Restoring India’s Post-pandemic economy – NBFCs leading the way

This essay was adjudged as one of the best entries in the Second NLUJ CSBF Essay Writing Competition, 2020-21 and received a Special Mention in the Competition. The article was submitted by Ayush Gattani & Kamal Kishor. The authors are students at National Law University, Jodhpur, and Maharashtra National Law University, Nagpur respectively.

Abstract:
NBFCs are an integral part of the system that provides funding service to a lot of diverse segments, generally, not funded by banks including Micro, Small and Medium enterprises, trade, industries, agriculture, corporate and rural loans among others. NBFCs majorly rely on bank borrowings to fund their disbursements and because of Covid-19 pandemic the banks have been reluctant to lend to NBFCs. Meanwhile, the central bank had intervened and using its power under section 45 JA of the RBI Act, it proposed various directions to ensure adequate liquidity for the sector. The authors aimed to discuss the role of NBFCs in the revival of the Indian economy from the blow of the Covid-19 lockdown. The essay does an in-depth study of various steps taken by the government and the RBI to increase the surveillance of sector and maintain adequate liquidity to ensure funding in the economy. Lastly, the authors have critically analyzed the government policies and has given their suggestions that could be taken into consideration to ease the difficulties faced by the NBFCs.

Introduction

Finance is pivotal to every economy. It fuels economic activities by providing additional funds to businesses, households, government, etc. which creates a cycle of savings, investment, infrastructure, employment, spending. It also provides the much-needed liquidity to the aforementioned stakeholders. Initially, these funds were provided by banks but during the economic crisis of 2009, businesses got struck as banks were not in the situation to provide loans. This is where a Non-Banking Finance Company (NBFC) played a vital role by creating an alternative to banks for fulfilling the diverse financial needs of different entities.

NBFCs are financial intermediaries catering to financial needs by providing loans and advances, acquisition of stocks, shares, bonds, etc.[i] NBFC provides most of the banking services without requiring a banking license from RBI. However, NBFCs cannot accept demand deposits, issue cheques, and be part of the payment and settlement system.[ii] Also, their customers are those who are generally not eligible/receive from banks, therefore, it forms the last mile link in the supply chain of credit to low-income households and businesses, particularly those who are in the business of microfinance, financing of equipment, small business loans whereas banks provide finance to majorly to the organized sector only.

NBFCs play a very crucial role in the development of the country’s core infrastructure by offering hassle-free funds and credit to the industry. Moreover, startups, MSMEs/SSIs, and households are dependent on funds offered by NBFCs. As these small businesses expand and/or diversify their operations, the need for skilled and unskilled labor goes up. However, in the recent past, a dreadful pandemic caused by the COVID-19 virus has resulted in an unpropitious financial condition of most of the NBFCs. Therefore, to identify how finance can be provided to entities, we will analyze what measures were taken and how these actions could tide them over from their ominous situation which only got worse with COVID-19. Additionally, we will also suggest some measures which will eventually help in achieving the goal of a 5 Trillion Dollar economy by providing cheaper finance.

The despicable situation of NBFCs

To identify the effect of the COVID-19 pandemic on NBFCs, we first need to understand what was the condition of NBFCs before the outbreak of COVID-19.

Over the past 2-3 years, the NBFCs sector is facing a lot of issues like cash crunch, rising cost of capital, and skyrocketing bad loans majorly because of maturity mismatch. All this was started with Rs 450 Crore default by Infrastructure Leasing & Financial Services (IL&FS) in September 2018. This was followed by resignation by the chairman and more defaults too. Later on, Dewan Housing Finance Limited (DHFL), found itself in deep water when a fund house sold its commercial paper at huge discounts which triggered the 60% fall in its share prices, which had an impact on other NBFC including Reliance Home Finance too.[iii] This has led to a surge in the average cost of borrowing for corporates by 100 basis points since April 2018, which pushed them to Hornet’s nest. This triggered defaults from various NBFCs due to which Mutual Funds and Banks turned highly cautious while lending to the NBFC sector. And then came the COVID-19 which probably put the last nail in the coffin for these NBFCs. Lockdown has only worsened the condition of these struggling NBFCs. Given below are some significant effects of the lockdown on the already struggling sector: –

