NBFCs see no sign of liquidity crisis easing, await RBI's rescue act

The liquidity crunch in non-banking financial companies (NBFCs) is showing no signs of easing, forcing the firms to sell their good assets just to keep afloat, and use their existing cash flows to lend, rather than raising fresh resources for expansion.

The Reserve Bank of India (RBI) on Thursday told NBFCs with asset size of Rs 5,000 crore and above to appoint a chief risk officer. The NBFCs maintain that they have been submitting their asset-liability report every quarter to the central bank, but the RBI hardly raised any objection about the mismatch.

About half of the funding in the sector used to come from the mutual fund (MF) segment, while bank loans filled up the rest. Both have narrowed down after the Infrastructure Leasing & Financial Services (IL&FS) group firms defaulted on payments last year, triggering a liquidity crisis in the market.

Before the IL&FS crisis in September, MFs had deployed Rs 1.3 trillion of their debt funds to less than 90-day commercial paper market. From 17.6 per cent of the funds deployed to this segment in August 2018, it slipped to 12 per cent (Rs 94,000 crore) by February 2019.

The banks, though, are somewhat supporting the segment by giving working capital loans to compensate for the lack of MF support. Bank loans to NBFCs stood at Rs 5.58 trillion by the end of January, from Rs 3.76 trillion a year ago, the RBI data shows.

NBFCs’ role in the economy

The recent rating downgrade of Reliance Home Finance has cast fresh doubt on the NBFC segment. Officials in some of the NBFCs say the situation won’t force good NBFCs to go belly up. But it will land many poorly managed NBFCs in trouble.

The shadow banking space in India is well capitalised, and the way they can survive now is by doing cash flow-based lending, which restricts their growth prospect but will not lead to a shrinkage in balance sheet size as of now. However, that would also mean that NBFCs will have to necessarily slow down their lending to the critical sectors of the economy.

“The NBFCs fulfil a critical function in the economy that banks cannot. The sad part is that everyone is painting all NBFCs with the same brush. The result is that customers are suffering, they are not getting the necessary credit,” said Jaspal Bindra, executive chairman of Centrum Group.

Gaurav Gupta, chief executive officer (CEO) of Adani Finserve, which focuses on lending to micro and small enterprises, said: “We create and support entrepreneurs, we facilitate financial inclusion, we go where banks are unable to go, we truly contribute to economic growth. Yet, they call our activities ‘shadow banking’. That isn't fair.”

The banking system liquidity remains in a mild-deficit mode. On a net basis, banks borrowed Rs 31,499 crore from the central bank on Thursday. But the liquidity squeeze in the NBFC space is acute and largely rating-agnostic.

“NBFCs continue to grow their asset base and gain market share. However, on the liability front, debt investments by MFs into the NBFC sector, which used to account for nearly half of NBFC funding, are frozen due to ALM issues, specific to a few NBFCs,” said Bhupinder Singh, CEO of InCred.

“While bank funding continues to flow through to the larger NBFCs, some of the smaller players will find themselves getting squeezed out,” Singh said, adding microfinance firms continue to remain liquid because their asset book qualifies for priority sector lending. InCred has recently raised enough equity, is and not affected by the turmoil, he said.

Bank of India’s Managing Director (MD) and CEO Dinabandhu Mohapatra said NBFCs do have a role to play in society, and it’s very unlikely that the RBI and the government will let the sector fail.

However, experts say that a specific lifeline from the government’s side is unlikely to come before the next government formulates its first Budget in July. Till then, NBFCs will have to survive through selling their assets, co-origination of loans with banks, and by working as agents of banks. The lending exercise would be strictly based on their cash flows from existing business. Not only have the bond market and banks turned averse to lending to the sector, equity valuation of the companies have almost halved in the past few months, making any equity infusion difficult.

Genesis of crisis

According to Ananth Narayan, associate professor for finance at S.P. Jain Institute of Management & Research, the seeds of the crisis were sown when the RBI ordered asset quality review (AQR) of banks in early 2015.

The AQR turned up huge non-performing assets (NPAs) in banks’ books, which led to banks tightening their purse strings for new credit. The NBFCs rapidly moved in to fill the gap, even as the number of NBFCs registered with the RBI started to come down.

The RBI data shows that as of March 2015, there were 11,842 NBFCs registered with the RBI, which fell to 10,190 by September 30, 2018. The share of NBFCs in total credit was 9.5 per cent in March 2008, which grew to 15.5 per cent in March 2017, soon after the government’s demonetisation exercise. The aggregate balance sheet size of the NBFC sector stood at Rs 26 trillion by September 2018, up from Rs 22.2 trillion in September 2017.

While triggers for NBFCs’ sharp asset growth were laid in 2015 because of AQR, experts say the cycle of weakening liability mix had their origins in the post-demonetisaion period.

“MFs started getting strong flow of money across categories after demonetisation was announced in November 2016. Suddenly, there was a gush of liquidity in the schemes and these funds had to be deployed somewhere. NBFCs’ need to frequently tap debt markets for short-term money dovetailed with liquid schemes, which received short-term flows from institutional and corporate investors,” said a debt fund manager, requesting anonymity. At the end of November 2016, the assets managed by liquid schemes stood at Rs 2.8 trillion, which surged two-fold to Rs 6 trillion by the end of August 2018.

“As MFs started deploying this liquidity into the bond markets, it created a cycle of falling rates. NBFCs started to further increase their borrowing from commercial paper market as the heightened liquidity pushed the rates even below the cost of borrowing from the banks,” another fund manager added.