Non-Banking Financial Sector – Sailing Choppy Waters

Just as the Non-Banking Financial Companies (NBFC) sector was emerging out of the recent Infrastructure Leasing & Financial Services (IL&FS) and the Dewan Housing Finance Limited (DHFL) crisis, COVID 19 hit the global markets. Recognizing the need for infusing further liquidity in the market, the Government of India announced an economic stimulus package on 13 May 2020, introducing a special liquidity infusion scheme of INR 30,000 crore and partial credit guarantee scheme (PCGS) of INR 45,000 crore for the NBFC sector.

How would the schemes work?

Liquidity Scheme

(a) A large public sector bank (PSB) would set up a special purpose vehicle (SPV) to manage a stressed asset fund; (b) this SPV shall issue interest-bearing special securities guaranteed by the Government of India and purchased by the Reserve Bank of India (RBI) only; and (c) the SPV shall issue securities as per requirement and up to an amount of INR 30,000 crore, the proceeds of which shall be used by the SPV to acquire short term debt from eligible NBFCs and/or Housing Finance Companies (HFCs). The Government's direct financial burden for this scheme is in the nature of equity contribution to the SPV (of INR 5 crore), beyond which, any financial liability would incur for the Government only on the invocation of the guarantee for the amount of default, which may extend up to INR 30,000 crore.

This scheme supplements the Targeted Long-Term Repo Operations (TLTRO) scheme announced on 17 April 2020 by the RBI. Under this scheme, RBI provides funds to banks at the prevailing repo rate for tenure of up to 3 years through an auction system. The total amount under this scheme is capped at INR 50,000 crores. The funds availed through this scheme are required to be apportioned in investment grade bonds, commercial paper and non-convertible debentures of NBFCs and Micro Finance Institutions (MFIs).

New Partial Credit Guarantee Scheme (PCGS)

This scheme is an extension of PCGS announced by the Government on 11 December 2019. Per the earlier PCGS, a sovereign guarantee of up to 10% of the initial loss or up to INR 10,000 crore, was provided to PSBs for purchasing pooled assets of NBFCs and HFCs rated BBB+ or above. The window was open till the earlier of 30 June 2020 or till assets worth INR 100,000 crore get purchased by PSBs. The new PCGS extends to cover borrowings such as primary issuance of bonds / commercial papers (CPs) issued by the NBFCs, HFCs and MFIs, with Government providing the sovereign portfolio guarantee of up to 20% of initial loss. Papers with ''AA'' rating and below, including unrated papers with original maturity of up to 1 year, which were not eligible under the previous scheme have also been included under the ambit of the present scheme. While the initial announcement of the extended PCGS was for INR 45,000 crore, the FAQs published on 20 May 2020 cap the total guarantees at an overall level of INR 10,000 crore, including guarantees for the purchase of pooled assets and guarantees for bonds / CPs.

Are these measures sufficient?

While market sentiment has improved with these measures, industry players are seeking to extend the tenure of (a) the Liquidity Scheme from 3 months to 3 years; and (b) the bonds / CPs under the PCGS from 9-18 months to 3 years. NBFCs also appear skeptical about the measures coming to the rescue of smaller institutions and await effective implementation of these measures without the imposition of any onerous funding conditions.

Moreover, NBFCs and HFCs are concerned about the low demand in the market and delayed repayment due to the moratorium extended to retail borrowers. The moratorium facility announced by RBI for term loans ensured that banks and NBFCs immediately extended a moratorium of 3 months on all installment payments falling due between 1 March 2020 and 31 May 2020 to their retail borrowers. But the RBI circular on moratorium remained silent on loans taken by intermediaries like NBFCs and the confusion heightened after an FAQ from the Indian Banks Association stated that NBFCs and MFIs were not eligible for the moratorium. NBFCs were apprehensive that disparity in treatment on moratorium would create short-term liquidity issues for them since they are extending the moratorium to their borrowers. While some banks have now agreed to extend the moratorium to their NBFC clients on a case-by-case basis, there is a requirement for legal clarification to be issued so that NBFCs do not bear the brunt of providing moratorium to the borrowers but not receiving the same from banks who finance such NBFCs.

This disparity can become more strained with the lockdown period being extended, moratorium period being extended by the RBI for another 3 months on 22 May 2020 and the possibility of the customers defaulting even after the moratorium. The Government’s move to purchase debt and CPs of the NBFCs will provide some relief to the sector but may not be adequate to address the NBFCs structural liquidity issue.

Another possible measure could be to provisionally reduce the capital adequacy ratio imposed by the RBI. NBFCs mostly rely on wholesale funding and do not enjoy the access to public deposits that banks do. Despite this, the minimum capital adequacy ratio requirement is higher for NBFC-ND-SI (SI being 'systemically important') at 15 per cent compared to 9 per cent for banks. Understandably the functions carried out by banks and NBFCs are different, but NBFCs could benefit from a reduced percentage of their reserve that remains out of circulation under the present mandated ratio.

Due to the disruption created by COVID-19, the extended lockdown and moratorium, the demand side along with the assessment of true existing demand for the NBFCs remains uncertain as NBFCs may find it difficult to assess their true loan book and quality of borrowers. On the whole, while the impact of the measures including proportion of the accrued relief and monetary circulation to the benefit of the sector remains to be seen, the measures introduced by the Government seem to be in the right direction albeit shortsighted.