  • Liquidity Crisis – The moratorium has allowed the customers to make delayed EMI payments which elongated the cash cycle and also affected the disbursements and impact the overall business.
  • Depleting Capital – They also faced the loss of capital where the market losses wiped out their capital reserves. This might have resulted in a violation of capital adequacy norms as NBFCs have to maintain their Capital to Assets ratio of 15% against 10% for Banks.
  • Reduced Earnings – Due to increasing cash crunch and depleting capital, a huge fall in earnings for the coming financial year has been projected by UBS analysts.
Figure- 1[iv]
  • Exposure to Risky Sectors – NBFCs are generally more exposed to riskier sectors like Real Estate which was crumbling even before lockdown. Therefore, it would increase the chances of more Non-Performing Assets and provisions mandatory for them.
  • Asset-Liability Mismatch – NBFCs are primarily dependent on bank borrowing for funding. Because of the pandemic, the banks had become reluctant to give loans to the sectors and it resulted in a huge difference between the assets and the liability of NBFCs.  

Relief Measures by the Central Bank 

During the pandemic, the RBI has taken multifarious measures to facilitate funds to NBFCs with a goal to boost liquidity in this sector. The measures taken by RBI were as following-

  • A new “Targeted Long-Term Repo Operation” (TLTRO) of Rs 500 Billion was introduced to target the medium and small sized NBFCs. Furthermore, many all-India financial institutions, such as the National Bank of Agriculture and Rural Development (NABARD), Small Industrial Development Bank of India (SIDBI), and National Housing Bank (NHB), would get refinancial support of Rs. 50,000 crore at the repo rate. This could then be used for refinancing by non-bank lenders. In the following chart, it can be seen that bank lending to NBFCs has increased considerably driven via TLTRO.
Figure- 2[v]
  • A reduction made in the reverse repo rate of 25 bp to 3.75% and increasing the corridor relative to the MSF rate to 90bp. The measure was proposed with the intention to encourage the banks to move the funds reserved in the central bank to flow credit in the economy so that the non-banking sectors can have access to those funds.
  • NBFCs were allowed a halt to asset classification till May 31, along with giving a further 90-day extension for asset recognition, i.e., a moratorium on NPA classification.
  • A sharp reduction was made in banks’ liquidity coverage requirement (LCR) from 100% to 80%. The reduction in LRC will help the banks to deal with NPAs and will further increase the cash flow to the private sector.   
  • RBI relived the provisions dealing with the loans given to Commercial Real Estates by NBFCs. Now, the NBFCs can extend the “Date of Commencement of Commercial Operations” by one year without affecting the asset classification just like the ordinary banks.
  • The “ways and means advances” limit for states has been increased by 60 percent to about Rs 67,028 crore. Though RBI increased this limit only for a short period, yet it helped to prevent a rush of market borrowings from states during the covid.[vi]

Recently, while addressing the problem of NPA in NBFCs, RBI proposed that the sectors must be regulated based on the Principle of Proportionality of the assets the NBFC is holding. It means that the NBFCs having higher assets shall have comparatively higher scrutinization than the NBFCs who have lesser assets.[vii]

In order to tighten the regulation over the non-banking sector, the RBI has proposed a multi-layer classification of the NBFC. Under Chapter 4 of “The Scale Based Approach” the RBI has proposed a pyramid-like structure comprising of four layers namely Base, Middle, Upper, and Top layers. The base layer will include the non-deposit-taking NBFCs who have assets of 1000 crore and interestingly 90% of the NBFCs will fall into this layer. Whereas, the deposit-taking NBFCs and non-deposit-taking NBFCs having a status of systematically important will fall under the middle layer. The upper layer will consist of systemically significant NBFCs, which will be regulated like banks. Lastly, the top layer also referred to as the Red Zone would remain empty. It is reserved for any NBFCs from the upper layer if it faces any increase in spillovers.

The bank proposed for higher supervision of these NBFCs. It would allow the NBFCs to grow in such financial or managerial complexity amids the intense supervisory scrutiny of the central bank.[viii]

