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Policy Imperatives For Strengthening The NBFC sector – key To India’s Economic Revival

Practical and easy to implement, albeit somewhat bold, steps like the above are needed to stave off a crisis brewing in the NBFC sector and pave the way for an orderly growth of the MSME sector as well as the infrastructure sector.

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We are in the midst of a raging wave II of the pandemic and experts agree that the mutating virus is something that we will have to learn to live with and wishing away the ill effects of Covid19 is not a solution. Whilst lives have to be saved and thankfully the whole country is now implementing public health measures with one voice, we also need to have bold policy interventions to sustain livelihoods. I intend to focus on the imperatives to rejuvenate the largely ignored non-banking financial (NBFC) sector to achieve the much desired economic revival. In the absence of pragmatic regulatory / policy initiatives, the NBFC sector will get permanently decimated with long term adverse implications for the MSME & SME sectors. It is well established that commercial banks cannot replace the role played by NBFCs and so a fast depleting NBFC space essentially means significantly reduced credit capacity of the overall ecosystem.

The micro, small and medium enterprise (MSME) sector has been one of the worst affected in India due to the COVID-19 pandemic. There are some 65 million MSMEs which account for more than 35% of GDP, 40% of exports and 32% of the total employment. The government and the Reserve Bank of India (RBI) have, therefore, rightly taken a number of steps to alleviate the pain of the MSMEs. The MSMEs are also poised to play a crucial role in the government’s elaborate plan to script an infrastructure-driven economic recovery as many of them are involved in activities like construction, transportation and allied services. 

Our policy-makers and regulators must keep in mind that for a vibrant MSME/SME sector we need a robust NBFC sector as well. It is the NBFCs which cater to the credit needs of the unbanked segments of the society, especially the MSMEs. Accounting for 20% of the total credit portfolio, NBFCs supplement and complement the banks in promoting financial inclusion. Capitalizing on their reach and penetration, the NBFCs ensure last-mile credit delivery fuelling entrepreneurship at the grassroots levels. In fact, in the pre-pandemic years, when the banks had cut down on their lending in order to tide over their bad loan problems, it was the NBFCs which had increasingly stepped in to fill up the void created by the banks. As on 31 March 2020, NBFCs had total assets of Rs. 51.47 trillion, almost 25% of India’s GDP. Thus, from a systemic point of view, a rejuvenated and healthy NBFC sector is crucial for India’s economic revival.  

However, the NBFCs have hit an air pocket since September 2018. The IL&FS fiasco had shaken the market confidence on NBFCs thereby restricting their access to funds. Traditionally, the banks and NBFCs have enjoyed a wholesaler-retailer relationship and more than half of NBFCs’ funds were sourced from scheduled commercial banks, and the rest from others like mutual funds and insurance companies. However, post-IL&FS, the smaller and mid-sized NBFCs with ratings of AA and below and the unrated ones have been shunned by both banks and markets, accentuating their liquidity risk. Things got further complicated when NBFCs were left out to fend for themselves by the RBI which inter alia allowed banks and NBFCs to offer a 6-month moratorium to their borrowers and also came up with a one-time restructuring plan for stressed borrowers in select sectors. NBFCs were obligated to provide leeway to their borrowers but had no such flexibility on their own liabilities from banks. While NBFCs adopted an accommodative approach for their customers following RBI rules, they themselves were not allowed to avail this restructuring window from their lenders, neither was there enough clarity on whether NBFCs were eligible for moratorium. On the liability side, NBFCs were left high and dry. Their revenues also dried up as most customers were not in a position to service their loans due to the economic downturn. This resulted in a severe mismatch in cash flows for NBFCs. 

Although both banks and NBFCs have similar functions, there has been a concerted effort to repair the banking system through a series of measures like capital infusion, providing regulatory leeway and the budget announcement of creation of a Bad Bank type structure to free the bank balance sheets from the non-performing assets (NPAs). But the problems of NBFCs have mostly been left unattended. It must also be kept in mind that for the banks, the RBI can play the role of the ‘lender of last resort’, but the NBFCs have no such fallback option. 

Several NBFCs are today facing an existential threat. Once a stressed NBFC defaults, the resultant downgrading not only dents its reputation, it closes most avenues of resource mobilization, virtually ending its chances of a revival. The failure of a few NBFCs can have a domino effect forcing many MSMEs to go belly-up. Also, it is worth noting that NBFCs can fill in a void created by banks, but the converse is not possible, as NBFCs enjoy certain inherent strengths and advantages which the banks cannot match.

A second and much stronger wave of the pandemic has arrived when recovery from the first wave was still nascent. Now many more accounts are likely to become stressed. The NBFC sector is therefore headed for more challenging times. 

In this backdrop, the following steps may be considered by our policy makers and regulators to strengthen the lending capacity of NBFCs and thereby to create an opportunity for MSMEs and SMEs to flourish: 

  • RBI should come up with a simple notification allowing every stressed entity, including NBFCs, to approach the lender(s) and seek a one-time restructuring of the loan account. Only those entities which were not NPA as on 29 February 2020 (the date after which the moratorium became effective) should be eligible. This window should ideally be kept open till March 2022 taking cognizance of the looming uncertainty. All lenders should be encouraged to make revised assessments of their stressed borrowers’ loan-servicing ability based on the cash flows (present and future), the value of the assets and collaterals, and other factors, and work out a restructuring plan, in consultation with the borrowers. The account should not be classified as an NPA. Retaining the ‘standard asset’ classification is necessary to avoid the defaulter tag. After all, these are extraordinary times and most recent defaults are a result of an unforeseen pandemic. 
  • To address the liquidity needs of the NBFCs, the RBI should consider setting up a refinancing agency exclusively for the NBFCs on the lines of the National Housing Bank which serves as a refinancing agency for the Housing Finance Companies. 
  • While a new development financial institution (DFI) has been announced in the last budget to provide a push to infrastructure creation, it will definitely take some time, at least a few years, before it gets operational. In the interim, to ensure that infrastructure financing is not hindered, it would be prudent to provide full government support to those few NBFCs which are already active in the infrastructure space but are constrained due to depleted collections from their customers given the unfolding impact of the pandemic.

Practical and easy to implement, albeit somewhat bold, steps like the above are needed to stave off a crisis brewing in the NBFC sector and pave the way for an orderly growth of the MSME sector as  well as the infrastructure sector.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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NBFC Sector economic growth

Rakesh Kumar Bhutoria

The author is CEO, Srei Infrastructure Finance Limited

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