence. This led to a rise in risk-premium of short-term debt instruments in the market. Yields on AAA-rated corporate bonds and commercial papers saw a sharp increase. With the increase in interest rates, profit margins of this segment are under pressure. This is compounded by lower probability of availability of funds. In the future, greater scrutiny of even highly-rated firms will make it difficult to raise capital, which could add to liquidity woes. This, along with liquidity deficit in the system (due to increase in government cash balances, RBI’s forex interventions, festive season demand), is worsening the situation.

The NBFC sector remained highly leveraged in FY18, with borrowings rising by 19% and share capital growth decelerating. They were also the largest net borrower of funds from the financial system, with gross payables of nearly `7.2 trillion and gross receivables of almost `419 billion in March 2018. This mismatch has been increasing over the past few years, rising from `4 trillion in 2015 to `6.7 trillion in March 2018. For NBFCs, 78% were long-term payables, while short-term payables accounted for 22%. Of this 22%, almost 50% were commercial papers. The scenario was much worse for housing finance companies (HFCs), which had 26% of short-term payables and commercial papers accounted for almost 57% of short-term payables. A situation of either redemption or roll-over, in this case, can be a cause for concern. In case of redemption, NBFCs will have problems raising new capital, and in case of roll-over, there is a risk of increase in interest rate of commercial papers.

RBI and SEBI have taken a number of measures to alleviate liquidity concerns, mandating greater transparency and more comprehensive disclosures from rating agencies and making certain regulatory and statutory provisions for NBFCs applicable to government-owned NBFCs as well, besides others. However, a risk to contagion prevails. Currently, macro-level analysis of NBFCs captures aspects such as growth, trends in the sector, and their drivers and other major financial indicators. Systemic risks cannot be accurately identified in the current stress test conducted by RBI as it does not include certain segments such as HFCs. A common comprehensive database for sharing of information and joint analysis by relevant authorities can help map the risk of contagion and common emerging risks.

The issues in the NBFC sector have come to the fore at an opportune moment. While regulators are more cautious about the banking sector, closer scrutiny of the NBFC sector could lead to development of a macro-prudential framework for NBFCs. It is pertinent to have a framework that safeguards investors’ money and instils trust in the sector.

The author is Lead Economist, Dun & Bradstreet India.

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