With India’s banking sector suffering from a lack of capital and mired in NPA issues, the NBFC sector was holding fort and growing strongly in the last 2-3 years. Credit from the NBFC sector grew by 21% year-on-year (y-o-y) in FY18 when bank credit growth was hovering at around 10%. However, the recent liquidity crisis has brought to fore some of the inherent weaknesses in the NBFC sector.
Woes in the NBFC sector started by the loan default of IL&FS in September of last year. The resulting crisis of confidence in the sector resulted in a liquidity crunch and sharp rise in the cost of funds for NBFCs. RBI came up with some liquidity easing measures. The NBFCs, on their part, resorted to increased securitisation of their loan accounts. They also had to curtail their fresh disbursements. Mutual funds, as lenders of funds to NBFCs, shifted to entities with good parentage (within the NBFC basket). So, it seems a massive failure of the system has been avoided for the time being.
NBFCs have exposure to wholesale and retail assets. Retail exposure includes vehicle financing, microfinance, and housing loans, while wholesale assets include infrastructure, developer loans, etc. Long-term assets like infrastructure and real estate developer loans form around 34% of total assets of the NBFC sector. With an aggressive growth in loan books, NBFCs had been relying increasingly on short-term funding routes to meet their long-term lending requirements. Share of CPs in total borrowings of the NBFCs increased from 5.4% in 2012 to 9.7% in 2018. NBFCs have been resorting to the rolling over of short-term debt to meet their long-term lending commitments. For NBFCs, the share of market borrowings (mainly CPs and debentures) is 52% while the share of bank borrowings is 26%. Hence, any crisis of confidence would lead to difficulties for NBFCs in raising funds from the market. Not surprisingly, in the fallout post IL&FS, NBFCs’ disbursements have fallen by 20-90% and the cost of funds has spiked by as much as 100 bps for some of them.
NBFCs have become a very important part of India’s financial system and we cannot afford to let the sector slip. Share of NBFCs in outstanding credit has increased to 17% in March 2018 from 9% in March 2009. In the last few years, the sector has been instrumental in meeting the credit requirements of the economy at a time when bank credit growth has been weak with a number of public sector banks under PCA (Prompt Corrective Action). The NBFC sector has helped in financial inclusion by reaching out to areas that are unbanked (smaller towns/rural areas) and also taking care of the category of borrowers who are not being fully serviced by the banking sector. NBFCs have a large share of around 53% for micro-finance and as high as 50% in auto-finance’s total credit requirements. The sector meets 40% of infrastructure and housing finance credit requirements.
Apart from growing size and reach, maintaining a good health of the NBFC sector is also critical due to its strong interlinks with banks and financial markets as a whole. NBFCs have a share of 6% in bank’s total lending. Bank credit to the sector was growing by a strong 40% till last year, as banks struggled to find better avenues for credit disbursement. Mutual funds have a higher exposure, with 35-40% of their debt investments in NBFC/HFC. Insurance companies also have at least some exposure to NBFCs (though at a lower level). This implies that any failure of the NBFC sector would have huge repercussions for the entire financial sector.
The quality of NBFC assets has deteriorated in the last few years, with the GNPA ratio increasing from 2.6% in 2014 to 5.8% in 2018 (though this is still less than the banking sector GNPA of 10.8%).With the importance of the NBFC sector in the economy growing and strong interlinkages within the financial system, there is definitely a need to get more stringent on regulations for the NBFC sector. RBI is relooking into the asset-liability management (ALM) regulations for the NBFC sector. The core vulnerability of NBFCs is borrowing short-term and lending long-term and this can only be tackled by strengthening the long-term bond market. Globally, long-term capital is raised via bond markets with pension funds and insurance companies as major investors. In India, there are stringent regulations guiding the investments by pension funds and insurance companies. Even within the stipulated limit, insurance companies or pension funds avoid taking credit risk. Intermediaries in the financial system and complex structures further complicate the issue. This also brings to fore the role of credit rating agencies in India, especially in light of the recent sharp downgrade of IL&FS debt instruments (from AAA rating) after the loan default.
A crisis in the NBFC sector may have been averted for the time being. But the episodes of the last few months in the form of a liquidity crunch, sharp fall in NBFC stock prices, and a sharp drop in disbursements by NBFCs have highlighted the vulnerability of the sector. There is a need for closer monitoring/regulations to prevent further deterioration in the asset quality of NBFCs. There is also a need to develop long-term funding avenues for the NBFC sector to take care of their asset-liability management.
