NBFCs or Non-Banking Financial Companies, play a very pivotal role in the Indian financial system, as they cater to the diverse financial needs of millions of individuals as well as small firms.
The health crisis caused by the Covid-19 pandemic has brought the economy of the country to its knees as lockdown has brought all economic activities to a standstill. This has resulted in a fatal blow to most of the sectors but sounds like a death knell for the NBFCs as they were already facing a severe liquidity crunch after the Infrastructure Leasing & Financial Services Limited (IL&FS) crisis in 2019.
What are NBFCs?
In simple terms they are exactly what their name suggests: financial services that function somewhat similar to the banks but are not banks. In the past decade or so the NBFCs have gained huge popularity in India due to its capability of catering to certain sections of the society- primarily the economically weaker sections, the people who found the banks unaffordable and inaccessible.
Then there are the Micro, Small & Medium Enterprises (MSMEs) that rely mostly, if not solely, on NBFCs to meet their credit requirements. The NBFCs are the primary financiers to the MSMEs, on whose growth greatly depends on the progress of the Indian economy.
Definition of NBFC
A NBFC is a company that is registered under the Companies Act, 1956 or 2013 and provides a wide range of financial services like giving loans and advances, insurance, etc. These are governed and regulated by the Reserve Bank of India (RBI) within the framework of the RBI Act, 1934.
Categories of NBFC
In terms of the type of liabilities the NBFCs are categorized as:
(i) NBFCs accepting public deposit (NBFCs-D) and
(ii) NBFCs not accepting/holding public deposit (NBFCs-ND)
Thus, all Non-Banking Financial Companies are divided as either deposit taking or Non-deposit taking.
The non-deposit taking NBFCs have ‘ND’ suffixed to their name (NBFC-ND) and on the other hand, the Systemically Important Non-deposit taking NBFCs have NDSI suffixed to their name and are denoted as NBFC-NDSI. Systemically Important NBFCs are those NBFCs which have an asset size of Rs.100 Crores or more.
Additionally, NBFCs are required to be registered with the RBI and must have taken specific authorization to accept deposits from the public.
Different Types of NBFCs
1) Asset Finance Company (AFC)
2) Investment Company (IC)
3) Loan Companies (LC)
4) Infrastructure Finance Company (IFC)
5) Systemically Important Core Investment Company (CIC-ND-SI)
6) Infrastructure Debt Fund (IDF-NBFC)
7) Non-Banking Financial Company – Micro Finance Institution (NBFC-MFI)
8) Non-Banking Financial Company – Factors (NBFC-Factors)
Importance of NBFCs in Indian Economy
As NBFCs cater to more diverse businesses and have penetrated the rural and remote areas of the country, they reach more companies and individuals than banks. Being less bound by regulations than the banks, NBFCs have taken lead in non traditional venues too. In the last decade or so the growth of NBFCs has contributed hugely in adding to India’s economic growth. Here are a few ways in which NBFCs has backed the country’s economic development:
- It has helped in converting savings into investments, thus leading to mobilization of resources.
- It aids to increase capital stock of a company resulting in capital formation.
- It provides specialized and long-term credit.
- NBFCs help in employment generation in a very big way.
- It helps in fulfilling the dreams of socially deprived people and small business entities.
- It attracts foreign direct investment.
Present Day Challenges For NBFC Sector
1.) IL&FS and NBFCs
2019 has not been a very good year for the NBFC sector as in late 2018 one of India’s leading infrastructure finance companies- Infrastructure Leasing & Finance Services (IL&FS), which was a core investment company, defaulted on payments to lenders in a big way.
The collapse of a big company like IL&FS, which was once rated AAA and was in the business for more than three decades, triggered a great panic in the market that especially led to a crisis in the NBFC sector.
This brought to light the shortfall of the Indian shadow banking industry’s dependency on short-term funding sources and when the “bubble” burst over in 2018, the entire NBFC sector was in a limbo.
