NBFCs need more funding options to keep rates affordable
Until not very long ago, many observers and commentators believed that the role of non-banking financial companies (NBFCs) in India‘s financial system was fast diminishing.
Until not very long ago, many observers and commentators believed that the role of non-banking financial companies (NBFCs) in India’s financial system was fast diminishing.
There were also fears that payment banks and small banks — two new categories of financial institutions — and a potentially longer queue in the coming years because of on-tap bank licences will eventually “crowd out” NBFCs from the institutional lending space.
Evidence of the last two years, however, has proved otherwise. The regulatory and policy changes have also demonstrated that the Reserve Bank of India (RBI) believes that NBFCs are vital cogs in India’s institutional lending landscape, which substantially support the government’s financial inclusion goal.
In November 2014, the RBI came out with a new set of guidelines, clearly defining the rules within which NBFCs will have to operate in India.
It has brought NBFCs at par with commercial banks so far as non-performing assets (NPAs) or bad loans are concerned.
The new NBFC framework is aimed at addressing risks and regulatory gaps and arbitrage both within the sector as well as other financial institutions and harmonise regulations “to facilitate a smoother compliance culture among NBFCs”.
NBFCs have gained a share in total credit in Asia’s third-largest economy. A December 2015 report of the Boston Consulting Group (BCG) and Confederation of Indian Industry (CII) showed that their share of credit rose to 13 percent in 2015 from 10 percent in 2005.
This is particularly significant in narrow market segments such as home loans, small ticket cash loans, and lending for two-wheelers and consumer durables.
According to the RBI, the introduction of differentiated banking licences, the landscape of the banking industry is expected to undergo significant changes. The central bank has acknowledged that the process itself is heralding a churning in various categories of financial entities, mainly NBFCs.
The inter-connectedness of the financial system is expected to get more embedded in the coming years. According to RBI data, while NBFCs continued to be the largest net receivers of funds from the rest of the system.
As of March 2016, the banking sector had an outstanding exposure of over Rs 2 lakh crore to NBFCs.
A careful scrutiny shows that large NBFCs have been increasing market borrowings, and most analysts expect this trend to continue in 2016–17 as the spread between market borrowings and bank borrowings stands high at 1–1.5 percent.
There is, however, a caveat that both the regulator and the industry has to remain alert to. Safeguards need to be fortified to deal with potential systemic risks in wake of NBFCs’ growing reliance on bank funding.
This is because the other refunding options for NBFCs are hardly available, if not completely non-accessible. This prevents NBFCs from getting access to a diversified funding structure. Diversified funding options are necessary. Cheaper funds will only help bring down final borrowing rates for consumers and aid financial inclusion.
This is particularly important because the funding structure is gradually moving from short-term to longer tenure borrowings. NBFCs are keen to take advantage of the soft interest rate regime that currently persists and, therefore, are tending towards locking-in longer-term borrowings from banks meet their funding requirements, and strengthen liquidity.
Since most NBFCs do not get recourse to the funding windows available to a conventional bank, it may be worthwhile to examine whether they should be given access to refinancing schemes from the National Bank for Agriculture and Rural Development (NABARD), National Housing Bank (NHB), Small Industries Development Bank of India (SIDBI), etc.
The RBI has rightly said that the new regulations are aimed at rationalisation and liberalisation to allow a greater operational freedom for other NBFCs.
Opening up new vistas for capital raising will fulfil a two-fold objective: it will allow NBFCs more “operational freedom” and, importantly also help keep lending rates low and affordable, which is critical for meeting the objectives of financial inclusion.