To Allow Or Not To Allow: NBFC Loans Under 3-Month Moratorium

The Reserve Bank of India (RBI) directive, suggested that all lending institutions such as banks, Non-banking Finance Companies (NBFCs), Housing Finance Companies (HFCs), Micro Financial Institutions (MFIs) and others will permit term loan borrowers (including agricultural term loans, retail and crop loans) and credit card borrowers a 3-month moratorium on payment of all instalments falling due between March 1 to May  31, 2020. RBI has also permitted to defer recovery of interest applied with respect to cash credit and overdraft facilities between a period March 1 to May 31, 2020. However, interest will continue to accrue on the outstanding portion of the term loan, cash credit (CC)/overdraft facilities (OD) during the moratorium period. In case, of CC and OD facilities, the accumulated accrued interest on such a sanctioned amount shall be recovered immediately after the completion of this period.  

The directive also mentioned that lending institutions shall frame Board approved polices for providing the above-mentioned reliefs to “all eligible borrowers” leaving the 3-month moratorium decision on the lending institutions policies. So lending institutions (especially banks), decided to permit all borrowers to avail the 3-month moratorium relief except the “NBFC category”. 

So, where is the problem is one might ask, there is an ongoing debate whether banks should provide a 3-month relief window to a NBFC (which is a banks’ borrower).

For example, the RBI directive requires clarity whether a NBFC can avail the 3-month moratorium relief from its bank lender under “easing of working capital financing.”

Can “Bank A” provide a 3-month relief window to its borrower NBFC X?

Well…. That Remains unclear.  

However, the Indian Banks Association (IBA) is mulling over whether a 3-month moratorium window for the loans of NBFCs should be considered?

What Will Happen If Nbfcs Are Unable To Avail The Moratorium Window?

Let us understand how NBFCs fund their balance sheets. NBFCs rely heavily on bank loans, commercial paper and debentures to fund their operations. Given, banks don’t allow the moratorium window, they will have to honour their loans and interest repayments. Under normal circumstances, a borrower at a NBFC would repay his loan (Cash inflow), the NBFC would use this cash to repay banks (Cash outflow) or debenture holders or commercial paper holders. 

If a 3-month moratorium is offered to NBFC borrowers, creates a problem. There is no or limited cash inflow from the borrower side but NBFC still has to honour their bank loan repayments (cash outflow). This will lead to a temporary asset-liability mismatch (ALM) and liquidity problem.

How Can An NBFC Resolve This Temporary Cash Inflow/Outflow Mismatch?  

The NBFC can approach the debt market for financing (raise new debt). RBI has provided for liquidity support to these Financial Intermediaries under the recently introduced Targeted Longer-Term Refinancing Operations (TLTRO). Under the TLTRO, banks can raise funds under this scheme, however they have to deploy it in investment grade corporate bonds, commercial paper and non-convertible debentures over and above their existing level of investments. One might think “problem solved”, however, banks will make investments in investment grade or high-quality instruments issued by NBFCs, with a good market standing. Not all NBFCs have a very high market standing. So, what will happen? A NBFC may not be able to raise funds in the debt market.

What If The NBFC Is Unable To Raise Finance In The Debt Market?

A NBFC has to repay not only bank loans (principal + interest) but also has to meet repayment of interest on debentures and commercial paper (No moratorium is provided on interest on debenture and commercial paper). So, in such an extreme scenario, 

1) new lending may be frozen 

2) inability to raise funds might lead to a default on loan repayments. 

In case a NBFC faces the heat on both ends, it may intensify borrower repayments or may go slow on offering the moratorium window to borrowers using the caveat in the RBI directive, “the 3-month moratorium relief window is based on board approved policies for all eligible borrowers” (rephrased). 

For instance, if a cab driver has an outstanding NBFC loan of Rs 500,000 at 12 per cent (p.a.). He is generating “negligible or limited” income during this lockdown period. If this cab driver avails the 3-month moratorium, the interest on his loan will continue to balloon i.e. Rs.5,000 per month and in June, he has to pay either the lump sum i.e. Rs.15,000 interest or partly (based on the NBFC policies) plus the interest on interest i.e. 150 (1 per cent on 5,000 interest). If the lockdown extends, the cab driver has limited time to generate income to meet the lumpsum or part payment or he will default. Expecting a slow economic recovery, there is a high likelihood that the cab driver might default and lose his car permanently (because a NBFC will seize possession of the car for non-repayment).

So, this 3-month moratorium window doesn’t provide adequate relief for small borrowers and RBI should consider a 6–12 month moratorium for loan repayment and include NBFCs under the moratorium window as well. Otherwise, not only will defaults increase but borrowers may permanently lose their income source.

The author is an Assistant Professor (Finance and Accounting), FLAME University