As the IL&FS crisis erupted, it negatively impacted the sentiments of the banks and they became averse to lending to the NBFC sector, putting them in a tight spot. The biggest concern of the sector was that they (NBFCs) may run out of money, due to lack of liquidity and this eventually would lead to defaults.
Amidst the looming fear of imminent default, the credit rating agencies downgraded most of the NBFCs and this aggravated the woes of Non-Banking Financial Companies as raising money became an uphill task for them.
2.) NBFC Liquidity Crunch & The Government
An economic slowdown was already creating hardships for the NBFCs and it was further aggravated by the IL&FS default. The market lost confidence in the NBFC sector and thus, they faced acute liquidity squeeze manifested.
However, the government and the banking regulator were not unaware of the alarming situation and they keenly watched the situation.
Talking about this, Injeti Srinivas, the Corporate Affairs Secretary said in an interview in May 2019, “There is an imminent crisis in the non-banking financial companies (NBFC) sector. There is a credit squeeze, over-leveraging, excessive concentration, and massive mismatch between assets and liabilities, coupled with some misadventures by some very large entities, which is a perfect recipe for disaster.”
The IL&FS default was just the trigger after which the cracks in the system started showing up. The real issue is the system that the NBFCs follow is flawed as they take short-term loans of between 3-6 months duration, using commercial papers (CPs), but on the other hand, they lend to businesses like home loans, commercial purpose loans, and vehicle loans etc. as long-term loans. This brings about asset-liability mismatch which becomes a major problem in times of economic uncertainties.
Thus, when the economy is on the track this system does not create any glitch to the cycle of payment & repayment, but with any upheaval in the economy, Non-Banking Financial Companies find their sustenance at stake.
This is what happened after the IL&FS crisis came into the open, and as a result, neither the banks nor mutual fund companies or other investors have been keen to bet their money on NBFCs.
The Narendra Modi-led government took cognizance of the liquidity crisis of NBFC sector that may eventually lead to hampering the economy of the country in a major way and thus, asked RBI to figure out a way to ease the liquidity situation.
RBI in response took steps to embattle the situation effectively by:
- pumping funds to improve the funding situation; these funds can be taken up by the banks to be lent to NBFCs.
- announcing new guidelines on Liquidity Risk Management (LCR) in 2019.
3.) Decoding LCR- Liquidity Coverage Ratio by RBI
RBI has introduced Liquidity Coverage Requirements (LCR) for the NBFCs vide its notification dated November 04, 2019.
The RBI has divided the NBFCs into 2 categories, for the applicability of LCR:
Category 1: (Deposit taking NBFCs)
Deposit taking NBFCs are those NBFCs which may accept deposits from the public. However, they are not empowered to repay these deposits on demand.
Category 2:(Non-Deposit taking NBFCs)
Non-Deposit taking NBFCs are those which cannot accept deposits from the public at large.
These Non-Deposit taking NBFCs are further divided into 2 categories as:
- Category 2.1: These are those NBFCs whose asset size is more than 5,000 crores but less than 10,000 crores.
- Category 2.2: These refer to those NBFCs whose asset size is more than 10,000 crores.
Now NBFCs are mandated by the RBI to maintain Liquidity Coverage Requirements and High Quality Liquid Asset (HQLA). This has been done by the RBI with the intention that:
- It will promote resilience in NBFCs.
- It will come handy at times of potential liquidity disruptions.
- It will help them to survive lasting for 30 days in any acute liquidity stress scenario.
The LCR RBI requirement of 100% High Quality Liquid Asset stock is to roll out in phases; the minimum HQLAs to be held being 50 per cent of the LCR, will be binding on NBFC registration from December 1, 2020. Liquidity Coverage Ratio will gradually have to be increased and reach up to the required level of 100 per cent by December 1, 2024.
The RBI requirement of 100% High Quality Liquid Asset stock is to roll out in phases; the minimum HQLAs to be held being 50 per cent of the LCR, will be binding on NBFCs from December 1, 2020. Liquidity Coverage Ratio will gradually have to be increased and reach up to the required level of 100 per cent by December 1, 2024.
