Nbfcs: What Will Be The Fall Out?

The non-banking finance companies (NBFCs) enjoyed more freedom in pricing their liabilities and assets, which commercial banks did not have, not now, but a decade ago. So they grew up fast to carve out a tier for themselves in the market structure.

A series of developments in the market have led to the present sagging confidence in them. NBFCs blossomed under conditions of easy liquidity (translating into adequate credit support from commercial banks) and a responsive capital market. The risk profile of their target market segment ensured them positive net interest margins over their cost of accessing bank credit. The premium on equity that they could garner lowered their cost of funds raised from the capital market. The collections through fixed deposits ensured them of continuous cash flows. Any inadequacies in pricing was not being felt by them immediately. The buoyant capital market prompted them to give focus on merchant banking activities. Bought out deals were perceived as gold mines. The corporate results thrived largely on "other income".

 

Today, when the market is revisited after a cycle, abundant liquidity is viable. Inflation, interest rates and real interest rates have come down. Yet, the NBFCs appear to be against the wall.

What transpired in the two year interregnum? Interest rate risk emanating from asset liability mismatch has crystallised. Market risk resulting from squeezing of bank credit to NBFCs has choked the cash flows. The slumber in the capital market left the NBFCs with junk stocks and closed exit routes in bought outs.

The inability to augment capital put constraints on growth in asset size, as capital adequacy prescriptions had to be met. As a fall out of reduction in corporate tax rates, leasing lost its charm as a route for tax shelter. They have been denied access to low cost foreign capital. The likes of CRB and ITC Classic weakened the credibility of the crowd.

What could be the fall out? In a regime of declining interest rates, the average investor will find fixed income securities unattractive. The basic instinct of avarice will turn them back to the capital markets. A proactive NBFC should see an opportunity for merchant banking business in this capital market revival.

The borrowers from NBFCs will see an opportunity to prepay their high cost debt. The NBFCs will find it difficult to pick up new assets at same yields that prevailed two years back.

So, while their assets get repriced downwards, their fixed rate liabilities continue in their books. The interest rate risk translates into a squeeze in net interest margins. The borrowers who have been regular in repayments to NBFCs will also be tempted to default on repayments and subsequently seek discounts for repayment in the wake of the introduction of income recognition and asset classification norms which have been made applicable to

NBFCs also. The realised yields of NBFCs will be lower than contracted yields.

The phase of stifled growth that may follow will be conveniently termed as a phase of consolidation. Those who have invested in risk management systems will see through the troughs and peaks while the also rans will get a feel of the potential energy latent in every fall.

(The author is dealer, money markets, State Bank of Travancore.

The views expressed here are his own.)