A LIFELINE FOR NBFCs

The government has finally stepped in to support the battered non-banking finance companies (NBFCs) with a Union budget proposal encouraging public sector banks (PSBs) to buy their pooled assets. It has decided to provide PSBs a one-time, six-month partial credit guarantee, amounting to a total of Rs 1 lakh crore, for the first loss up to 10 per cent for the current financial year. This lifeline thrown to the NBFCs was much needed because the sector plays a key role in driving consumption demand in the economy, especially mortgages, vehicle and consumer durable loans as well as supporting small and medium enterprises hit by demonetisation and GST. This comes at a time when investments and exports, the other GDP growth drivers, are lagging.

Securitisation or pooling of assets is a well-accepted practice in the banking industry to buy out the retail portfolios of NBFCs. Under the proposed scheme, an NBFC sells a pool of assets (say, a set of affordable loans or loans in a certain category or geography) to a PSB in return for immediate payment. In the bargain, the PSB picks up secured, interest-paying retail assets, while the originator NBFC gets money to redeploy in fresh loans. In addition, the NBFC earns a fee income for collecting EMIs and maintaining the loan account. “We have never had an issue with pooled assets bought from NBFCs in the past,” says Rajkiran Rai, managing director at the Union Bank of India. Rai adds that the non-performing asset (NPA) level in pooled portfolios is very low.

NOT WITHOUT RISK

While the new incentive will encourage banks to buy pooled assets, the buyouts are not entirely risk-free. The Reserve Bank of India (RBI) and PSBs, already recovering from asset quality shocks, need to be very careful as these portfolios are built during the good times. Since NBFCs lend to customers who are typically less creditworthy than bank customers, banks need to be duly diligent about the pooled assets and the NBFCs.

NBFCs have suffered big losses in the past. The 2008 financial meltdown wiped out many NBFCs doling out small-ticket-size personal loans. Similarly, the microfinance institutions (MFI) crisis that hit Andhra Pradesh in 2010 resulted in huge losses.

THE LIKELY FRAMEWORK

Under the budget proposal, the pooled assets have to be rated by a rating agency. Bankers say there are practical difficulties in rating a large pool—it is time-consuming and rating the accounts entails a cost. “We can rate a sample within the pool,” suggests a banker. If the RBI decides to go by a corporate entity’s rating, there are external experts who question the credibility of rating agencies. This is because some highly rated investmentgrade companies have defaulted in the recent past.

The other criterion is that only financially sound NBFCs be eligible to sell pooled assets to PSBs. Currently, however, there are no criteria in place to determine financial health. The RBI is likely to specify conditions, such as the profitability record, capital base, low NPAs and a reasonable balance-sheet size.

The NBFC sector saw big growth in the past 4-5 years because PSU bank balance-sheets were in a mess. A former chief economic advisor had suggested an asset-quality review of NBFCs, similar to the RBI exercise done for banks. The banking sector has still not recovered from that shock. “The asset quality risk shouldn’t transfer to banks from NBFCs,” cautions an expert. Banks will need to devise a strategy for the kind of assets they buy since the government guarantee comes for only the first six months. Some say an asset coverage of Rs 1 lakh crore won’t be enough for the NBFC sector as the liquidity requirement is much higher. But a banker favourably disposed to the government initiative says: “We should look at the intent of the government rather than the [partial credit guarantee] amount.”

The proposal isn’t risk-free. Banks would be well advised to do due diligence regarding NBFCs and their pooled assets