4.) COVID-19 and NBFC Sector
By the end of 2019, the NBFC Sector was able to shrug the negative effects of the IL&FS crisis and was on the path to recovery, and 2020 was predicted to be a better year by all means. But this was not to happen as pandemic COVID-19 struck India in March, 2020 and this unique and unforeseen health crisis triggered an economic slowdown like never seen before.
Declared as an emergency, entire India was put under complete lockdown bringing the country to its knees and this has put the entire economy under distress but for the already beleaguered NBFC sector this was a fatal blow.
With the economic operations and consumption activities coming to a standstill for more than 60 days, the impact of this crisis across various classes of non-banking financial companies can be assessed by the exposure it has towards the various borrower segments. Sectors such as real estate and micro-finance, whose economic activities have been severely impacted, the NBFCs with loan exposures in the said sectors are the ones to be the worst hit in the wake of this global pandemic.
Another problem that aggravated the liquidity crisis in this sector was the announcement of the COVID-19 regulatory relief package by the Reserve Bank of India (RBI) on March 27, 2020.
The RBI Relief Package asked the lending institutions to grant a moratorium of three months on payment of all installments falling due between March 1, 2020 and May 31, 2020. This was further extended by another three months i.e., till August 31, 2020.
This posed a major problem primarily for the NBFCs as they utilize the cash inflows from the payments made by their borrowers to repay the liability owed towards their lenders.
The sector operates on very thin short-term liquidity and therefore, granting a moratorium to its borrowers on payment of loan installments came up as a serious trouble for the NBFCs. All these factors put together have once again led to a stark asset-liability mismatch in NBFCs.
So on the one hand the NBFCs are directed to offer the moratorium to its debtors, on the other they are not getting the same benefit from its lenders. Additionally, the NBFCs with high share of capital market borrowings are expected to make repayments on time as no moratorium has been announced for capital market borrowings (such as bonds and commercial paper).
Government’s COVID-19 Rescue Package
The countrywide lockdown imposed to check the spread of COVID-19 has continued for more than 60 days and has caused an economic turmoil so huge that it is said to be the worst since the 1930s.
The pandemic has had the same impact globally and to combat the economic losses the nations around the world have announced in what is come to be known as ‘Coronavirus Stimulus Packages’.
Prime Minister Narendra Modi leading from the front, on May 12, 2020 in a live telecast addressed to the nation pledged India’s economic rescue package of a total spending of Rs 20 lakh crore. This stimulus package to weather the fallout of the coronavirus pandemic is one of the largest that has been announced by other nations around the world.
Modi termed this package that is about 10 percent of India’s GDP in 2019-20 as ‘Atma-nirbhar Bharat Abhiyan’ or Self-reliant India Mission. The Finance Minister, Nirmala Sitharaman while announcing the details of the mammoth relief package reiterated the same sentiments and said that this economic package would spur growth and help to build a self-reliant India.
Explaining the details of the Rs 20 lakh crore economic package, Union Finance Minister Nirmala Sitharaman on May 14 announced a huge benefit for non-banking financial companies (NBFC), housing finance companies (HFC) and microfinance institutions (MFI).
Divided into 2 distinct schemes, the stimulus package for NBFCs is a whooping Rs 75,000 crores.
#1. Rs 30,000 Crore Special Liquidity Scheme for NBFCs/HFCs/MFIs
The FM said that the government was acutely conscious that NBFCs/HFCs/MFIs were finding it very difficult to raise money in debt markets and to deal with this problem the government has launched Rs 30,000 crore Special Liquidity Scheme.
- This scheme allows investment to be made in both primary and secondary market transactions in investment grade debt paper of NBFCs/HFCs/MFIs
- Additionally, this scheme will supplement RBI/Government measures to help ease liquidity
- The scheme also lays down that the securities will be fully guaranteed by the Government of India
The FM expressed optimism and said that this step would provide the much needed liquidity support for NBFCs/HFC/MFIs and mutual funds and help to create confidence in the market.
