SHADOW BANK­ING WOES

De­fault on pay­ments has put NBFCs un­der scru­tiny and ex­posed the fault lines in the com­mer­cial pa­pers they have is­sued

Business Today - - THE HUB BANKING - by Apra­jita Sharma Il­lus­tra­tion by Ajay Thakuri

Mul­ti­ple loan de­faults by IL& FS and the sub­se­quent panic around com­mer­cial pa­pers (CPs) has put the spot­light on non-bank­ing fi­nan­cial com­pa­nies (NBFCs), In­dia’s shadow bank­ing space. To gain mar­ket share, NBFCs in­creas­ingly is­sued CPs – a short-term debt in­stru­ment – to fi­nance long-term projects at a time when credit growth in banks slowed. The over­all value of out­stand­ing CPs (the in­ter­est­bear­ing bal­ance of a loan) was ` 6.4 lakh crore as of Ju­lyend; 96 per cent growth since July last year. Mu­tual funds and banks bought such CPs ow­ing to NBFCs hav­ing shown bet­ter loan growth and stronger net in­ter­est mar­gins than

banks. But the golden phase did not last long.

IL& FS de­fault­ing on debt pay­ments and fund house DSP sell­ing DHFL pa­per at a steep dis­count had a domino ef­fect across NBFC yields, whose stock prices also crashed. While some say that the liq­uid­ity cri­sis has been blown out of pro­por­tion, the govern­ment and the Re­serve Bank of In­dia (RBI) have gone into dam­age con­trol mode.

A con­se­quence of these events is that NBFCs are likely to now face higher cost of bor­row­ing, which means growth pre­dic­tions will have to be re­cal­i­brated and net in­ter­est mar­gins (NIMs) would shrink.

NBFCs have grown at a fast clip in re­cent times even though the bank­ing sec­tor has con­tracted. The com­bined loan book of NBFCs and hous­ing fi­nance com­pa­nies (HFCs) grew from ` 11 lakh crore in FY13 to ` 24 lakh crore in FY18 – a 17 per cent com­pound an­nual growth rate (CAGR). Their share in over­all sys­tem credit rose from 17 per cent in

FY13 to 21 per cent in FY18. Bank loans to NBFCs also grew sub­stan­tially (nearly 50 per cent) in the last three years. Ac­cord­ing to RBI’s June fi­nan­cial sta­bil­ity re­port, there were 11,402 NBFCs reg­is­tered with it as of March 2018, 156 of which were de­posit-tak­ing firms and

249 were ‘sys­tem­i­cally im­por­tant’ non- de­posit ac­cept­ing firms. Their com­bined bal­ance sheet size stood at ` 22.1 lakh crore.

Given this size, it is un­der­stand­able that there are con­cerns re­gard­ing NBFCs’ as­set li­a­bil­ity mis­match (ALM), which is the dif­fer­ence between in­flows or as­set ma­tu­ri­ties and out­flows or li­a­bil­ity ma­tu­ri­ties. NBFCs re­ly­ing ex­ces­sively on short-term pa­per to fund long-term projects is a worry.

ALM pro­files of NBFCs sug­gest that HFCs ( bar­ring HDFC) are ad­versely placed on ma­tu­rity pro­file, i.e., li­a­bil­i­ties are ma­tur­ing faster than as­sets. Ac­cord­ing to bro­ker­age Emkay Global, 12 per cent of DHFL’s li­a­bil­i­ties (17 per cent of over­all mar­ket bor­row­ings) will ma­ture in three months against

9 per cent of to­tal as­sets (3 per cent ad­vances). As­set Fi­nance Com­pa­nies are rel­a­tively bet­ter-placed with the ex­cep­tion of Cho­la­man­dalam Fi­nance, where 15 per cent li­a­bil­i­ties (14 per cent of mar­ket bor­row­ings) are ma­tur­ing in three months ver­sus 7 per cent of to­tal as­sets (7 per cent ad­vances).

“Shri­ram Trans­port also has ad­verse ALM mis­match.... Ba­jaj Fi­nance is best placed with 12 per cent li­a­bil­i­ties (13 per cent of mar­ket bor­row­ings) ma­tur­ing in three months against 18 per cent of to­tal as­sets (18 per cent ad­vances). Mahin­dra & Mahin­dra Fi­nan­cial Ser­vices and HDFC also have favourable ALM ma­tu­ri­ties,” Emkay Global’s re­port states.

AAA-rated NBFC CPs with strong parent­age are bet­ter placed. They con­tinue to bor­row from banks at mar­ginal cost of funds­based lend­ing rate (MCLR) or mar­ginal pre­mium to it (25 ba­sis points),i.e. sub-9 per cent. AA-rated NBFC CPs bor­row at higher rates

(9-9.5 per cent) and longer ten­ure of re­sets (monthly or quar­terly in­stead of an­nual).

