Better safe than sorry: RBI starts inspecting NBFCs for exposure to high-risk assets

As a cautionary measure, the Reserve Bank of India (RBI) has started an inspection of several non-banking finance companies (NBFCs) to assess their exposure to high-risk assets, sources told Moneycontrol.

"The central bank has called for an inspection of several systematically important companies to check which of them have over-leveraged their loan exposures to the risky portfolios. The scrutiny on the NBFCs has been tightened. Especially, when they are growing at a high rate and after seeing the IL&FS crisis," a source said.

RBI had not responded to our query when this article was published. Vulnerable NBFCs and housing finance companies (HFCs) will likely be watched closely from hereon.

The recent panic in the market had intensified after it became known that in an internal communication with banks around mid-September, the RBI had assessed the health of the top 20 HFCs, six (smaller ones) of which had relatively-high risk profiles. As a result, banks were asked to reduce their exposure to these HFCs.

Most public sector banks and some large private sector banks, have been facing high levels of stress in loans given to corporate borrowers. Over the past few years, they have refrained from lending to even riskier segments such as small and medium enterprises (SMEs) and affordable housing borrowers, all of which depend on the performance of large corporate borrowers.

"A lot of NBFCs have also given loans against properties and they are now facing liquidity crunch given the stagnancy in the real estate market prices and the economy," one of the sources said.

Growth of non-banks

NBFCs, including HFCs, have grown dramatically over the last 3-4 years. The industry's loan growth was 21.2 percent, while its borrowings grew by 19.1 percent. Also, gross non-performing assets (NPAs) decreased to 5.8 percent in 2017-18 from 6.1 percent in 2016-17.

"The genesis of this problem rests in the rapid pace of rise in NBFCs' share in financial intermediation since 2014-15, when banks were battling with rising stressed loans and slow credit growth," DBS economist Radhika Rao siad in a report.

Banks, however, continued to lend to NBFCs because their relatively high capital bases made it easier to recover dues from them in case there is a default.

As a result, NBFCs grew rapidly by taking on more credit risks at a time when banks were averse to lending. Easing of rules by RBI and a huge untapped market also led to a proliferation these companies. The number of HFCs alone went up from around 50 in 2013 to nearly 100 right now.

As at the end of March 2018, there were a total of 11,402 NBFCs registered with RBI, 156 of which were deposit-taking firms and 249 were systemically important non-deposit accepting ones.

Their combined balance sheet size stood at Rs 22.1 lakh crore, according to RBI's financial stability report released in June.

Cash crunch or systemic issue?

NBFCs' prolific rise brought with it two vulnerabilities, Rao said in the report.

"Firstly, there was a sharp deceleration in the share capital growth of NBFCs in FY18, whilst borrowings quickened, implying rising leverage.

"Secondly, the liabilities breakdown shows bank borrowings account for 16 percent of total in FY17, while market-based instruments like debentures (33 percent) and commercial papers (6 percent) assume a bigger proportion of liabilities. Ample liquidity along with rating upgrades opened an avenue to tap debt markets, enjoy tighter spreads and lower cost of funds but made their balance sheets prone to sharp re-pricing in cost of funds," the economist said.

According to some industry players, this is not a systemic issue but a precautionary move by RBI.

"I think we all are connecting unconnected dots…We do have a liquidity crunch but that is across sectors and this is not a crisis of asset liability mismatches barring a few large long term financing NBFCs (such as IL&FS…Yes, the RBI is maintaining extra caution but there is no need to panic," said Raman Aggarwal, Chairman of Finance Industry Development Council, an industry body.

Nachiket Naik, Managing Director at IREP Credit Capital, a Mumbai-based non-deposit taking NBFC, said: "I think a lot of focus is on the NBFCs with asset liability management (ALM) mismatch, their (NBFCs') tolerance limit, so it is more compliance issue if there were any gaps and if there is any chance of a default from the systemic risk perspective."

Naik believes that over the last two years, when banks' lending had slowed, NBFCs were filling the void created by them. However, this did not happen at the expense of asset quality. "Current problem is more of an ALM mismatch and RBI is ensuring if there is enough backup that it does not lead to a contagion impact."

He also said that most NBFCs have not witnessed any asset-backed problems. The concern is more due to the fact that some of these companies have borrowed short-term money to fund projects that have long gestation periods.

Meanwhile, RBI has also been cancelling licences of several NBFCs that have capital bases of under Rs 2 crore. Since 1997, a total of 4,230 NBFC licences have been cancelled, most of which was done over the last few months.

Aggarwal said that RBI had issued show-cause notices to the firms, asking them to meet the capital requirement of Rs 2 crore, which many failed to do. Over 95 percent of all licence cancellations were on account of capital issues and not the risk taken on by these companies.

However, given that the cash crunch at IL&FS has resulted in the lender defaulting on multiple debt obligations since August, and the concerns over redemptions of such borrowings and the subsequent drain on liquidity for other NBFCs will keep the banking regulator on tenterhooks.