What RBI can do to back-pedal NBFC crisis
What exactly is troubling NBFCs (Non-Banking Financial Companies) at present? Is it the liquidity crisis or is it something else? Recently, several reports suggest that it is not the lack of liquidity which is troubling the NBFCs, but loss in faith of the money market in NBFCs’ balance sheets and the ratings of the credit rating agencies. What should RBI do now? Instead of cutting down repo rate/SLR/CRR, the RBI (Reserve Bank of India) should focus more on evaluating the balance sheets of NBFCs and should make the results public.
NBFCs hold an important position in the housing sector, SMEs and auto industry in India. As of December 31, 2018 NBFCs account for 21% of the total credit to SMEs and 54% of loans to real estate sector. It is well known that NBFCs lent loan where the private sector banks prefer not to lend. It could be because of the higher risks or may be because of the lower returns. Unfortunately, after the IL&FS crisis, NBFCs have found it difficult to access funding. The reason is simple, NBFCs work on the borrowings from the banks and other money markets.
More than half of the funding of NBFCs were from Mutual Funds in form of commercial papers (CPs) or certificate of deposits (CDs). The share of CPs just got doubled in between 2014 and 2018. The period saw a great increase in the margins of NBFCs because of relatively lower costs and a sharp rise in the share of CP borrowings. Having said that, it made the asset-liability mismatch more vulnerable, often the NBFCs have short-dated borrowings and long-dated assets. When the NBFCs are not able to tackle the CPs financing, solvency issue increases and the growth is negatively impacted.
Furthermore, the rating agencies have severely degraded the debt documents of several lenders. This withheld their capacity of raising capital from MFs and banks. The precondition with MFs while lending capital to firms is that they cannot fund those rated below B. The shortage of funding has a macro impact on the slowing down of the overall Indian economy from past six months. The direct repercussions can be observed in record falling auto sales and down going real estate.
RBI’s compulsory AQR (Asset Quality Review) for all the banks, under which the balance sheets are scrutinised to check whether the banks are underestimating their NPA (Non-Performing Assets) or not. After a long six months of mind bogging exercise of the officials, it was found that many banks were understating their NPAs. After the information was made public, a number of CEOs resigned from their posts. Most of those banks have raised fresh equity capital and with this, the faith in the bank’s balance sheet has been restoring, resulting in recovery of the financial market gradually.
Although, NBFCs are not in a position for compulsory AQRs, an option should be left for voluntary AQR. After the RBI cleans the balance sheet of NBFCs opted for voluntary AQR, they are given a lower regulatory requirement (RCR). The RCRs can also be reduced for the NBFCs when they lend on negatively impacted sectors such as real estate, auto industry, etc. RBI can choose top 100 NBFCs and exercise AQR on them, which would pull the economy right on track. It will enhance the quality of how NBFCs perform and also improve CD and CP market. This will cheer up MFs and big corporates to buy CPs and CDs issued by AQR done NBFCs.
This will resume the lending activity of the NBFC and hence, could be a potential solution for improving the NBFCs crisis. Solving the NBFC problem will definitely impact the Indian economy positively.