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New NBFC norms may affect credit growth, trigger consolidation

c1c473d2-808b-11e9-b05e-26562fe9c132_1558985156593_1558985389333Acentral bank proposal to introduce liquidity buffers for non-banking financial companies (NBFCs) may crimp their ability to lend in the short term and trigger consolidation among weaker non-banks.

The Reserve Bank of India (RBI) on 24 May said it planned to implement liquidity coverage ratio (LCR) in a phased manner over four years starting April 2020. Setting aside 60% of NBFCs’ net cash outflows, as envisaged in the initial phase, in so-called high-quality liquid assets such as government securities and cash will prevent them from deploying these funds for lending.

A possible consequence of the norms is that weaker NBFCs with poor liquidity management will get absorbed into their larger counterparts to comply with RBI’s liquidity buffer norms.

Leena Chacko, partner at law firm Cyril Amarchand Mangaldas, said, “There is likely to be consolidation because NBFCs with higher liabilities and lower liquid assets will have to consolidate in order to meet the regulatory requirement. This should help improve the creditworthiness of the NBFCs and ensure that they are able to meet their liabilities.

The norms could lead to a credit slowdown for NBFCs that do not have a well-managed asset-liability situation, said Madan Sabnavis, chief economist of CARE Ratings. “Once these lenders start maintaining LCR, they might end up with less cash to lend. While the large NBFCs are better managed in terms of liquidity, even they are unlikely to have 100% LCR,” said Sabnavis.

To be sure, these suggestions are still part of RBI’s draft guidelines and the final one will be prepared after receiving responses from the stakeholders.

Although NBFCs will need to maintain LCR of 60% from April 2020, they will gradually have to move towards 100% LCR by April 2024.

LCR, maintained in high-quality liquid assets, ensures that financial institutions have enough liquidity to fall back on for 30 days in case of a significant liquidity stress.

The slowdown, if it happens, could affect overall credit growth since NBFCs play a significant role in the lending market. They have been gradually bolstering their market share in total loans, as banks have turned risk-averse. For instance, NBFCs, which accounted for 13% of the total loans in fiscal year (FY) 2012, now account for 23% in FY19. Consequently, the share of banks has been declining from 87% in FY12 to 77% in FY19, according to data compiled by Emkay Global, a Mumbai-based brokerage.

While some NBFCs could see their margins shrink in the short-run, the long-term benefits will eventually offset this, experts said. A note by Jefferies said that LCR norms would affect margins and returns in the medium term, especially for housing finance companies (HFCs), given their higher asset liability management (ALM) mismatch.

Some experts say that apart from debt market investors, these guidelines will also help calm the nerves of banks that have been reluctant towards additional NBFC exposure ever since the defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS) happened last year. They feel that while the liquidity crunch is real, it is affecting the smaller non-banks even worse since the ones with good parentage are able to raise funds even in this market.

Following a series of defaults by IL&FS last year, mutual funds with exposure to debt papers of the company had to write off a chunk of their holdings.

This, and the ensuing defaults by some NBFCs, had led to a liquidity crisis. Since then, mutual funds have largely avoided investing in commercial papers of non-banks, worsening the liquidity crunch.

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