Despite RBI move, NBFCs' woes to continue till permanent funding fix found

The nuance that has been lost is whether the move is aimed more to free up the capital of banks or to help loan companies

The Reserve Bank of India’s (RBI) decision to go easy on the risk weights on bank loans to non-banking financial companies (NBFCs) has been cheered all around, but it may well be a case of premature exuberance.
 
Bank credit to “loan companies” – the likes of Bajaj Finance, Manappuram, Muthoot Finance, Muthoot Capital, Shriram City Union — is expected to fall 20-50 per cent from the 100 per cent based on the credit rating; it’s expected this will lower their borrowing costs, particularly for those entities rated “AA” and below. This will bring them on a par with Asset Finance Companies, NBFCs-Infrastructure Finance Companies, and NBFCs-Infrastructure Development Fund (NBFCs-IDF). Link the change in the treatment of risk weights with the 25 basis points cut in the repo rate cut and the overall dovish stance (to ‘neutral’ from calibrated tightening’), and you have every reason for a song and dance.
 
The nuance that has been lost in all this is whether the move is aimed more at freeing up the capital of banks, or to help loan companies.
 
Says Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India: “For NBFCs, it will optimise their funding cost, but the larger picture lies in the freeing of capital for the banks. As per our calculations, the change of risk weights as per rating distribution would lead to capital saving equivalent to 7.58 per cent of the assets under consideration, thereby releasing an amount of Rs 19,000 crore”.
 

The big picture
 
A key reason for the move is the role of such entities. A Mint Road study focussing on loan companies, which has not got much attention, points out that these firms had a share of 38.5 per cent in credit (of NBFCs which were not deposit-taking, but systemically important). The decline in share of bank credit extended to real estate, consumer durables and vehicle loans to 74.6 per cent in March 2018 from 88.1 per cent in December 2015, was entirely made up for by loan companies, whose share went up to 25.4 per cent from 11.9 per cent during the same period. It also notes that the business model and the clientele of both banks and these firms are similar. This last point is ominous because it’s entirely possible that banks will now grow their books by directly lending or buying portfolio rather than lending to these entities. Simply put, it’s not that banks will lend more just because they can; it’s not like night follows day.
 
Says AM Karthik, Assistant Vice-President at Icra: “Reduction in risk weights for NBFCs is expected to free up the equity capital for banks against their exposures to firms, which banks can use for incremental credit growth or improvement in their capital ratios. While this can also result in reduced borrowing rates and incremental credit supply for NBFCs, it will depend on banks’ willingness to do so”.
 
A variable that has not been factored into all is that Mint Road is set to tweak the asset-liability management (ALM) guidelines for banks.
 
The RBI latest Trend and Progress of Banking in India (2017-18) refers to this aspect: “…the instructions are less granular compared to that for banks. Further, the ALM instructions for registered Core Investment Companies are minimal. The RBI intends to strengthen the ALM framework for NBFCs on lines similar to that for banks and harmonise it across different categories of NBFCs”.
 
Mint Road’s new norms on NBFC’s ALM are expected down the line and it may well include caps on commercial papers and their rolling over, and even a tweak in banks’ exposure to the sector. This should be seen in the context of RBI deputy governor N S Vishwanathan’s statement that “there are ALM guidelines, but we are looking at strengthening them so that we can avoid this roll-over risk going forward”.
 
Incidentally, at a meeting with RBI governor Shaktikanta Das, heads of NBFCs made the point that more avenues for fund raising be opened up, perhaps even allow the better rated ones to raise deposits.
 
Another point made was that bank lending to NBFCs be treated as part of priority sector targets, which had been the case till 2011 when this was done away with.

For NBFCs, the wait could take a little longer.

The wait will continue

 

• RBI’s move seen helping banks more by freeing up their capital which may not necessarily be given out as loans to NBFCs
• Loan companies in the retail space have a business model akin to banks and the clientele are similar
• Banks may opt to grow their books by directly lending or buying out portfolios rather than lend to these NBFCs
• RBI set to align ALM framework for NBFCs with that of banks and harmonise it across different categories of NBFCs