G. Chokkalingam, founder at Equinomics Re­search, be­lieves there is no risk to fi­nan­cial sta­bil­ity be­cause NPAs of most NBFCs are within man­age­able lev­els — non­per­form­ing loans for NBFCs are 5 per cent, com­pared to 10 per cent

for state- owned banks. But, higher bor­row­ing cost will af­fect growth. “The bor­row­ing cost would go up by at least 50-75 ba­sis points for NBFCs, but since most of them do not have an NPA cri­sis, they will slowly ad­just to ALM balanc­ing. In the process, how­ever, their mar­gins may fall,” says Chokkalingam.

Will Buy­ers Say No?

Apart from fac­ing higher cost of funds, NBFCs may also face hur­dles when it comes to those that buy their CPs, es­pe­cially mu­tual funds. In the past two years-plus, the share of NBFCs in the over­all debt in­vest­ments of fund houses has al­most dou­bled — from ` 1.2 lakh crore in March 2016

(15 per cent of mu­tual funds’ to­tal debt in­vest­ments) to ` 2.3 lakh crore in July

2018 (17 per cent).

“While debt in­stru­ments are 60 per cent of as­sets un­der man­agem­nent or AUM, in­vest­ments in CPs within debt funds have dou­bled (16 per cent in FY15 to 33 per cent cur­rently). Rollover risks, there­fore are high, as a third of cor­po­rate money in debt in­stru­ments has a ma­tu­rity pro­file of less than a month,” Jef­feries’ Sep­tem­ber 2018 re­port states.

Faced with a risk of con­ta­gion, mu­tual funds may shun NBFC CPs as re­demp­tion pres­sure could worsen their liq­uid­ity. But, ex­perts feel the RBI could step in to pro­vide di­rect liq­uid­ity to fund houses against their G-Sec and cer­tifi­cates of de­posit.

Banks, too, may not be able to in­cre­men­tally lend to NBFCs as many banks are ap­proach­ing their ex­po­sure limit to the sec­tor. In ad­di­tion, 11 pub­lic sec­tor banks are un­der the RBI’s Prompt Cor­rec­tive Ac­tion (PCA) frame­work, and tech­ni­cally can’t lend. This is a ma­jor con­cern as NBFCs look to bank bor­row­ings when in­ter­est rates go up.

“If banks and mu­tual funds stay away from lend­ing or in­vest­ing in NBFCs, the lat­ter could face fur­ther is­sues. A lot would de­pend on the in­flows into debt funds, de­posit growth and other lend­ing op­por­tu­ni­ties for banks. We be­lieve NBFCs may not be to­tally shunned by these en­ti­ties, but they will be­come more selec­tive,” says Deepak Jasani, head – re­tail re­search, HDFC Se­cu­ri­ties.

To al­le­vi­ate the over­all liq­uid­ity con­cerns, the RBI re­cently an­nounced open mar­ket op­er­a­tion of ` 36,000 crore for Oc­to­ber. The govern­ment has also re­duced its H2FY19 bor­row­ing tar­get by ` 70,000 crore, and the SBI has an­nounced that it would tre­ble the amount of loans it buys from NBFCs to about ` 45,000 crore in FY19.

Nip­ping at the Bud

The root cause of the prob­lem is lack of av­enues to fund long-term projects. Long ges­ta­tion as­sets should not be fi­nanced ei­ther by banks or NBFCs be­cause they don’t have long-term funds, says R.V. Verma, for­mer CMD of Na­tional Hous­ing Board. “The govern­ment must create a be­he­moth of ex­ist­ing in­fra fi­nanc­ing in­sti­tu­tions and look for a way to de­ploy pen­sion and prov­i­dent funds. Al­ter­na­tively, banks and NBFCs can co-fi­nance long-term projects.”

He fur­ther says, “The RBI, Sebi and other over­sight au­thor­i­ties must build a co­or­di­nated ap­proach at the reg­u­la­tory and su­per­vi­sory level.” Verma sug­gested an in­ter­nal rat­ing mech­a­nism that sup­ple­ments rat­ings of ex­ter­nal agen­cies. “AAA-rated com­pa­nies can eas­ily build ex­ces­sive lever­age. The RBI must con­stantly keep a watch to see if credit rat­ings have in­flu­enced fi­nan­cials of NBFCs, es­pe­cially on the li­a­bil­ity side,” he says.

Ra­josik Ban­er­jee, Part­ner – Fi­nan­cial Risk Man­age­ment, KPMG, mir­rors the thought say­ing some NBFCs ne­glect due dili­gence when seek­ing more busi­ness. “There must be an in­creased over­sight by NBFCs on the pre-sanc­tion and post-sanc­tion pro­cesses for lend­ing.”

The NBFC cri­sis is a re­minder that the un­der­belly of In­dia’s shadow bank­ing must be su­per­vised strictly, lest they pose a threat to the over­all fi­nan­cial sta­bil­ity of the sys­tem.

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