For more than a year, an overwhelming drive seems to be underway to label non-banking financial companies (NBFCs) as anathema to the economy. It’s easy to paint all NBFCs with the same brush, but it can be quite flippant to ignore the contributions they have made in addressing economic demand that has helped in financial inclusion.
‘Shadow banking’, a term borrowed from the West, suggests being outside the scope of the financial regulatory system. This is completely untrue for India. It is incorrect to believe that NBFCs and housing finance companies (HFCs) are significantly riskier than banks. Many banks don’t have the wherewithal to cater to the segment that NBFCs are able to reach out to.
Many NBFCs specialise in lending in a particular sector, and develop skill sets unique to that customer base. Many unbanked borrowers avail credit from NBFCs and later use their track record to become bankable borrowers.
The Infrastructure Leasing & Financial Services (IL&FS) default in September 2018 was not a systemic issue. The pain seen in the broader NBFC sector was largely one of liquidity, and not a solvency crisis. Nonetheless, the IL&FS default created a ‘risk aversion’ in the system. It signalled the end of easy money — that is, using cheaper, shortterm market instruments to fund longer-term assets.
Admittedly, perception and liquidity issues have affected NBFCs that, to some extent, have caused the fall in credit to the auto, real estate, agriculture and small and medium enterprises sectors. Many well-managed NBFCs continue to do well, but others are struggling.
RBI has strengthened the regulatory framework of NBFCs by introducing a robust liquidity framework, and proposed a liquidity coverage ratio for large NBFCs, which is currently applicable only to banks. RBI could also consider:
1. Initiate conversations with senior bankers and provide assurances, so that banks can start feeling more confident of funding NBFCs.
2. Examine a roadmap for the merger of NBFCs into banks, with appropriate guidelines to grandfather the existing NBFC balance sheet from maintenance of the cash reserve ratio, statutory liquidity ratio and priority sector lending requirements of a bank.
3. Increase the threshold entry level of NBFCs and HFCs by raising the minimum capital requirements. Regulating over 10,000 NBFCs is clearly a very difficult task.
NBFCs will have to focus on liability management. Most large NBFCs are well capitalised, but have got exposed due to excessive short-term borrowing.
The stronger NBFCs and HFCs have a more diversified funding base. Very few non-bank financial entities have the benefit of retail deposits, a source of stable funding, especially in these times. NBFCs are considering other instruments to raise money, such as masala bonds or external commercial borrowings. In fact, larger NBFCs offering good collaterals are accessing funds from global investors.
An alternate source of long-term funding beneficial for the lender is the securitisation of mortgage loans. Securitisation provides much-needed liquidity to the balance sheet of an HFC, as it helps the company to churn its portfolio and make room for fresh assets. According to the International Monetary Fund (IMF), securitisation helps free up capital that allows banks to extend new credit to the economy.
Another potential fund source is covered bonds. These are the largest asset class in the European bond market.
Covered bonds are held on the balance sheet of the issuer — not in the special purpose vehicle (SPV) — and in an event of the bankruptcy of the issuer, the covered pool is protected and can be claimed by the investor. They also receive a higher credit rating, as they are backed by high-rated pool of assets.
From a housing finance perspective, there is a need to ensure that appropriate measures are taken to further develop the corporate bond market. In the current scenario, banks and mutual funds have shown little interest to invest in long-term bonds. Debt financing will be an important source of stable longterm funding.
Currently, negative sentiments have percolated to all sectors including housing, particularly high-end housing. Like all asset classes, housing markets go through cycles. Yet, the current issues in the housing sector seem more symptomatic of a cyclical downturn, rather than a deep-rooted structural slowdown. In this context, finance minister Nirmala Sitharaman needs to be congratulated for introducing a Rs 25,000 crore special window to revive stuck projects, subject to certain conditions.
There is no substitute for prudent lending. By sacrificing margins or appraisal norms, you can capture all the growth you want. But this kind of growth will not lend to sustained longterm success. By covering a wide spectrum of customised services and innovative products, NBFCs have played an active role in strengthening the economy, and will continue to do so.
The writer is vice-chairman-CEO, HDFC