RBI's PCA framework to discipline NBFC sector in long run, say analysts

Three different risk thresholds, three different yardsticks to measure PCA risk thresholds. The curns against the NBFC get progressively tightened as they breach higher threshold levels

The Reserve Bank of India’s (RBI) Prompt Corrective Action (PCA) framework for the non-banking finance companies (NBFCs) may not have an immediate impact on the sector but will surely act as a deterrent and discipline the sector, going forward, analysts and experts reckoned.

The PCA framework excludes government firms, non-deposit taking NBFCs with asset size of less than Rs 1,000 crore, as well as private sector housing finance companies.

As per RBI’s framework, there will be three different risk thresholds, and three different yardsticks to measure the PCA risk thresholds. The restrictions against the NBFC get progressively tightened as they breach higher threshold levels. Breach of any criterion – capital adequacy ratio, tier-1 capital ratio, and net NPA ratio triggers PCA (or regulatory) action.

If the net NPA ratio of the NBFC is above 6 per cent but less than 9 per cent then it breaches the first risk threshold of RBI’s PCA framework. According to rating agency ICRA’s initial analysis, three entities are in breach of the NPA criterion as per September quarter numbers.

It is important to note that this framework will come into effect from October, 2022, based on the financial position of NBFCs on or after March 31, 2022. Experts reckon, NBFCs have ample time to address their financial ratios by the end of this financial year to avoid falling into the PCA framework of the RBI.

However, if one were to go by the September 2021 quarter numbers, a report by Motilal Oswal Securities states that Mahindra & Mahindra Financial Services’ (Mahindra Finance) net NPAs is in excess of 6 per cent (6.4 per cent). But it can conveniently bring it down to less than 6 per cent by the end of the current financial year (FY22). The company has, in the past, articulated that it will endeavour to deliver net NPAs of less than 4 per cent by end of FY22. Others say that as the economy picks up, the NPA ratios of NBFCs will also moderate.

Mahindra Finance did not respond to Business Standard's queries.

Similarly, Tata Motors Finance has a net NPA ratio of 7.34 per cent as of September quarter (Q2FY22), its latest financial disclosures showed. Tata Motors Finance is engaged in financing the entire range of Tata Motors commercial and passenger vehicles. Responding to a Business Standard query, the spokesperson said, “We are assessing impact and will take appropriate actions to comply.”

Another large finance company with a net NPA ratio of over 6 per cent is Hero FinCorp, the finance arm of auto major Hero MotoCorp. As per Q2FY22 figures, the company’s net NPA stands at 6.16 per cent. An email sent to Hero FinCorp did not elicit any response.

“We don’t expect any mid or large CRISIL-rated NBFCs to face immediate challenges given their comfortable capitalisation levels. The RBI has also provided a reasonable transition time for NBFCs to strengthen their balance sheets, some of which have been impacted by asset quality challenges following the Covid-19 pandemic,” said Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, CRISIL Ratings.

A research note by PhillipCapital said, “None of the NBFCs under coverage is breaching the required thresholds, hence no impact on the coverage NBFCs. Nonetheless, we believe these guidelines will bring some discipline among NBFCs with respect to keeping adequate provision buffer.”

However, one may still need to see how some of the relatively smaller unlisted players fare in terms of being compliant of the rules that are effective next year.

"As per MFIN - quick check suggests that some of the NBFC MFIs (microfinance institutions) could be well above NPA threshold levels but should be reasonably capitalised and thus may not attract PCA action," said Anand Dama, Head BFSI at Emkay Global Financial Services.

Experts are of the opinion that these regulations by the RBI are another step in the direction of bringing the NBFCs at par with banks on the regulations and supervisory front. Prior to this, the RBI came out with scale-based regulations for the sector and also harmonised the NPA recognition norms.

The IL&FS fiasco, which resulted in a shortage of liquidity for the sector, thus exposing the asset-liability mismatch of many entities, pushed the RBI to monitor the sector more closely and since then RBI has been bringing in regulations that is significantly reducing the regulatory arbitrage that the sector has enjoyed for many years.