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Funding non-banking financial companies (NBFCs) on a 'non-recourse' basis by acquiring retail portfolio through buy-outs is inferior than direct lending, as banks typically lend to NBFCs at 15-25bp over the one-year lending benchmark which does not adequately factoring in reasonable credit costs estimates says India Ratings and Research (Ind-Ra). Effectively, in a rising credit cost scenario, banks could be receiving much lower comparative returns for direct assignment (DA) transactions compared to other alternate investments/lending avenues such as non-convertible debentures (NCDs), loans and pass-through-certificates (PTCs). In FY16, of the total off-balance sheet funding availed by NBFCs of about INR700billion, almost INR450 billion (64%) was contributed by DAs. The share of public sector banks in the overall 'off-balance-sheet' funding to NBFC's was about INR330 million.
Ind-Ra's simulation exercise highlights that even assuming credit cost equivalent for banks' self-originated retail asset lending book on the portfolio acquired from NBFCs, pre-tax return on asset on DA is at least 40% lower than banks' self-originated retail asset book and 25% lower than the return on a PTC. In FY16, retail credit growth of PSU banks was 15.8% (net of repayments) accounting incremental retail credit of about INR1.4 trillion, of which at least one-fifth was accounted by DA pool buyouts from NBFCs.
Ind-Ra believes public sector banks in a quest for growing their retail asset loan books may have taken their eyes off other critical factors such as risk adjusted return and optimal utilisation of capital while underwriting a DA transaction.
Ind-Ra believes when accounting for capital efficiency, a PTC compares superior to DA transactions for banks. Ind-Ra's analysis reveals PTC transactions are at least 50% more efficient when considering capital consumption. This is because portfolio acquisition under the DA option attracts higher risk weights (ranging from 35-100% across different retail categories) and considered for risk weights as if originated by the buyer. This is in sharp contrast to the investment in other capital market instruments (NCDs and PTC) which attract much lower risk weights (20% on 'AAA' rated instruments and 30% on 'AA' rated instruments).
Ind-Ra's analysis indicates that microfinance as an asset class, which is prone to various local socio-political factors and other idiosyncratic issues, exhibits very high volatility of defaults (4-5x higher) than other retail loans, thus making it a less suitable choice for DA buy-outs. Asset classes such as mortgages and commercial vehicle loans that have seen many business and credit cycles from established NBFCs/housing finance companies are more amenable to direct portfolio buy-outs, if at all, suitable through-the-cycle credit costs that are built into the initial pricing, resulting in a commensurate return for buying banks.
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