NBFC business has to hit the reset button after RBI strengthens norms

Shadow banks will have to review how they lend money as Mint Road puts a squeeze on their credit lines

“We will raise Rs 300 crore via bonds of two-, three- and five-year tenures. This will be our maiden bond issuance and is part of our effort to widen funding sources,” says Vimal Bhandari, executive vice-chairman and chief executive officer (CEO), Arka Fincap. The firm, a subsidiary of Kirloskar Oil, is only five years old and small (assets of around Rs 5,000 crore with an “AA” rating), but the response to this float will be closely watched: It would be the first by a non-banking finance company (NBFC) after Mint Road upped the risk weights on bank exposures to them by 25 percentage points.
 

The move by the Reserve Bank of India (RBI) has caught NBFCs off guard even though the issue had been flagged by Governor Shaktikanta Das with their corner-room occupants (and that of banks) in July and August 2023 – on consumer credit and the dependency on bank borrowings. But the red lights were flashing before this interaction.
 

The RBI’s 'Financial Stability Report' of June 2023 drew attention to NBFCs’ personal loan growth: It rose year-on-year by 31.3 per cent while that to industry grew slower by 12.7 per cent. During the last four-year period, the portfolio grew rapidly – at a compound annual growth rate of more than 30 per cent, and its share of the book moved up to 31.3 per cent in March 2023.

And two years ago, the 'Report on Trend and Progress of Banking in India' (T&P: 2020-21) gave a hint on what could be in store. Bank credit growth had remained subdued, “but NBFCs have stepped up to fill this space… concerns have emerged about NBFCs’ asset quality.”
 

So, why did RBI not step in earlier on the consumer and unsecured exposure front, and do what it has done now? Perhaps, it was waiting for the blush of this festival season to get over.

A blunt regulatory move?

Y V Reddy, as RBI governor then, upped the risk weights on consumer credit and banks' capital market exposures to 125 per cent from 100 per cent before the financial flu of 2008; Das is also doing the same before a bubble builds up – a preemptive strike. It is as good as hiking the repo rate, but without the optics surrounding it as a busy electoral season is in front of us. That said, a major peeve is in its efforts to curtail the runaway growth in consumer credit, especially unsecured, the RBI’s hammer has come down on NBFCs’ liabilities side (read funding). And that too, five years after co-lending was set in motion between banks and NBFCs. And the smaller NBFCs and the segments they cater to, will be the worst hit.
 

Gurpreet Chhatwal, managing director (MD) of CRISIL Ratings, says: “The recent regulatory measures are targeted at unsecured retail loans and do not impact the secured asset classes where growth is expected to be steady”. But the Finance Industry Development Council  – a lobby group for shadow banks – sees it differently. According to its director- general Mahesh Thakkar, it will affect NBFCs which have little to do with consumer credit. He’s for a rollback “of risk weights on bank loans to NBFCs” in cases where a majority of the loanbook is to micro, small and medium enterprises, vehicle finance, and categories of loans that have been excluded from the purview of the RBI circular.

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The bigger players will weather the storm. “We are not dependent on bank funding. Only around 25 per cent of our borrowings are from banks. NBFCs will have to diversify their funding avenues, be it through bonds or securitisation,” says Y S Chakravarti, MD and CEO, Shriram Finance.

But this window will be open only for select players. ICRA, in a November 23, note observed the sell-downs of personal loan retail pools, which had gained momentum in recent years, will be affected: These stood at about Rs 1,150 crore in FY23 and had already crossed Rs 800 crore in H1 FY2024 (that is, four times of the volumes seen in H1 FY23). Such transactions had picked up pace given the growing financing needs of NBFCs to meet the strong credit demand for consumer and personal loans. Plus, the huge appetite for personal loan as an asset class by banks that were purchasing these pools as well. This loop is set to be broken.
 

Bond market in the spotlight
 

The Securities and Exchange Board of India has said that large companies with ratings of “AA” and above, should borrow 25 per cent of their funding through the bond market. It will reduce their reliance on bank finance. It’s also desirable on its own as a measure – banks being the only lenders in town is an archaic notion (though it’s only the US which has a deep corporate bond market in the truest sense). Another variable is the HDFC Ltd-HDFC Bank merger: It has increased the headroom for issuers of corporate bonds as HDFC Ltd will not be in this market here on (CRISIL Ratings has estimated that it used to be at 8 per cent of the bond market.) Technically, this represents an opportunity for all manner of issuers. Can the corporate bond market become a major source for funding for NBFCs? Unlikely: Given the general feeling that many NBFCs may see a deterioration in their books; and are basically tapping this market following the RBI’s decision to tighten the screws on bank credit lines to them.
 

In FY22, ratings were assigned to 1,235 corporate debt securities amounting to Rs 22.55 trillion. Of these, 278 or 22.5 per cent were rated “AAA” and 358 (or 29 per cent) were rated “AA”; and 66 issuances (or 5.3 per cent) were non-investment grade. The skew is much more pronounced when looked at in value terms – 80 per cent of issuances in value terms were rated “AAA” and another 15 per cent were rated “AA”. “While we can discuss the reasons for this trend, it is clear that the corporate bond market largely meets the needs of highly rated corporates,” said RBI deputy governor T Rabi Sankar in his speech on 'Corporate bond markets in India: Challenges and prospects' (August 24, 2022). Then, the bulk of issuances every year is through private placements, rather than the public route. In FY22, public issuances stood at Rs 11,589 crore – just about 2 per cent of the amount of money raised through private placement at Rs 5.88 trillion. And “what is somewhat unique in India is that investors in debt-oriented mutual funds – which is the avenue through which globally the retail investor participates in the debt markets – are also largely institutional.”
 

An elephant in the room is the the Insolvency and Bankruptcy Code (IBC) and its linkage with the bond market. “Currently, highly-rated bonds attract domestic and foreign investors. Certainty of outcome (of resolution) within a realistic time frame will build investor confidence in bonds issued by lower-rated issuers,” says Divyanshu Pandey, partner at S&R Associates. That’s because a key difference between the bond and bank-loan market is that in the former (in many cases), bond holders at the time of default might not have direct contact with the issuer – as the bonds would have traded hands. It becomes all the more difficult to get a resolution going as just about everybody at the table pulls in different directions. In the case of RBI-regulated entities, this is not a headache: The banking regulator steps in to facilitate the resolution process. But this should not distract from the fact that for a wider bond market, the IBC process must become swifter.
 

In the immediate, an across-the-board hike in NBFCs’ cost of funds is on. And it will be passed on some time down the line in the case of NBFCs with better unsecured portfolios as the yields will be more than adequate to cover for the uptick in the cost of funds. There could be changes in the inhabitants in the RBI’s four-layered scale-based regulatory framework as well – a shakeout in the base layer (NBFCs with asset size below Rs 1,000 crore) may be on the cards.

The shadow banking business will never be the same again.

Reducing Risk

- The RBI’s strictures on risk weights have caught NBFCs off guard even though the issue was flagged before

- The regulator is curtailing the runaway growth in consumer credit, and its hammer has come down on NBFCs

- The impact will be a across-the-board hike in NBFCs’ cost of funds. It will be passed on down the line in the case of NBFCs with better unsecured portfolios