Fixing NBFCs, cleaning up bank balance sheets among govt's 100-day plan

The National Democratic Alli­ance government’s resounding return to power will signify policy continuity, and that’s a great relief for the investor community.

Most of the important policies would be related to the financial sector, going by the tasks left undone by the previous government.

The biggest agenda is consolidation in the public sector banking space. The government has merged State Bank of India associates with the parent, bunching Bharatiya Mahila Bank with it. The consolidation of Bank of Baroda with Vijaya Bank and Dena Bank took place in April.

More will come as the government aims to create big Indian banks. Bank of India and Punjab National Bank are the prime anchor candidates while the banks under the prompt corrective action (PCA) framework being the likely merger targets.

However, privatisation of public sector banks is a sensitive issue and requires a consensus building.

But these two agendas will likely play out over the next five years. In the next 100 days, during which falls the Union Budget in July, the government will be busy with pending issues, mostly those remaining stuck because of the model code of conduct in place during the elections.

Some of the issues that need immediate attention can be: Resolving the crisis in the non-banking financial companies (NBFC) sector; a possible booster dose of recapitalisation of public sector banks as a whole, at least trying to bring some banks out the PCR regime through recapitalisation; sorting out the economic capital framework of the RBI; encouraging the RBI to go for a monetary stimulus through steeper rate cuts; improving liquidity in the banking system so that banks can be pushed to drive credit growth; fast-tracking the resolution process through amending the Insolvency and Bankruptcy Code; managing portfolio inflows trying to take positions in Indian assets; and, of course, trying to deepen the corporate bond market to encourage companies and NBFCs to borrow. The ruling party’s election manifesto stated it would continue to build on Jan-Dhan, Aadhaar and financialisation, and will clean up the banking sector. Reform of bank boards is unlikely to be taken up immediately by the government even as that is a crucial reform agenda that must be addressed.

Restoring confidence in the NBFC sector would be the immediate and most daunting challenge. NBFCs are not able to borrow from the markets, and the confidence of retail investors is shaken following the deposit withdrawal freeze by the second-largest housing finance company, DHFL Ltd. Not to mention defaults by two very large NBFCs — IL&FS, which was a government-supported entity, and Reliance Capital. 

While the RBI board has rejected the idea of a credit line, and the central bank last week came up with a draft rule on how to improve the liquidity profile of NBFCs, analysts still expect a helping hand to tide over the temporary crisis. “Every four-five years we see crisis for NBFCs triggered by lack of access to liquidity. Deepening debt markets with various incentives should be a priority,” said Alpesh Mehta, deputy head of institutional research and banking analyst, Motilal Oswal Financial Services Ltd.

“This will not only de-risk the banking system but also reduces the cost of funds for corporate borrowers including NBFCs. Further, NBFCs /HFCs (housing finance companies) beyond the particular size should be allowed to tap the RBI window in the case of severe liquidity crunch. In the near term, we expect the RBI to increase liquidity in the system, considering the moderate deposit growth, improving loan growth and continued liquidity crisis for NBFCs/HFCs,” Alpesh said.

In the absence of adequate credit in the productive and consumer sector, a role efficiently performed by NBFCs, the real economy can get hit. But banks can step in, fulfilling credit needs. “The new government should streamline the credit market and encourage banks to lend more. Every other issue will follow suit,” said Jayesh Mehta, country treasurer, Bank of America Merrill Lynch.

“Let there be consolidation in PSBs. However, the government must open up the banking sector and let smaller banks come up. Let investors buy regional rural banks, let NBFCs easily convert into banks. We don’t want only the ‘shadow banking’ system to take care of the economy,” Mehta said. 

Currently there are six banks under PCA. The government in February asked these banks to improve their key ratios so that they could get out of PCA. Recapitalisation has been adequate enough to meet their minimum capital needs, but more could be needed to clean the balance sheet, which is a crucial focus of the government. Last year the government infused Rs 88,139 crore for bank recapitalization. Of that Rs 52,311 crore was allocated to 11 public sector banks under PCA. Bank of India, Oriental Bank of Commerce and Bank of Maharashtra got out of PCA, while Dena and IDBI Bank were merged with Bank of Baroda and Life Insurance Corporation of India. Analysts expect more capitalisation in the space, and that could be allocated in the Budget.

“(According to our calculations), a $10 billion capitalisation of the financial system can potentially boost credit by up to $100 billion,” UBS said in a report.

While the RBI continues to pump enough liquidity through bond purchases and dollar swaps, more needs to be done to improve rate transmission. Here, a 50 basis point cut by the Reserve Bank of India can help. On June 6, when the monetary policy comes, the expectation is that there will be at least a 25 basis point cut. However, the government seemed to have ruled out a fiscal package in order to keep its deficit within 3.2 per cent of gross domestic product, which can work as a confidence-booster.

One critical factor the government needs to handle immediately is improving the efficiency of the Insolvency and Bankruptcy Code.

The RBI’s revised circular on stressed asset resolution will play an important part in it. According to sources, the one-day default norm will likely stay, but the government needs to amend the IBC Act to prevent opportunistic players from delaying recovery. Non-serious bidders have been a problem area for long and fresh bidding even after the closure of a bidding process needs to be plugged in, say analysts.

One critical issue is how the Jalan committee report would spell out the reserve transfer to the government. The expectation is that the RBI can transfer Rs 2-3 trillion to the government.

“Ideally, any excess capital transfer to the government should be used for recapitalising PSBs and not for deficit financing,” said Gaurav Kapur, chief economist, IndusInd Bank.