Important Relieving measures under Budget for NBFCs

Under the Budget 2021, the Finance Ministry has proposed that NBFCs having a minimum asset size of Rs. 100 crores will be covered under the SARFAESI Act. It has further allowed lowering the minimum loan size from Rs. 50 lakhs to Rs. 20 lakhs to be eligible for debt recovery under the Act. Considering the number of loan defaults that emerged under the veil of the pandemic, the government is ensuring that NBFCs can take quick action against defaulters by lowering the limits of the loan. Moreover, considering the fact that the Civil court has no jurisdiction over the matters under the SARFAESI Act, lenders can recover their dues faster as the Act does not require time-consuming civil court proceedings.[ix] Under the Act, recovery can be made against secured loans, and it allows lenders to auction the property to recover dues from borrowers who have defaulted on loans.[x] It applies to home loans, loans against property, and loans against collateral availed by MSME. Hence, by allowing application of the Act over NBFCs the FM has opened the gates for NBFCs to curb the problem of defaulters. The budget has also proposed for setting up institutions like asset management company (AMC) and asset reconstruction company (ARC) to curb existing stressed debt of public sector banks; and NBFCs may also get benefit from this going forward, if made applicable, for their wholesale exposures.[xi]

NBFCs revamping the economy Post-Covid

It has been anticipated by various rating agnecies that by the end of the current fiscal year NBFCs’ stressed assets may reach the figure of Rs. 1.5 to 1.8 lakh crore. As Mr. Krishnan Sitaraman, Senior Director of CRISIL Ratings has stated that “This fiscal has bought unprecedented challenges to the fore for NBFCs. Collection efficiencies, after deteriorating sharply, have now improved, but are still not at pre-pandemic levels. There is a marked increase in overdue across certain segments and players. Nevertheless, gold loans and home loans should stay resilient, with the least impact among segments.”[xii]

Stress asset estimates across segment for NBFCs:

Figure- 3[xiii]

Based on the new regulations policies and the relaxations granted by the government, the following points make it clear that the non-banking sector is going to be a key player in the post covid economic development:

Financial Stimulus

The pandemic has caused loss of livelihood for millions of people across the globe, it has made them use their financial reserves to survive the pandemic. After a pause for a couple of months, when life is getting normal in various countries, the people do not have any sufficient financial support to restart their life. The announcement by the Finance Ministry for a financial stimulus package of Rs. 20 lakh crores in a way played a vital role for the NBFCs and it is eventually helping the Indian economy to get back on track after the COVID-19 situation.

The World Bank data depicts that the MSMEs cover approximately 90% of the global business and are responsible for almost half of the global employment.[xiv] Similarly, in a country like India where a large portion of the population has their livelihood depends on these small and medium enterprises. Now, after passing a whole year without the income they are totally dependent on their work to restructure their debt and the cash flow. Therefore, if the FM keeps allowing such support to NBFCs, the sector will certainly play a crucial role in strengthening such MSMEs to give them financial support and wriggle them out of this crisis.

Deferring loan repayment

To support the citizens in cash flow various countries around the globe are taking different steps. Many states have made provisions for various subsidies and deferring the payment of non-commercial loans so that the payment to the government can be reduced for the time being. Further, many governments have opted for the direct transfer of the money to the affected citizens. Whereas a country like India which has a population near 1.5 billion, and more than of which is middle class and do not possess huge savings. The government has opted for the moratorium. The government has allowed the citizens to postponed payment of their debts so that it can avoid unnecessary burdens on the financial institutions. Considering the fact, the NBFCs provide for small loans for households, vehicles, etc., NBFCs also supported the idea of postponement of repayment of debts. Even NBFCs has further agreed to extend the period of the moratorium till the issue of liquidity is under control. Now when the citizens can avoid the cash outflow in form of repayment of loans; they can spend it somewhere or save in banks or invest in the capital market which will eventually infuse more cash into the economy. The government can use this opportunity to reduce the load on the banking sector for time being to focus on the overall economic growth.[xv]

An incentive to attract liquidity

To tackle the issue of cash flow the central bank is trying to maintain liquidity by various means like reducing their rates including RR and RRR and allowing the banks to have more liquidity.

The expansionary and growth-focused Budget 2021-22 is an attempt to provide the much-needed impetus to the economy, following the slowdown induced by the COVID-19 outbreak. Recently, the Finance Ministry has announced a new policy and under the policy, the ministry has allowed unrated papers and AA-rated papers to get loans from the banks instead of NBFCs. This step shall reduce the burden on the non-banking sector and will allow it to get further funding from the market.

