NBFCs will play a pivot for growth revival. Let more liquidity flow

Rupa Rege Nitsure

The coronavirus pandemic will not just cost many lives, but also institutions, if there are recognition and response lags in economic policies. While policymakers’ immediate focus is on controlling the disruptions from the pandemic, the eventual goal of putting the economy back on its feet once the pandemic abates, should not be lost sight of. It needs to be recognised that banks and NBFCs (non-banking financial companies) will play a critical role when India will get ready to kick-start production once the immediate health crisis has passed.

The crisis brought about by the pandemic is not a financial crisis, but a real crisis that has impacted both demand and supply, disrupted value chains, increased unemployment and reduced income levels across the globe. The IMF (International Monetary Fund) has warned about the worst global recession in almost a century.

Different countries, including India, have responded with traditional tools of countercyclical monetary and fiscal policy to avoid a rapid contraction. However, there is a growing feeling in all parts of the world that monetary policy has lost most of its ineffectiveness and fiscal interventions too need to go beyond countercyclical “pump priming” and instead take on responsibility for directly leading recovery, investment and growth.

In the Indian context, the Reserve Bank (RBI) tried to support the financial sector through two sets of broad measures within just a month to battle a slowdown.  In the last week of March, its Monetary Policy Committee slashed the repo rate by 75 bps and introduced a 3-month loan moratorium to provide relief to borrowers. On April 17, it announced additional measures, including targeted long-term repo operations (TLTRO) for lending to NBFCs (with 50 percent reserved for smaller NBFCs), another 25 bps cut in reverse repo rate to encourage banks to lend more and relaxing NPA (non-performing asset) recognition and liquidity coverage norms for banks. The idea was to ensure survival of healthy NBFCs that in a normal business situation support growth.

However, RBI’s measures are not enough to ensure NBFCs will receive it in sufficient quantity as credit outlook is still uncertain and banks do not have adequate level of risk capital. The day on which the RBI announced its second set of measures, S&P Global Ratings revised downwards its economic growth projections for India and its ratings and rating outlook on a few NBFCs, saying the overall impact of economic slowdown will be more pronounced on NBFCs than on the banking sector because the former lend to riskier people and businesses.

S&P expects NBFCs to face accentuated liquidity risks. As a large proportion of borrowers opt for the moratorium, cash inflows for NBFCs may be limited, making them dependent on their liquid assets and refinancing to service their upcoming debt maturities.

There are many anomalies in the measures taken so far. While most NBFCs and MFIs (microfinance institutions) will have to give loan moratoriums to their borrowers (as economic activity has stopped and norms of physical distancing create barriers for collections), they are yet to receive a moratorium from banks from whom they have borrowed money.

Moreover, NBFCs borrow money not just from banks but also from capital markets and no forbearance is given on capital market instruments. These will have to be retired as and when the liability is due for repayment.  Even the RBI’s TLTROs are not helping much to take care of the liquidity mismatch, as the risk appetite for money market instruments of NBFCs is not very high.

According to a Credit Suisse report, mutual funds have reduced their aggregated exposure to NBFCs by nearly 45 percent over the past 18 months and the dip was 14 percent in just March 2020, in line with overall debt and liquid fund AUM (assets under management).

Large NBFCs with a strong parent are relatively well placed at this juncture with sufficient liquidity, comprising liquid assets, undrawn lines from banks, and in some cases funding lines from group companies. But this comfort may not continue for very long, if the period of lockdown gets extended indefinitely.

At this stage, the policymakers need to flatten two curves - the epidemiological and the curve of the economic shock. As NBFCs are an essential component of the Indian financial system, it is imperative that this credit machine does not collapse due to illiquidity. To avoid a series of rating downgrades and possible defaults, the key players of the financial sector -- RBI, SEBI (Securities and Exchange Board of India), MoF (Ministry of Finance), etc) -- need to work in a coordinated fashion and bring about clarification on the pending issues of moratorium on debt instruments of NBFCs like NCDs (non-convertible debentures), PTCs (pass through certificates) and NBFCs’ bank borrowings.

Given the unprecedented speed and the scale of this pandemic, the RBI needs to develop ‘Emergency Credit Facilities’ for the non-bank financial system similar to what the US Federal Reserve had done in 2008. This extended the Fed’s traditional role as lender of last resort from the banking system to the overall financial system for the first time since the Great Depression. Many of these facilities were structured as special purpose vehicles controlled by the Fed because of restrictions on the types of securities that the Fed can purchase.

Even from the fiscal side, the extension of credit guarantees and bridge loans will be more effective than nudging banks to take higher credit risks or invest in low-rated investment instruments. More than easy monetary policy, what will work in the current situation is the direct fiscal intervention in various sectors, including NBFCs.

Following the Bank of England, the regulators of NBFCs should also make an effort to enhance the robustness of and bring greater consistency in the application of Ind-AS (Indian Accounting Standards), a version of IFRS 9 (International Financial Reporting Standard), as it will be tough for NBFCs to make forward-looking judgements in their financial statements in the current environment of heightened uncertainty.

Since the current phase of large-scale economic disruption is unique, there is a need to revisit the role of rating agencies and rating actions until the situation returns to normalcy. Otherwise, rating actions will give rise to unnecessary panic rather than optimum resolution.

The coronavirus pandemic is the most serious challenge to banks and NBFCs in nearly a century as they will be coping with a long-term slowdown.  Giving enough support to their ecosystems at the right time will ensure the eventual economic recovery will be as vigorous as possible.

Rupa Rege Nitsure is Group Chief Economist, L&T Financial Services. Views are personal.