RBI VS GOVT: WHAT TO EXPECT 11 PCA BANKS NOW CLOSER TO STABILITY THE BANK’S BOARD AND ITS GOVERNORS

3 CRITICAL ISSUES AT BOARD MEET TODAY: NBFC liquidity, PCA regime and economic capital framework

On Monday, the Reserve Bank of India’s (RBI) board is expected to take up several issues on which sharp differences exist between the government and the central bank. Three are reportedly of critical importance.

First, the liquidity crunch facing the non-banking financial companies (NBFCs). Second, the slowdown in credit to micro, small and medium enterprises (MSMEs). And third, whether the RBI is holding on to excess capital on its balance sheet.

Addressing liquidity concerns

Since the implosion of IL&FS, there have been concerns that with liquidity drying up, as buyers of commercial papers (CPs) had turned cautious, NBFCs would have a tough time rolling over the debt obligations.

November was believed to be a particularly crucial month as ~1.03 trillion of NBFC debt (excluding debt of relatively safer entities such as Nabard, NHB, LIC housing) was set to mature.

But, two weeks later, there is an uneasy calm.

In the first fortnight of November, NBFCs were able to issue CPs worth ~1.03 trillion as against debt of ~726.8 billion that was set to mature during this period, data accessed by Business Standard shows.

A look at the day-wise yield to maturity (weighted average) of CPs issued during this period suggests little evidence of systemic stress. To be fair, there are outliers. Granular data shows that yields of some NBFCs have touched north of 10 per cent. But, NBFCs have been able to either roll over or retire their debt.

This raises questions - Who is buying? And has normalcy been restored in the market?

“It is possible that financial institutions such as SBI and LIC have stepped in to calm the market,” market participants said. “Mutual Fund houses may have also helped rollover debt as a default could have had a cascading effect,” they added.

Higher securtisation transactions may have also helped meet repayment obligations. According to Crisil Ratings, securitisation volumes had touched ~180 billion in October. And while data for November isn’t available yet, the volumes are robust, experts told Business Standard.

The situation may have improved, but it is early to say if the worst is behind us. “~720 billion of NBFC set is maturing between November 19 and 30. A single default could have huge ramifications,” experts said.

It is important to note that these liquidity concerns also have a bearing on credit flow to MSMEs. Data from Transunion Cibil shows that the share of NBFCs in total credit to MSMEs has jumped from 8.4 per cent in June 2016 to 11.3 per cent in June 2018, implying that liquidity issues could have a direct impact on credit flow to MSMEs.

Easing RBI’s PCA framework

The other area of disagreement revolves around RBI’s PCA framework. Of the 21 public sector banks in India, 11 are currently under PCA, which the government believes has disrupted credit flow to MSMEs.

The fundamental question is whether the RBI should tweak its PCA framework? Should it allow banks under PCA to lend to MSMEs or should some banks be allowed to exit? And will this improve credit flow to MSMEs?

Now, the quarterly results show that while the financial position of some PCA banks has improved, it remains precarious. In absolute terms, gross NPAs of these banks appear to have peaked in March 2018. But as their loan book has shrunk, their GNPA ratio (as percentage of advances) has worsened, rising from 20.45 per cent in Q4FY18 to 21.01 per cent in Q2FY19, CARE Ratings data shows.

On the other hand, the provision coverage ratio of these banks has improved over the period. But while their cumulative losses have declined, only Bank of Maharashtra, OBC and Corporation Bank reported profits in Q2FY19.

Of these, OBC and Corporation Bank are in better shape. These banks have a higher capital adequacy ratio, have higher provision coverage ratios and have registered a decline in their absolute GNPAs. However, their net NPAs remain high at 10 and 11.65 per cent, respectively, well above the first PCA risk threshold level of 6 per cent.

At this stage, it is difficult to know for sure if bringing these banks out of PCA or easing their lending restrictions will help improve credit flow to MSMEs.

Data accessed by Business Standard shows that 10 of the 12 banks (including a private sector bank) under PCA had already achieved the priority sector lending sub-target of 7.5 per cent to the micro sector as of March 31, 2018.

Besides, the direction of credit also needs to be factored in.

At the aggregate level, bank credit to micro and small enterprises (MSEs) has risen from ~7.2 trillion in April 2014 to ~9.9 trillion in September 2018, shows RBI data. But much of this growth has been directed towards MSEs in the services sector, which has surged from ~3.7 trillion to ~6.3 trillion over this period.

By comparison, credit to MSEs, mediumand large-sized industrial firms has barely registered a rise over this period.

This raises the question – if bank credit to industry is almost the same as it was four years ago, will tweaking the PCA framework improve credit flow to MSMEs?

Economic capital framework

The board is also likely to discuss RBI’s economic capital framework to determine if the level of reserves it holds is excessive or not. Now, RBI’s currency and gold revaluation reserves stood at ~6.9 trillion at the end of June 2018, up ~1.6 trillion from last year, benefitting from the rupee’s depreciation. While some have argued that this reserve should be excluded from RBI’s capital calculations as it is an unrealised gain, one should point out that losses on this account are charged from the contingency fund.

(With inputs from Abhishek Waghmare)