Furthermore, the ministry has allocated a sum of Rs. 30,000 crore under “Special Liquidity Scheme” especially for the sector. Under the “Special Liquidity Scheme,” the NBFCs will get investment-grade papers (having very low risk of default) on the guarantee of the government which means that NBFCs will have more credit availability it will increase the capacity of the sector to provide funds for the MSMEs and households who have a comparatively higher risk of default.  Moreover, if the government allows some relaxation on funds raised by a non-citizen enterprise from any Indian NBFC. It will give NBFCs access to the debt market of the other countries, which eventually will provide even more funding to the economy and it will lower the risk in the country.[xvi]

Budget Policies

The government proposed setting up a Development Financial institution (DFI) with a capital of Rs. 20,000 crores having a credit portfolio of about Rs 5 lakh crores for three years for which a bill titled as “The National Bank for Financing Infrastructure and Development (NaBFID) Bill, 2021” will be introduced in Lok Sabha in the coming week[xvii] as the proposal for DFI has been approved by Union cabinet last week.[xviii]. Further, NBFC-IDFs, as per the budget proposal can issue zero-coupon debentures, which would help widen their investor base. These initiatives would facilitate long-term financing to NBFCs lending to the infrastructure and related segments.

The new voluntary scrappage policy for commercial vehicles and personal vehicles could give a fillip to the replacement demand, which would require financing. There are almost 1 million vehicles that are more than 15 years old and the market would require almost 15 Billion USD to meet the demand for new vehicles. The proposed tenures for scrappage are fairly high and a large part of these vehicles would already be under replacement process, the impact of this proposal would hinge on the incentives and implementation mode.[xix]

 Since NBFCs also stand to be benefited from the reduction in the minimum loan size for recovery under the SARFAESI Act, it can help MSMEs under the flagship of Atmanirbhar Bharat with a considerably lower risk of loan defaulting and allow the economy to grow much faster.[xx]

Conclusion and Suggestions

Though the pandemic had put the whole economy on a long halt, the collection of loan installments had substantially reduced in the immediate aftermath of the stringent lockdown announced in late March 2020, and, an extension of the moratorium on loan repayment to borrowers. In the third quarter, CRISIL released their report stating that the collection of NBFCs is getting better and in the future, it will be more than that of pre-covid time. Now when life is getting back to normal and since the vaccination has started it is expected that the NBFCs will help the economy to prosper even at a better and faster rate.

The government and the RBI are relying on funding from the non-banking sectors for financing the MSMEs, trade, industries, agriculture, corporate and rural loans among others. The Central Bank has laid down various policies to ensure that undisturbed liquidity for NBFCs, moreover, the finance ministry also incorporated various policies in the Budget 2021 especially targeting the sector. Following is a critical analysis of different policies proposed by the central bank and the government.

The Way Forward

After analyzing the probable effects of the multi-layer classification of the NBFCs, it is clear that if such measures are implemented then it would make the sector even more resilient to credit shock. Although, the RBI has attempted to regularize the NBFCs yet it has failed to address the core issue of funding and liquidity. As per the proposal, the upper layer NBFCs will be having regulations similar to the banks but the NBFCs are not covered under the RBI’s liquidity regulations i.e., CRR and SLR, which could be helpful in maintaining the liquidity in the NBFCs from the upper level.

Before the Budget announcement, the RBI had proposed that NBFCs who are operational for more than ten years and have assets of more than Fifty Thousand crores should be given banking licenses. Since different NBFCs covers different sectors, if they are provided with banking licenses, they can reduce the burden from the banks for their specific sectors, and considering the fact that these NBFCs are in function for so long, they will be having lesser risk for the government in the post covid time when the government cannot take such risks.

For example, Shriram Transport Finance Company Ltd mainly focuses on the funding of vehicles, especially commercial vehicles. Considering the data provided by the RBI NBFCs covers almost 65% of the funding for the commercial vehicles if, it is allowed the banking license, for the time being, it will not only allow the sector to grow in this time but also lower the burden on the banking sector.

Since the government is trying to recover the economic growth, it must focus on the sectors which have a high potential for growth as well as an exponential impact on the economy. Since these sectors will need low cost, the NBFCs once getting a banking license may help in reducing the cost of capital of the banking sector.

Also, we need to focus on the core issue of asset-liability mismatch to improve the overall situation. This problem arises because the bond market in India is not deep. For improving this, there is a requirement of a corporate bond market that allows the issuance of 15-year bonds.

Another issue that requires attention is the current method of rating and revenue model of rating agencies. Rating agencies in the present times mostly rely on historical data only i.e., financial statements of companies that do not necessarily provide the expected performance in the future. Due to this, rating agencies can downgrade on the home stretch only. Additionally, the company being rated is the one that pays the agency which is a serious flaw because there are high chances of it affecting the objectivity. Therefore, there is a need to address these issues. One way of bringing out all the issues and problems to the fore can be conduction an Asset Quality Review.


