Himadri BuchMoneycontrol
The Narendra Modi government’s decision to demonetise Rs 500 and Rs 1,000 currency notes is expected to have an adverse short-term impact on a number of sectors.
Analysts believe that a small but fast-growing segment for banks and non-banking financial companies, or NBFCs, termed loan against property (LAP), is at particular risk from the government’s move to crack down on the cash economy.
In this, a lender issues a loan keeping a customer’s property as security, with sanction being typically up to 60 percent of the underlying’s market value. Customers take out these loans for personal or business needs or even to buy another property.
At Rs 2.5 lakh crore split roughly evenly between banks and NBFCs, LAP is among the fastest growing segments in the country’s Rs 80 lakh crore credit industry.
It has been one of the engines of growth for NBFCs, whose loan books have grown in the high teens in the most recent financial year, compared to single-digit growth for banks.
But demonetization could cause near-term disruptions in collection cycles along with a spike in overdues, which could put NBFCs’ liquidity strength and disbursal cycle under pressure.
Especially hit would be housing finance companies that cater to the self-employed segment or offer small-ticket loans.
In the wake of demonetization, experts believe the cash economy – estimated to be about 15 percent of the GDP – could come to a grinding halt. This is expected to put pressure on ability of customers who dealt primarily in cash to pay their EMIs on time.
“NBFCs with deep linkages to the cash economy will face business challenges as their borrowers would have to reinvent their business models and pay higher taxes, which would affect their profitability and financials,” Kotak Institutional Equities said in a note.
According to Religare Securities, also hit would be customers belonging to the micro, small and medium enterprise (MSME) segment – who typically pledge property to obtain working capital loans, etc. “They may see their cash flows getting impacted in the short term,” it said in a note.
As a result, going forward, NBFCs will have to modify their credit evaluation processes to “accommodate whatever impact demonetization has on their total business, monthly cash flows and surplus to service LAP installments,” said Sachin Khandelwal, CEO, Magma Housing Finance.
Further, experts also believe that the note ban could cause property prices to crash in at least some, overvalued, pockets in the country.
This would put pressure on the loan-to-value ratios for companies that have lent aggressively. In the unlikely scenario of value of a property going below loan amounts, outright customer defaults would also be possible.
It is not that demonetization is the only factor that is the cause of stress. Following years of fast growth, cracks had started to develop in the business model.
Recently, India Ratings had warned that signs of early stress were clearly visible in the LAP business, indicated by a sharp rise in 90 days past due (dpd) delinquencies, for some of the large players.
“A combination of stagnant property prices, especially in metros and large cities, which are the primary markets for large and medium ticket LAP, and squeeze on refinancing due to risk aversion building up in some financiers, is bringing stress to the fore,” Harshal Patkar, analyst at India Ratings, wrote.
Aware of the rising risks, NBFCs too had started to take action. Indiabulls Housing Finance, among the pioneers in the LAP segment, had decided to reduce its exposure and assess risks that it writes in its books. Bajaj Finance had trimmed its LAP loans, which fell 5 percent during the previous quarter.
But Bajaj Finance, which recently informed the exchange that it sees a ‘low short term impact’ on its LAP collections following the currency ban, is also optimistic about the move.
It believes that the cash ban – which is expected to give a boost to the formal economy by forcing customers to transact through banks – will be a boon for business over the long term.
Bajaj said that besides help cut interest rates in the economy -- leading to a significant spur in demand in the medium term -- it will result in a significant increase in “financialization of business”.
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