New LCR framework to strengthen NBFCs' liability profile: Ind-Ra

New guidelines on liquidity risk management (LCR) announced by the Reserve Bank of India (RBI) for non-banking finance companies (NBFCs) including core investment companies (CICs) will increase discipline in liquidity maintenance and improve transparency through better reporting standards, according to India Ratings and Research (Ind-Ra).

It could also strengthen the liquidity position of NBFCs as it disincentives short-tenor borrowings. The circular enhances disclosure requirements for NBFCs pertaining to the concentration of sources of funding which will result in the better dissemination of information and increase transparency enabling more informed decisions by stakeholders.

Ind-Ra said the well spread across implementation periods will enable NBFCs to gradually shore up their liquidity and give them time to reconfigure their balance sheet to ensure minimal impact on profitability during the transition period. It had highlighted the shift of focus for NBFCs towards tangible liquid buffers when RBI had released its proposed draft guidelines.

In the liquidity risk management framework, the RBI has introduced the LCR framework for NBFCs (except CICs, Type 1 NBFC-NDs, non-operating financial holding companies and standalone primary dealers) where non-deposit taking NBFCs with asset size of Rs 10,000 crore and above and all deposit taking NBFCs irrespective of their asset size will be subject to LCR requirement of minimum 50 per cent by December 1 next year, progressively reaching up to 100 per cent levels by December 1, 2024.

Similarly, non-deposit taking NBFCs with asset size of Rs 5,000 crore and above but less than Rs 10,000 crore will be required to maintain LCR at minimum 30 per cent by December 1, 2020.

The requirement of additional liquidity varies across NBFCs. This is because even though funding has been challenging for NBFCs, especially for NBFCs with weaker financial profiles, these companies have prudently and gradually beefed up their on-balance sheet liquid assets over the past year.

Based on the asset liability management (ALM) assessment of the top 20 NBFCs, there was a shortfall of high quality liquid assets (HQLA) at the end of FY19 to the extent of Rs 2,400 crore (1 per cent of total assets) and Rs 8,700 crore (2.3 per cent of total assets) for NBFCs unable to meet the 50 per cent and 100 per cent LCR requirement respectively compared to a corresponding shortfall of Rs 4,300 crore (2.44 per cent) and Rs 11,900 crore (5.44 per cent) in FY18.

However, as per Ind Ra's calculations, there will be negligible impact on return on assets (ROA) due to negative carry from additional liquidity to be maintained by NBFCs to meet the 50 per cent LCR requirement.

Also, since some of the excess liquidity was already maintained in the form of liquid mutual funds that are lower yielding than their advances book, a shift from mutual funds to other liquid securities may not have a major impact on their ROAs.

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