[i]§45 I, Reserve Bank of India (Amendment) Act, 1934, No. 2, Acts of Parliament, 2019 (India).

[ii] Ibid.

[iii] Prathamesh Mulye, A timeline of the crises that brought India’s $370 billion shadow banking sector to its knees, Quartz India, https://qz.com/india/1860466/how-indias-nbfc-crisis-deepened-from-ilfs-defaults-to-covid-19/ (Last accessed on March 21, 202).

[iv] NBFCs stare at 30-70% fall in FY21 earnings due to coronavirus pandemic, Business Standard, https://www.business-standard.com/article/markets/nbfcs-stare-at-30-70-fall-in-fy21-earnings-due-to-coronavirus-pandemic-120042001322_1.html (last accessed on March 24,2021).

[v] Non Non-Banks: Growth to revive in FY2022; key performance indicators however would remain under pressure January 2021, CRISIL https://www.icraresearch.in/research/ViewResearchReport/3441, (Last accessed on March 21, 2021).

[vi] RBI’s new measures will give some respite to NBFCs & MFIs- says economists, BFSI The Economic Times, https://bfsi.economictimes.indiatimes.com/amp/news/policy/rbis-new-measures-will-give-some-respite-to-nbfcs-mfis-say-economists/75200263#aoh=16160870919135&referrer=https%3A%2F%2Fwww.google.com&amp_tf=From%20%251%24s, (Last accessed on March 21, 2021).

[vii] Chapter 3, Revised Regulatory Framework for NBFCs – A Scale-Based Approach, https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=20316,  (Last accessed on March 20, 2021).

[viii] Chapter 4, Revised Regulatory Framework for NBFCs – A Scale-Based Approach, https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=20316, (Last accessed on March 20, 2021).

[ix] §34, The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, No. 54, Acts of Parliament, 2002 (India).

[x] §13, The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, No. 54, Acts of Parliament, 2002 (India).

[xi] Union Budget 2021-22 Analysis, PRS India, https://prsindia.org/budgets/parliament/union-budget-2021-22-analysis#:~:text=Expenditure%3A%20The%20government%20proposes%20to,higher%20than%20the%20budget%20estimate, (Last accessed on March 21, 2021).

[xii] NBFC stressed assets may hit Rs 1.5-1.8 lakh crore by fiscal-end, CRISIL, https://www.crisil.com/en/home/newsroom/press-releases/2021/02/nbfc-stressed-assets-may-hit-rs-1point5-1point8-lakh-crore-by-fiscal-end.html, (Last accessed on March 20, 2021).

[xiii] Ibid.

[xiv] SMALL AND MEDIUM ENTERPRISES (SMES) FINANCE, The World Bank, https://www.worldbank.org/en/topic/smefinance, (Last accessed on March 20, 2021).

[xv] How NBFCs Can Play A Pivotal Role In Economic Recovery In India, Business World, http://www.businessworld.in/article/How-NBFCs-Can-Play-A-Pivotal-Role-In-Economic-Recovery-In-India/04-06-2020-194267/, (Last Accessed on March 18, 2021).

[xvi] Ibid.

[xvii] Govt to introduce DFI Bill in Lok Sabha next week to fund infra projects,  Business Standard, https://www.business-standard.com/article/economy-policy/govt-to-introduce-dfi-bill-in-lok-sabha-next-week-to-fund-infra-projects-121031900580_1.html, (Last accessed on March 19, 2021).

[xviii] Govt to introduce DFI Bill in Lok Sabha next week, The Times of India, https://timesofindia.indiatimes.com/business/india-business/govt-to-introduce-dfi-bill-in-lok-sabha-next-week/articleshow/81586156.cms. (Last accessed on March 20, 2021).

[xix] Voluntary Retirement Scheme for Commercial Vehicles – A game changer for the NBFC sector, The Economic Times, https://auto.economictimes.indiatimes.com/news/commercial-vehicle/mhcv/opinion-voluntary-retirement-scheme-for-commercial-vehicles-a-game-changer-for-the-nbfc-sector/80916761, (Last accessed on March 18, 2021).

[xx] Union Budget 2021-22 Analysis, PRS India, https://prsindia.org/budgets/parliament/union-budget-2021-22-analysis#:~:text=Expenditure%3A%20The%20government%20proposes%20to,higher%20than%20the%20budget%20estimate, (Last accessed on March 21, 2021).

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