New banking guidebook: What does it mean to the industry?

Excerpts from Markets Midday on CNBC-TV18 Watch the full show » City Union Bank BSE | NSE 29/05/12 Are Mutual Funds betting on City Union Bank? Other Stocks in this news Bajaj Finserv | Shriram Transport Finance Corporation | Mahindra & Mahindra Financial Services | Shriram City Union Finance | Bajaj Finance |

A few days ago, the Reserve Bank of India (RBI) presented a couple of important pieces of discussion. One of them was the working group report on regulations for non-banking finance companies (NBFCs), which have not been framed into rules yet, but might kick in anytime soon.

The provisioning norms are being changed. Earlier, a loan was said to be bad if the interest didn't come in for six months, now a loan is termed so if the interest doesn't come in for three months. So, NBFCs now have to provide more services, and, quickly.

In an interview to CNBC-TV18, Sampath Kumar, analyst at IIFL; Sanjeev Bajaj, managing director of Bajaj Finserv and N Kamakodi, managing director and chief executive officer of City Union Bank discussed their views on the NBFCs as well as the impact of the bank license rules.

Here is the edited transcript of the interview. Also watch the accompanying videos.

Q: As far as the set of working paper indications were concerned, have you marked anyone lower or within the entire sector? Would you put a sell or underweight on any of the stocks?

Kumar: In terms of the recent changes, we would not mark on anybody at this point of time. Clearly, this puts an end to the uncertainty in the investor's mind. The issues addressed by the RBI looks like a good long-term structural change than being negative. Negative implications can be in the shorter term.

Higher and tighter NPA norms and provisioning norms means that NPLs and provisions would go up in the shorter term. As far as tighter capital adequacy requirements are concerned, the NBFCs might not be able to leverage as one would believe.

If NBFCs do not maintain or follow the practices in asset liability management, liquidity coverage ratio will have some issues. We don't find significant issues on the NBFCs that we cover.

As far as the tighter NPA and provisioning norms are concerned, NPAs will rise by about 60% as a result of bringing down the NPA recognition norm from 180 days to 90 days.

Currently, the companies that we cover have an NPA of about 2.8%, which will inch closer to about 4.7 or 4.8%. The current set of practices that the companies follow in terms of recovery and monitoring are geared for 180 days. They will be given sometime with a phased manner.

When banks moved from 180 days to 90 days, then we got a three year window. If NBFCs too get this three year window, then they would tighten their recovery and monitoring process, and bring down some of this impact.

If none of that happens, NPAs go up from 2.8% to 4.8% and higher provision kicks in, the earnings will get impacted by about 5% and no more. When the new NPLs brought under the tighter recognition process, it will all as substandard. It will be required to provide only 15% of the substandard assets.

All these NBFCs carry a very high provision at this point of time. Shriram Transport and Mahindra Finance carry more than 80%. The provision coverage may not get as much diluted.

Given all these factors, the impact might be negative on the short-term, but would not be significantly large. The assets are typically of three-four years in terms of tenure. The change in norm will not change the underlying behaviour of the assets. What we might end up providing now, it might not be required to carry on forever.

Q: Which is the most vulnerable from this NBFC?

Kumar: We cover Shriram Transport , Mahindra Finance , Shriram City Union and Bajaj Finance . For these NBFCs, we don't see any impact more than 5% at this point of time. We need to fine tune our view as we go along and engage these companies in the discussion. Given the valuations, we don't need to be very cautious in any of these names.

Q: On the strength of draft rules, are you moving ahead on tanking up or de-tanking on any of them? For example, the Tatas have a little over 4% in DCB and the other south based bank City Union also held a little bit by Larsen. Will these become attractive pickings? Would this be the logical way to go? This diversified ownership indicates that Larsen appears to have chance better than others in terms of no identifiable promoter. Are you marking up any stock on the strength of the draft rules?

Kumar: The draft rules suggest that there are more contenders than what we would have thought sometime before. There is no bar for corporate houses to enter this space. The RBI's discussion paper said that there will issue limited number of licenses, which will be slightly difficult to guess on who will win and who will not get it.

L&T is a diversified company, run by professionals. It has NBFC within the group which fits into the holding company structure that RBI wants. L&T looks like a lead contender at this point of time. The number of licenses that RBI will issue will include some of the NBFCs, which will get converted.

I don't know whether L&T comes under NBFC route or industrial group route. Shriram group could be a contender in this case. It will be difficult to pick the winner, but one or two would rank high in the order and L&T will be one of them.

Q: Have you not yet marked anyone plus or minus because of the bank rules?

Kumar: That's right.

Q: This margining system, which brokers have been against because the NBFCs have side stepped the margining system by saying that they are not under SEBI, but RBI. This rule might ask them to obey the SEBI rules. On the strength of that, are you marking down any of the NBFCs that you cover?

Kumar: We don't cover any of the NBFCs in the capital market business. At this point of time, we don't have a view on the impact.

Q: Does the company qualify for banking license as of now?

Bajaj: Bajaj Finserv qualifies. By and large, the guidelines are in line with what we have been hearing. We have put in certain requirements on capital adequacy in the initial years. The penetration into rural areas is in line with both the government's and RBI's desire to increase financial inclusion. We will evaluate within the company, but it makes sense to apply.

Q: One of the contentious issues which came up in this draft guideline is that the central bank has not specified what exactly diversified ownership means and how they will judge the business of professional management of banks by corporates. What is your sense on this guideline?

Bajaj: These are open areas. That is in the last part of the guidelines, it says that the final discretion to grant licenses is with the RBI. Prior to that there will be a high powered committee which will go through these applications and make the recommendations. So, RBI has left these areas consciously at a larger level so that they can take a final call.

This is still a draft guideline and the final guideline will come after people have given their comments. I believe they will in many ways just be similar to where they are now with just some tweaking. There is still time between now and when this process will end.

The Banking Regulations Act has to be modified which RBI has clearly said, we will have to precede this grant of new licenses. So I am sure we will hear more in coming months. There is discretion that RBI will apply to decide who to eventually grant licenses out of the eligible which is fair.

Q: There is no mention of takeover of smaller banks  in the regulations but there are some contenders one would think. Are you looking at that route, buying a bank to expand?

Bajaj: This guideline clearly talks about setting up new banks. That is a part of the intention to have few more banks so that we can push banking penetration in this country. We know that it doesn't happen overnight. It will happen over a number of years. The act does address the issue of allowing to buy an existing bank to some extent in terms of additional voting rights. Beyond that, in the current situation it is on a case to case basis. If someone has a business plan and goes to RBI, its for them to take a call.

Q: Would you think some restructuring would be required in Bajaj FinServ inorder to meet the diversified ownership guidelines?

Bajaj: When I read through the guidelines, I believe Bajaj Finserv today is the holding company for our financial services business and ends up qualifying by itself. But I am not an expert on structuring. We will be talking to the right people and will take a look at these guidelines in greater details. Once the final guidelines come we will then decide if something needs to be done. As of today, we are almost home as far as the basic structure is concerned.