RBI operating norms for NBFCs were long overdue PDF Print E-mail
Wednesday, 29 May 2019 04:48
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Shobhana edit


RBI's decision to make operating norms for non-banking financial companies (NBFCs) a lot more stringent have come ten years too late but will, hopefully, be in place soon. The central bank’s key proposals which include enforcing liquidity coverage ratios and improving the ALM (asset–liability mismatch) framework, are in the right direction. As is now well-known, many NBFCs, and probably a couple of housing finance companies(HFCs) have been borrowing short-term money—from mutual funds, for instance—and giving borrowers long-tenure loans. This worked well as long as there was plenty of liquidity and lenders were not too risk-averse. After the IL&FS crisis that hit the markets in late August, and the DHFL crisis that followed, every lender has become picky. One reason for this is that both NBFCs and HFCs have increased their exposure to wholesale real estate loans or loans to developers; by one estimate, this has gone up to 55% in Q3FY19, from 29% in FY15.Many property developers are in trouble because they are unable to finish projects or sell completed projects.

Also, flows into debt schemes of mutual funds have not been so robust, slowing down sharply in some months; in some instances, MFs have needed to mark down the net asset values of schemes or extend their tenures because these were impacted by defaults. MFs have pruned their exposure to NBFCs to 27% of the AUM from 34% in August 2018, with exposure to commercial paper (CP) of NBFCs down 40%.

Had the State Bank of India not rushed to their rescue, it is possible the market would have seen some big defaults. While top tier NBFCs would always be careful, there is always the risk of the second-rung players taking imprudent stances on interest rates and liquidity, especially when interest rates are rising. Essentially, they would be tempted to borrow for shorter periods to try and protect their margins. A tighter ALM framework will usher in discipline, offer greater comfort to lenders, and not disrupt the market. If RBI’s draft guidelines become the rule, NBFCs must hold enough high quality liquid assets to cover the estimated net cash outflows over the next 30 calendar days, in case of a severe liquidity stress scenario. Obviously, this would mean parking funds in risk-free or near risk-free instruments, which don’t offer the highest returns,and could hurt the margins. But, this is absolutely necessary. NBFCs have played, and continued to play, a big role as intermediaries, and are able to reach out to sections of borrowers which banks are reluctant to lend to because they lack the expertise to both appraise and follow-up with these customers.However, unless their balance sheets are strong—as reflected in the credit ratings—they will not be able to access resources either from banks or retail deposits. Indeed, the recent stress in the sector would have made small savers cautious of parking their savings with NBFCs. RBI cannot let the entire sector get a bad name and suffer just because there are a few rotten apples.For some reason, both NBFCs and HFCs have been less regulated than required, and that must change. An asset quality review—of the sort that was undertaken for banks in late 2015—would not be out of place. Indeed, given how banks continue to report large slippages, it should be done without delay.



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