The NBFC crisis

Downgrades add fresh stress to the sector

Non-banking finance companies (NBFCs) are once again in the spotlight after a spate of rating downgrades over the past week, including the Anil Ambani group’s finance companies. For the bond market, which has been walking on thin ice since Infrastructure Leasing & Financial Services (IL&FS) defaulted in the second quarter of FY19, the fresh downgrades have revived concerns on NBFCs’ cost of capital and growth. In the past few years, NBFCs accounted for around 70 per cent of the borrowing in the corporate bond market. But after the IL&FS episode, the demand for their papers plummeted, along with evaporating liquidity in the system. Meanwhile, credit-rating agencies downgraded the more vulnerable firms or revised outlook in some others. Today, NBFCs that are able to raise bonds have seen their costs escalating, with AAA-rated NBFCs shelling out around 150 basis points over government bonds. AAA-rated non-finance companies are raising funds 100 basis points higher. Before IL&FS, the spread between corporate bonds and gilts was 50 basis points. 

The problems of the NBFC sector have been exacerbated by low liquidity in the system. Demonetisation led to a huge spurt in liquidity, which the Reserve Bank of India (RBI) took away through open market operations (OMO) and other measures. However, in FY19, the RBI had to infuse liquidity through OMOs worth about Rs 3 trillion, the highest in history, besides $10 billion of dollar swaps. These steps have helped in bringing gilt yields down, but even after two rate cuts, the cost of borrowing for NBFCs remains high as lenders do not have the appetite. Mutual funds, which were key buyers of NBFC papers, became risk-averse because they were singed by downgrades in their portfolios and the inability to exit papers without a loss after the IL&FS crisis. Mutual funds were also hit by another problem because they had to suspend their lending to the promoters of the Essel and Anil Ambani groups with shares of listed companies as collateral. The industry, caught on the wrong foot, saw net outflows of Rs 68,000 crore in their debt funds and Rs 1.3 trillion in their debt schemes between September 2018 and March 2019. 

Another worrying development is that the domestic wholesale debt market appears to be differentiating among NBFCs, according to analysts. Housing Development Finance Corporation and LIC Housing Finance account for the lion’s share of bond raising since the IL&FS crisis surfaced. Those perceived to be strong or backed by parent have been able to tap the domestic bond markets, but issuances from the rest of the NBFC universe were minimal. With the door of the wholesale debt market virtually shut, NBFCs are looking at other sources of funds such as external commercial borrowings and the retail segment, or even selling down assets, thereby reducing balance sheets.

In the past few years, NBFCs have played an important role in providing credit to retail and small and medium enterprises (SMEs), which banks have not been able to reach. Besides, state-owned banks have been too mired in their bad loan problem to expand their loan book. While some NBFCs may fail or will be forced to merge with stronger ones, an industry-wide shrinkage does not augur well for the economy. SMEs, which were affected by demonetisation and the adjustment to the goods and services tax regime, need capital at a reasonable cost. Retail credit too is crucial for driving the country’s consumption engine because there is no sign yet of investment picking up.