Multiple loan defaults by IL&FS and the subsequent panic around commercial papers (CPs) has put the spotlight on non-banking financial companies (NBFCs), India's shadow banking space. To gain market share, NBFCs increasingly issued CPs - a short-term debt instrument - to finance long-term projects at a time when credit growth in banks slowed. The overall value of outstanding CPs (the interest-bearing balance of a loan) was Rs 6.4 lakh crore as of July-end; 96 per cent growth since July last year. Mutual funds and banks bought such CPs owing to NBFCs having shown better loan growth and stronger net interest margins than banks. But the golden phase did not last long.
IL&FS defaulting on debt payments and fund house DSP selling DHFL paper at a steep discount had a domino effect across NBFC yields, whose stock prices also crashed. While some say that the liquidity crisis has been blown out of proportion, the government and the Reserve Bank of India (RBI) have gone into damage control mode.
A consequence of these events is that NBFCs are likely to now face higher cost of borrowing, which means growth predictions will have to be recalibrated and net interest margins (NIMs) would shrink.
NBFCs have grown at a fast clip in recent times even though the banking sector has contracted. The combined loan book of NBFCs and housing finance companies (HFCs) grew from Rs 11 lakh crore in FY13 to Rs 24 lakh crore in FY18 - a 17 per cent compound annual growth rate (CAGR). Their share in overall system credit rose from 17 per cent in FY13 to 21 per cent in FY18. Bank loans to NBFCs also grew substantially (nearly 50 per cent) in the last three years. According to RBI's June financial stability report, there were 11,402 NBFCs registered with it as of March 2018, 156 of which were deposit-taking firms and 249 were 'systemically important' non-deposit accepting firms. Their combined balance sheet size stood at Rs 22.1 lakh crore.
Given this size, it is understandable that there are concerns regarding NBFCs' asset liability mismatch (ALM), which is the difference between inflows or asset maturities and outflows or liability maturities. NBFCs relying excessively on short-term paper to fund long-term projects is a worry.
ALM profiles of NBFCs suggest that HFCs (barring HDFC) are adversely placed on maturity profile, i.e., liabilities are maturing faster than assets. According to brokerage Emkay Global, 12 per cent of DHFL's liabilities (17 per cent of overall market borrowings) will mature in three months against 9 per cent of total assets (3 per cent advances). Asset Finance Companies are relatively better-placed with the exception of Cholamandalam Finance, where 15 per cent liabilities (14 per cent of market borrowings) are maturing in three months versus 7 per cent of total assets (7 per cent advances).
"Shriram Transport also has adverse ALM mismatch.... Bajaj Finance is best placed with 12 per cent liabilities (13 per cent of market borrowings) maturing in three months against 18 per cent of total assets (18 per cent advances). Mahindra & Mahindra Financial Services and HDFC also have favourable ALM maturities," Emkay Global's report states.
AAA-rated NBFC CPs with strong parentage are better placed. They continue to borrow from banks at marginal cost of funds-based lending rate (MCLR) or marginal premium to it (25 basis points),i.e. sub-9 per cent. AA-rated NBFC CPs borrow at higher rates (9-9.5 per cent) and longer tenure of resets (monthly or quarterly instead of annual).
G. Chokkalingam, founder at Equinomics Research, believes there is no risk to financial stability because NPAs of most NBFCs are within manageable levels - non-performing loans for NBFCs are 5 per cent, compared to 10 per cent for state-owned banks. But, higher borrowing cost will affect growth. "The borrowing cost would go up by at least 50-75 basis points for NBFCs, but since most of them do not have an NPA crisis, they will slowly adjust to ALM balancing. In the process, however, their margins may fall," says Chokkalingam.
Will Buyers Say No?
Apart from facing higher cost of funds, NBFCs may also face hurdles when it comes to those that buy their CPs, especially mutual funds. In the past two years-plus, the share of NBFCs in the overall debt investments of fund houses has almost doubled - from Rs 1.2 lakh crore in March 2016 (15 per cent of mutual funds' total debt investments) to Rs 2.3 lakh crore in July 2018 (17 per cent).
"While debt instruments are 60 per cent of assets under managemnent or AUM, investments in CPs within debt funds have doubled (16 per cent in FY15 to 33 per cent currently). Rollover risks, therefore are high, as a third of corporate money in debt instruments has a maturity profile of less than a month," Jefferies' September 2018 report states.
Faced with a risk of contagion, mutual funds may shun NBFC CPs as redemption pressure could worsen their liquidity. But, experts feel the RBI could step in to provide direct liquidity to fund houses against their G-Sec and certificates of deposit.
Banks, too, may not be able to incrementally lend to NBFCs as many banks are approaching their exposure limit to the sector. In addition, 11 public sector banks are under the RBI's Prompt Corrective Action (PCA) framework, and technically can't lend. This is a major concern as NBFCs look to bank borrowings when interest rates go up.
"If banks and mutual funds stay away from lending or investing in NBFCs, the latter could face further issues. A lot would depend on the inflows into debt funds, deposit growth and other lending opportunities for banks. We believe NBFCs may not be totally shunned by these entities, but they will become more selective," says Deepak Jasani, head - retail research, HDFC Securities.
To alleviate the overall liquidity concerns, the RBI recently announced open market operation of Rs 36,000 crore for October. The government has also reduced its H2FY19 borrowing target by Rs 70,000 crore, and the SBI has announced that it would treble the amount of loans it buys from NBFCs to about Rs 45,000 crore in FY19.
Nipping at the Bud
The root cause of the problem is lack of avenues to fund long-term projects. Long gestation assets should not be financed either by banks or NBFCs because they don't have long-term funds, says R.V. Verma, former CMD of National Housing Board. "The government must create a behemoth of existing infra financing institutions and look for a way to deploy pension and provident funds. Alternatively, banks and NBFCs can co-finance long-term projects."
He further says, "The RBI, Sebi and other oversight authorities must build a coordinated approach at the regulatory and supervisory level." Verma suggested an internal rating mechanism that supplements ratings of external agencies. "AAA-rated companies can easily build excessive leverage. The RBI must constantly keep a watch to see if credit ratings have influenced financials of NBFCs, especially on the liability side," he says.
Rajosik Banerjee, Partner - Financial Risk Management, KPMG, mirrors the thought saying some NBFCs neglect due diligence when seeking more business. "There must be an increased oversight by NBFCs on the pre-sanction and post-sanction processes for lending."
The NBFC crisis is a reminder that the underbelly of India's shadow banking must be supervised strictly, lest they pose a threat to the overall financial stability of the system.
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