#2. Rs 45,000 Crore Partial Credit Guarantee Scheme 2.0 for NBFCs
Union Finance Minister Nirmala Sitharaman stated that NBFCs, HFCs and MFIs which have low credit rating require liquidity to do fresh lending to MSMEs and individuals.
- Existing PCGS scheme to be extended to cover borrowings such as primary issuance of Bonds/ CPs (liability side of balance sheets) of such entities
- First 20% of loss will be borne by the Guarantor that is, the Government of India.
- AA paper and below including unrated paper eligible for investment (esp. relevant for many MFIs)
Thus, this scheme will result in infusing liquidity of Rs 45,000 crores and certainly help those NBFCs which are lower in the ladder of credit rating.
What Impact is Expected?
The Finance Minister’s announcement of this ₹75,000-crore package has come as a silver lining for the NBFC sector and will certainly help them to tide over the liquidity crunch being faced by the majority of them.
This move may see borrowing costs fall and liquidity increase even for those entities that are at the lower end of the rating curve.
The FM’s proposal of twin funds- a special fund of ₹30,000 crore + partial credit guarantee scheme worth ₹45,000 crore has helped to ease fears that some of these lenders would have to shut shop due to tight liquidity. The two schemes shall not only help these firms raise money, but also go beyond and lend to SMEs.
Giving a very positive response on this mve, Rashesh Shah, chairman of Edelweiss Group said, “Both the moves should help allay apprehensions, as they offer more flexibility to raise money. NBFCs can sell both portfolios and bonds under the latest version of the partial credit guarantee scheme, which also cuts down the lengthy approval process.”
Though the schemes have been lauded as a right step by the government yet there are few apprehensions and concerns on whether smaller firms will be able to benefit from the twin moves.
P Satish, executive director at Sa-Dhan, an industry association of MFIs, expressed his fears thus, “We welcome the announcement of Rs 30,000-crore liquidity support. The credit guarantee scheme will also give fillip to MFIs. But in both the schemes, we hope that smaller MFIs, which are below investment grade, will not be overlooked”.
In continuing with its intent to grant relief to NBFCs the government of India, the RBI has recently come out with the eligibility criteria for the special liquidity scheme and it includes registered NBFCs, micro-finance institutions (MFIs) and HFCs under respective laws.
RBI states that the CRAR/CAR of NBFCs should not be below the regulatory minimum of 15 per cent as on March 31, 2019, and moreover, the net non-performing assets of these NBFCs should not exceed 6 per cent.
Another mandated criteria is that these NBFCs must have made net profit in at least one of the last two preceding financial years, that is, 2017-18 and 2018-19. Along with this they must not have been reported under SMA-1 or SMA-2 category by any bank for their borrowings during the last one year prior to August 01, 2018.
The RBI has shared information that to manage this operation the State Bank of India subsidiary ‘SBICAP’ has set up a special purpose vehicle (SPV) -SLS Trust which will purchase the short-term papers from eligible NBFCs/HFCs. It is specified that these entities shall utilize the proceeds from this scheme solely for the purpose of extinguishing existing liabilities.
However, this facility shall cease to exist and will not be available for any paper issued after September 30, 2020 and the SPV would not make any fresh purchases after this date and would recover all dues by December 31, 2020.
Recognizing this as an advantageous situation for the NBFCs, Sharad Mittal, CEO, Motilal Oswal Real Estate Fund says, “NBFCs have CP repayments of close to Rs. 65,000 crore between July and September of this year. These NBFCs could benefit considerably from this special liquidity window”.
Although these pro measures have somewhat eased the situation for the NBFC sector at large yet, there are few more demands by the sector to be able to override during this unprecedented time.
The Finance Industry Development Council (FIDC) which is a representative body of assets and loan financing NBFCs, has recently shot a letter to RBI Governor Shaktikanta Das in which it states, “We urge upon RBI to consider, as a one-time measure, to allow NBFCs to draw-down from their Reserves and adjust towards additional Expected Credit Losses (ECL) provision requirement, in excess of provision calculated as per normal Probability of Default (PD) and Loss Given Default (LGD)”.