- RBI worried about the NBFC space
- The risk to the system from failure of large NBFCs is very high
- NBFCs with poor reputations finding it difficult to raise resources
- NBFCs are leading the delinquency table in various retail lending segments
- Greater regulation with no bank-like access to low-cost funding will exert pressure on profitability
- Has the time come to grant banking licences to some more NBFCs to reduce systemic risks?
The shadow banking sector is not small anymore and the evolving crisis in the segment has left the banking regulator worried. This was evident in the recently released Financial Stability Report (FSR). With the brisk pace of growth, some of the large NBFCs (non-banking finance companies) and HFCs (housing finance companies) are much larger than many banks today. So will the regulator be willing to grant banking licences to some of the larger non-bank entities to reduce systemic risks?
Systemic risks posed by large NBFCs very high
In the recently released FSR, the Reserve Bank of India says the collapse of some NBFCs/HFCs can result in systemic losses comparable to those caused by the failure of big banks. This underscores the need for greater surveillance over large HFCs/NBFCs.
NBFCs as well as HFCs in recent times have been in focus for all the wrong reasons - their exposures, poor quality of assets and asset-liability mismatches (ALM).
While recognising the liquidity stress in the NBFC sector in the wake of the IL&FS crisis, the RBI observed that there was an increase in funding costs as also difficulties in market access for some. However, better performing NBFCs with strong fundamentals were able to manage their liquidity even though their funding costs moved with market sentiments and risk perceptions.
Weaker NBFCs getting into a vicious cycle
But the events of the last couple of months show that even the larger NBFCs (and HFCs) with not so great reputations found it hard to get liquidity support, especially from mutual funds that had been their key funding line pre-IL&FS crisis. The waning liquidity worsened their asset liability mismatch (ALM) problem. Finally their target lending markets, many of which are reeling under a long slowdown, are reaching a point of capitulation, thereby bringing to the fore the issue of asset quality.
Bank borrowings, debentures and commercial papers are the major sources of funding for NBFCs. Bank borrowings have shown an increasing trend as their share to total borrowings have increased from 21.2 percent in March 2017 to 23.6 percent in March 2018 and further to 29.2 percent in March 2019. This indicates that banks are compensating for the reduced market access for NBFCs in the wake of stress in the sector.
So the IL&FS stress episode has inadvertently brought the NBFC sector under greater market discipline as the better performing companies continue to raise funds while those with ALM and/or asset quality concerns are subjected to higher borrowing costs.
In a way the system is forcing the “survival of the fittest” with the weaker ones gradually losing significance in terms of market share.
Are the NBFC’s lending practices an area of added concern?
Thanks to the NBFC boom and the stress in the corporate credit pace, the consumer credit sector has seen a huge upswing.
While the relative share of banks and NBFCs in four consumer credit products, viz. auto loan, home loans and loans against properties and personal loans has been more or less constant, given the substantial growth rate in these sectors, a possible concern is dilution in credit standards.
A look at the bad loans in each of the segments shows that NBFCs as a group have been leading delinquency levels in almost all the sub-segments of consumer credit (except in loans against property where they stand a close second to PSU banks) when a uniform delinquency norm of 90 days past due is applied.
So while NBFCs are now an important part of the financial system – close to Rs 20 lakh crore in outstanding loans, or almost 20 percent of the size of the banking system---their business model remains a source of concern for the central bank.
But RBI is not the sole regulator of the entire shadow banking space, the housing finance companies are regulated by the National Housing Bank.
Can NBFCs survive with ‘bank like’ regulations?
While stricter control on NBFCs is a given, with greater regulation the compliance cost of doing the business will only go up whereas they will be still at a disadvantage with respect to banks in terms of funding (banks have access to low-cost CASA and stable term deposits).
So the time may be opportune to take a re-look at banking licences for some of these large but troubled entities so that the risk to the system from their sheer size gets reduced. Their direct regulatory oversight by the RBI and also a viable business model in a banking avatar should be good news for the financial system.Is the probable merger of a large troubled HFC with a small old private bank a reflection of this worry? If yes, this could be the beginning of a new trend in the Indian financial sector.