Repairing NBFCs

RBI can't allow liquidity crisis to lead to solvency issues for the sector

Recently released data from the Finance Industry Development Council (FIDC) delineates the extent of the slowdown in the non-banking finance companies (NBFC). According to the data, when housing finance companies were excluded, the quantity of loans sanctioned by NBFCs fell by 31 per cent year-on-year in the fourth quarter of 2018-19, between January and March of this year. This came after a 17 per cent year-on-year decline in the third quarter of the same financial year, between October and December of 2018. This was the period in which defaults by entities associated with Infrastructure Leasing and Financial Services or IL&FS, reported last September, rocked the NBFC market and severely affected investor confidence. The liquidity crunch in the sector had become a cause of concern, as the shortage of funds for NBFCs was negatively impacting the broader economy and reducing growth potential. There is little reason to believe that things have gotten better for the NBFC sector in the first quarter of 2019-20, which is now coming to a close. 

A more granular analysis of the data from FIDC reveals that the biggest problem in sanctions comes in long-term lending by NBFCs, which fell 77 per cent year-on- year in the January to March quarter. This is not surprising as the question of maturity mismatch — lending long to projects while borrowing short from banks — was central to the concerns around IL&FS and other NBFCs. This has major implications for growth and employment. The smooth flow of project finance is central to ensuring that growth reaches a new and higher plateau, and that employment generation continues apace. Unskilled workers are particularly dependent upon a thriving infrastructure and construction industry. The slow-motion bank crisis caused by excessively burdened balance sheets in public sector banks had meant that NBFCs had stepped in as intermediaries for lending to infrastructure in particular. But the troubles in the sector meant that bank finance to NBFCs dried up. Mutual fund investors also soured on the sector. 

Now, although banks are showing signs of recovery, they have not yet stepped up to replace NBFCs, nor have they resumed lending to NBFCs. Repayment concerns have pushed funding costs at NBFCs to multi-year highs. Spreads on top-rated five-year bonds of NBFCs have risen 70 basis points in the past year. This is why NBFCs had argued with the Reserve Bank of India (RBI) that a separate credit line was necessary. There are good reasons why the central bank was unwilling to set up such a window. Moral hazard must be avoided, and a gradual clean-up of the NBFC sector, which had expanded unsustainably, should be incentivised. Some economists have suggested there is a lack of information about NBFC health that can be remedied perhaps through an asset quality review (AQR), as was undertaken for banks. This might aid in restoring investor confidence in “good” NBFCs without opening the tap of government aid to “bad” NBFCs. While all these arguments have merit, the point to note is that the RBI should not allow the liquidity crisis to lead to solvency issues for the entire sector. To assume that there is no systemic risk and the crisis is limited to just a few bad apples can be a mistake as inter-linkages do play an important role in the financial system. What is essential is for the RBI to frame a comprehensive turnaround plan and find a solution that restores the sector to health.