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Treating Symptoms, Not The Disease

Though the Budget has provided immediate relief to the NBFC sector, it has failed to tighten the systemic noose around the factors that created this crisis

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One of the many issues that have dominated the Indian financial landscape is the credit crisis that painfully unfolded after IL&FS failed to service its debt obligations in the last quarter of 2018. The three-decade-old lending giant defaulted on a few payments and failed to service its commercial papers (CP) on the due date. A similar story unfolded at DHFL (Dewan Housing Finance), another shadow bank engaged in housing finance activities, followed by smaller names, thereby inviting a series of downgrades from the rating agencies. Although the market was rife with fears that IL&FS’s collapse would lead to a chain reaction across the NBFC space, but nothing of the sort has happened even after 10 months. It is increasingly being realised that there were company-specific reasons at play.

The IL&FS debacle has served to underline the high risks inherent in NBFC business models that rely on short-term market borrowings for long-term loans. The resulting risk aversion by lenders has landed NBFCs and Housing Finance Corporations (HFCs) with high asset-liability mismatches in hot waters (for instance Reliance ADAG firms and DHFL). The NBFC sector plays a critical role in powering consumption and ensuring credit flow to unbanked segments and its troubles needed objective assessment and solutions.

The Budget was expected to go for structural reforms while addressing the fundamental ailments faced by some sectors, NBFCs being one of them. But it stopped short of that. Several steps have been announced but they are inadequate on some counts.

Proposals in the Budget 
The government provided credit guarantee to banks to purchase Rs 1 lakh crore worth of pooled assets of highly-rated NBFCs for six months.  Further, to enable the banks to implement this announcement effectively, the RBI said it would provide a liquidity backstop to the banks against the excess G-Sec holdings. This partial credit guarantee would help NBFCs raise funds from PSU banks in a relatively easy manner. Also, the government has mooted the proposal to remove Debenture Redemption Reserve (DRR). Currently, NBFCs raising public funds have to set aside 25 per cent of the proceeds as DRR. It would bring public issuances of NBFC bonds on a par with private placements. The government even proposed to remove Section 43D related to taxation of income on NPA helping NBFCs to bring down their cost of operations. The Budget also proposed moving HFCs under the RBI regulation. So far, they were under the National Housing Board (NHB).

According to Milan Vaishnav, Consulting Technical Analyst, Gemstone Equity Research & Advisory Services, these steps provide symptomatic relief and seem grossly inadequate to counter the crisis from happening again. “No doubt, some amount of liquidity has been pumped in but there could have been more to tighten noose over the reasons of the crisis,” says Vaishnav.

Finding the Root Cause
The origins of the credit crisis can be traced partly to the period between 2004-05 and 2008-09, when commercial credit offtake grew 100 per cent. The businesses borrowed furiously so as to capitalise on the growth opportunities. Banks and lending institutions compromised on the creditworthiness of the borrowers. Massive investments went into infrastructure and related areas such as power, telecom, roads, aviation, etc. But the intentions and the ability of the borrowers to repay were either overlooked or intentionally compromised. After the passage of a few years, all NBFCs started facing re-payment delays, which resulted in a liquidity crunch. These lenders started to face contraction in spreads, sustained rise in funding costs and increased the spotlight on the asset-liability mismatches. The mismatches further led to constrained financing from the market-based sources like CP, non-convertible debentures (NCDs) and banks.

It must be noted that even if the domino effect is missing there are several problem areas. One, under pressure from their investors to curtail exposure to NBFCs and lower-rated bonds, mutual funds have sharply cut back on their participation in the CP market, forcing NBFCs/HFCs relying on rollovers to scrounge for funds. Two, redemption pressures on credit funds and general risk aversion from institutional investors have led to a skew in funding towards big NBFCs/HFCs while lesser ones struggle. Three, funding costs have seen a sharp spike irrespective of the category of non-bank borrower. While bond market funding of NBFCs has shrunk, banks have stepped up their lending. Between August 2018 and April 2019, even as the mutual fund exposure to NBFCs fell from Rs 3.8 lakh crore to Rs 3.1 lakh crore, their outstanding bank credit shot up from Rs 4.9 lakh crore to Rs 6.2 lakh crore. Smaller NBFCs, which rely exclusively on banks and not market borrowings, have had access to credit lines. All this needed to be addressed in the Budget.
The real challenge is how to boost the credit offtake of the NBFCs. According to Alok Mundra of KPMG India, “The bank re-capitalisation is adequate enough and some moves have been made relating to NBFCs… but the real challenge remains on how to boost credit offtake.”

Also, RBI will now have to undertake special audits in view of the loss of confidence in credit ratings and accounting practices of non-banks. This may be essential to shore up the market confidence in the sector and help lenders to separate the wheat from the chaff. This required some regulatory framework.

However, it must be also noted that it is not really the absence of regulations but ineffectual supervision by the RBI and NHB that left the doors open for the IL&FS and non-bank crises to play out. Therefore, rather than adding to their voluminous regulations, the regulators need to deploy additional manpower and acquire forensic capabilities to more closely monitor the frequent statutory filings of individual firms.

Finally, it must be said that the government could have taken strong steps in introducing structural reforms in this sector like better risk-evaluation and risk-management within the NBFC sector. The steps taken in the current budget are inadequate to ensure such a mess from resurfacing again in the future.  


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