NBFCs remain crucial

Don't throw the baby out with the bath water

The crisis caused owing to successive defaults by subsidiaries of Infrastructure Leasing & Financial Services (IL&FS) continues to roil the non-banking financial company (NBFC) sector. Many NBFCs have seen their share prices plunge after the Reserve Bank of India indicated last week that new rules might be brought in to moderate “rollover risk” in the sector. There is the risk that a liquidity crisis might erupt in an NBFC if it is unable to refinance its existing short-term borrowing at a remunerative rate. NBFCs that had been issuing short-term commercial paper might have to shift to debentures or long-term bank finance, which would significantly increase their cost structure. At the post-policy press conference on Friday, RBI Deputy Governor Viral Acharya had said that NBFCs that had been growing thanks to the issuance of short-term debt were following a “myopic strategy”.

Since 2013, when bank credit growth began to slow, Indian infrastructure projects, in particular, had begun to look to the NBFC sector as a source of long-term finance. NBFCs had become an intermediary between banks and others which were not willing to lend to long-term projects and the projects themselves. This is, per se, not an unproductive niche in the real economy. The problem, however, is that it simply shifts the asset liability mismatch problem away from the banking sector to the NBFC sector. The problem of how long-term financing can be arranged for projects continues to be unanswered. This is especially acute, given the volatility of much short-term global capital. Recent efforts by the government to create other avenues for long-term capital to get into Indian project finance, such as the National Infrastructure Investment Fund, or NIIF, are therefore welcome.

While there will undoubtedly be a shake-up in the NBFC sector as a result of this crisis, and any stricter financing norms would likely cause many smaller NBFCs to shut down, it is important not to throw the baby out with the bath water. There is much utility to this level of intermediation within financial markets, occupying a level between banks or mutual funds and the micro-finance institutions at the ground level. NBFCs are often capable of financial innovation, which does not come easily to banks. Many borrowers outside the main metropolitan cities rely on NBFCs for credit, and gutting the sector or raising its costs too high would have a deleterious effect on investment and growth in some of India’s most under-banked regions.

Thus, the RBI must keep the sustainability of growth momentum in mind when it frames its rules for NBFCs. Certainly, the chances of major crises must be reduced. But it is not possible to force all forms of rollover risk out of the equation completely, and it would be unwise to try to. Maturity transformation is an important task for this level of financial intermediaries. In the absence of many other routes for solid financing of longer-term projects, the NBFC sector remains crucial — and the new regulations must reflect that reality.