Liquidity crisis: Banks get RBI nod to raise credit to NBFC bonds

In a move that could provide some liquidity to the cash-starved non-banking financial companies (NBFC), the RBI on Friday allowed banks to raise credit to bonds issued by the systemically important NBFCs and housing finance companies (HFCs).
 
Credit enhancements have been allowed for corporate bonds for the infrastructure sector but there weren’t many takers for this, said bond arrangers. Through such an arrangement, credit of the issue gets enhanced as banks take responsibility of a part of the issue. This enables corporates to access funds from the bond market on better terms.
 
Under RBI rules, a bank can provide credit enhancements to the tune of 20 per cent of the bond size, for entities rated BBB or better.
 
Still, if banks offer credit enhancements, there would some amount of confidence back in the system to invest in bonds issued by large NBFCs and housing finance companies. More than 70 per cent of the issuance in the corporate bond market are from the NBFC sector. However, since the IL&FS defaults, sentiments have been hit and investors are wary of subscribing to bonds issued by the NBFC sector.

 
“Prospects for partial credit enhancement for retail or SME funding for NBFCs can be somewhat better than the infrastructure sector (where it did not take off). This is because an underlying NBFC’s credit can improve size, increase equity and demonstrate management capabilities,” said Shameek Ray, head of debt capital markets, ICICI Securities PD.
 
“Thus, if the base credit rating improves, then the credit enhanced rating which is, say, two notches higher, can also improve correspondingly. Therefore, a credit enhancement can actually crowd in potential investors for NBFC and HFC bonds,” Ray said.
 
However, this assumes that the underlying rating of the NBFC is being used and not that of an identified portfolio for the specific tranche. This gives rise to the risk of further defaults as the previously-issued bonds come for maturity and the NBFCs would require roll-over finance to honour their commitment.

 
The RBI  said the duration of bonds issued by the NBFCs and HFCs should not be less than three years. The proceeds of the bonds, backed by such enhancements, should be used only to refinance the existing debt.
 
Exposure of the bank by way of such enhancements should be “restricted to one per cent of capital funds of the bank within the extant single/group borrower exposure limits,” the apex bank said.