NBFCs in India – an existential crisis?

It all started post Lehman in India.  We decided to fire on both cylinders – monetary and fiscal. What came to be known as the GFC had not hit us directly, we had no sub prime mortgages and relatively no asset bubble so to say. We reduced the Repo by 425 bp over six months, increased the fiscal deficit at both the centre and the state levels, reduced corporate and personal taxes, opened FDI selectively (even in real estate, if one would recall) and intended to spend our way out of the anticipated crisis (In the United States the Federal Government had intervened directly thru the TARP programs).  

Infrastructure investments were announced  for new power plants and highway alignments and banks were encouraged to heavy lift these along with the additional capacities required in the steel, cement, EPC and other sectors. What was done then, at that time, was perhaps, required in the best interests of the country ,given the options available.  Excess capacities created during such times even out in subsequent periods, normally, without being too disruptive. 

However, we did not factor in the delays and cancellations in the clearances, quotas and allocations which led to most of these projects requiring regulatory extensions and forbearances.  These may have resulted in the costs that we are bearing today in the financial sector specially the public sector banks and the NBFCs. Asset Quality Reviews(AQRs) by RBI, which followed suit, resulted in total cessation of further funding for the projects and, in some cases, even to the group companies on account of over leveraging relative to their EBITDAs.  

During this process, the promoters of these companies kept their hopes alive based on perhaps, their previous experience in the last downturn and borrowed from NBFCs, against their listed shares and real properties, to infuse equity to service and sustain.  Resultantly, when most of the large groups were trying to deleverage with the banks, there was increased demand from the NBFC sector and based on their AAA and AA rating ,the banks lent them further, restricted only by single borrower and group exposure limits.  Since most of such exposures were heavily collateralised and backed by liquid securities, at that point of time certainly, and as these had been lent at remunerative IRRs, and as the AQRs unearthed newer stressed assets, the demand for such loans continued unabated.  In the pursuit of higher yields, the NBFCs explored alternate sources of liabilities, thru NCDs, then ECBs, and to arbitrage further, CPs. 

All good things come to an end sometime, and this ALM(asset and liability management) mismatch was exposed, quite suddenly, with the default of ILFS on their CPs with Mutual Funds.  DHFL and Altico followed leading to extreme risk aversion by the banks for this sector. CPs were replaced by NCDs for most and, for the better rated and those backed by corporate houses, banks made some concessions and continued to repose faith.

In the process, a couple of things happened, firstly, the liability side of the balance sheet became more relevant for the NBFCs and secondly, all of them started revisiting their business models focusing more towards retail backed by cash flows and enabled by digitalisation.  This helped them to disperse the risk and limit their exposures. Lending against real estate, shares, and commodities completely stopped. This was for the new book. The old book, however, required more time to unwind and/or liquidate.

And then came COVID.  Moratorium was announced by RBI on 27th March, 2020 to be made available to all regular accounts as on 1st March, 2020 by all banks and lenders.  All borrowers, given the uncertain cash flows, started making a queue for availing this to their lenders. Some extended this to all, some required applications and some retained their discretion.  In short, adding more uncertainty in these perilous times.

The NBFCs were, however, not eligible for this moratorium as per the Indian Banks Association, leaving them high and dry as they had no option but to use their cash reserves to meet maturing liabilities in the face of limited inflows. As cash reserves deplete, their ratings would be impacted adversely affecting their ability to raise further funds.   It was a classic Scylla and Charybdis situation, the NBFC would be perceived to be weak if it sought deferment and it would become weaker if it did not.

If COVID-19 continues unabated beyond the 3 months envisaged presently by RBI and moratorium is similarly extended for all borrowers without making the same dispensation available to NBFCs, continued drawdown from their liquidity to repay maturing liabilities would result in an existential crisis for them.  The financial system in India has faced many crises in the last year and we have, most recently, had interventions with Yes Bank with it being bailed out by SBI and other banks. This has indeed been unparallelled and quite commendable. There has been a greater appreciation of the interconnectedness of all the participants in the financial system.  The system cannot afford more such systemic disruptions.

We are, as yet, an underbanked and financially exclusive country, at least as far as credit is concerned.  Mishaps and mistakes have happened, but in the process, institutions and intermediaries have also been created.  These can be allowed to fail and perish and newer ones may replace them over time – that is one option. The other, of course, is to give them time, and find a non-precipitative solution, where they can co exist and collaborate with the banking system, who can leverage their reach and efficiency to connect with the hitherto unbanked last mile.  Perhaps, giving them a fresh lease of life through a line to take care of their maturing liabilities over some defined period would enable them to exist and impart some degree of certainty and stability in our financial system. Clearly, we do not want a resurgence of the informal lender to fill in the gap which will only be a sub optimal solution, nay, a bigger problem actually  going forward.

Jai Hind!

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