 "Gunit Chadha")
When the Reserve Bank of India’s (RBI’s) internal working group (IWG) suggested in November last year that shadow banks with assets of over Rs 50,000 crore could aspire for a banking licence, a collective gasp went up: Here was a window to move on in life. Only a few can hope for a banking licence. So, what happens to the rest of the crowd? And, will this model fly in the days ahead?
A total of 9,601 non-banking financial companies (NBFCs) were registered with the RBI in 2019-20 — 66 of them deposit-accepting, and 278 systemically important non-deposit accepting entities. Although the combined balance-sheet size of NBFCs is about one-fifth that of banks, their importance lies in last-mile credit delivery and the niche-segment support they provide. The proposed four-layered structure for NBFCs is for a progressive increase in the intensity of regulation, but it will also cut down the space for arbitrage (regulatory).
“NBFCs will supplement banks in providing access to credit to the under-banked segment, either due to their specialisation or on account of their reach, where banks have not been able to go. Good examples are small business loans to micro-enterprises in the tier-2 and tier-3 towns and rural areas; or monoline specialists in financing products which remain challenging for banks — gold loans being a good example,” notes Gunit Chadha, founder of APAC Financial Services.
APAC is among a small group of NBFCs that is pursuing growth through focussed lending to micro, small and medium enterprises (MSMEs) which provide a hugely scalable and sustainably profitable opportunity. “We have added several branches and a digital footprint in the last few quarters to reach out to the under-banked MSMEs. Raising capital is not a constraint. Building a ground-up granular well-managed business model is our focus now,” adds Chadha.
Jaspal Bindra’s Centrum Group is also in growth mode. It has made an ambitious bid along with BharatPe for the beleaguered Punjab and Maharashtra Cooperative Bank. As for the funding side, chairman Bindra is of the view that NBFCs that are able to manage liquidity and maintain healthy credit ratings to securitise their portfolios will continue to grow, as they will be able to house assets on their balance sheets. What about NBFCs which cannot manage liquidity or just don’t have the smarts to morph into a bank? “The ones that are unable to do so will remain as connectors to banks and large NBFCs,” adds Bindra.
Systemic liquidity issues were raised in the RBI’s Financial Stability Report (FSR) of July 2020. Banks and market borrowings account for over 70 per cent of total outside liabilities of the NBFC sector. With the waning of market confidence, the share of long-term market debt (non-convertible debentures in total borrowings of the NBFCs) declined to 40.8 per cent at end-December 2019, from 49.1 per cent in 2016-17. The consequent funding gap was met through bank borrowings, which rose to 28.9 per cent of total borrowings, from 23.1 per cent over this period.
The RBI’s concern over the declining share of market funding for NBFCs arises from its potential to accentuate the liquidity risk for these firms as well as for the financial system. Smaller, mid-sized, “AA-or lower rated” and unrated NBFCs have been shunned by both banks and markets, accentuating the liquidity tensions they face.
Now take a look at the emerging supervisory architecture and the fact that regulatory arbitrage is on its last legs, and that many NBFCs played off it. The architecture for banks, urban co-operative banks and NBFCs is now integrated, with the objective of harmonising the supervisory approach based on their activities and size.
Steps are also being taken to progressively harmonise instructions issued, albeit with proper grading, so that supervisory arbitrage is reduced. Like banks, senior supervisory managers (SSMs) are being appointed in all these entities.
While such harmonisation is desirable, in some aspects, regulation continues to privilege one set of entities over another.
For instance, to securitise portfolios, both RBI and Securities and Exchange Board of India norms need to be adhered to. “A unified framework that makes it simple for both issuers and investors, including foreign portfolio investors, is required,” says Bindra. Access to short-term liquidity windows from the RBI, along with a deep bond market that caters to BBB-rated papers and above, will help NBFCs achieve better asset-liability management.
NBFCs source bank credit for refinancing their books. However, the RBI prohibits banks from lending to NBFCs for bill-discounting and unsecured lending. Moreover, bank loans to NBFCs cannot be rolled over or re-priced without attracting the provisions of “restructuring”. Says Bindra: “Some of the RBI guidelines should be revisited to make it a more level playing field.”
Some numbers may still not yield the correct picture. For instance, according to rating agency Crisil, the median collection ratios for November 2020 pay-outs for commercial vehicle loan pools jumped to 93 per cent, from a paltry 24 per cent in May 2020. It was 98-99 per cent for January-March 2020. Collection efficiency for mortgage-backed loans was 96 per cent in October-November 2020, compared to 99 per cent in March 2020 and 71 per cent in June 2020. And this is only for Crisil-rated NBFCs.
The median collection efficiency of pools backed by microfinance loans is not comforting either. It declined precipitously in April and May 2020 and, despite recovering sharply to above 70 per cent in September, has since only inched up, as cash flows of vulnerable borrowers in the segment have yet to reach pre-pandemic levels. Median collection ratios were 82 per cent for November 2020 pay-outs, still below the business-as-usual level of 98-99 per cent.
Is the NBFCs’ approach to business itself flawed? A point often missed is that most loan providers take only a product approach driven by assets under management (mistakenly assuming that this means valuations) rather than a blended approach to truly understanding customer needs.
“On the flip side, NBFCs providing loans to the mid- and large corporates simply due to regulatory arbitrage (between banks and NBFCs) is frankly low-value add. A bad risk doesn’t become good just because it’s housed in a bank or an NBFC or a PE fund — a costly lesson some have learnt recently,” quips Chadha.
For many shadow banks, the shadows may only get longer.
