RBI’s New Guidelines To Affect NBFCs

New Delhi, May 27: The Reserve Bank of India’s (RBI) draft guidelines on liquidity risk management framework for non-banking financial companies (NBFCs) may bring some short-term pain, but they are expected to bring better order and governance to the crisis-hit sector, and would eventually strengthen it.

Academicians as well as market experts agree that the new proposals, like a gradual shift to liquidity coverage ratio (LCR), liquidity risk monitoring tool and adoption of the “stock” approach to liquidity, are all welcome steps for the industry, which will effectively counter any such situations like the one the industry is facing now, courtesy the IL&FS crisis, from recurring in future.

However, since the existing businesses will have to do lot of modifications to their existing business portfolios in the run up to the introduction of these norms, this period of readjustments would be “definitely painful”, said Dr. Joseph Thomas, Head of Research, Emkay Wealth Management.

“The only relief is that the norms will be implemented only over a period of time… The gradual unwinding of the asset-liability mismatches, and the realignment of business to realistic cost and revenue levels would all mean short-term pain. But it is definitely going to put the sector on a stronger base for sustained growth. This would also help the sector to re-gain the confidence of investors and their lenders,” Thomas said.

In its draft guidelines released on Friday, the RBI proposed to introduce LCR – the proportion of high liquid assets set aside to meet short term obligations – for NBFCs having an asset size above Rs 5,000 crore.

It said that NBFCs will have to maintain a minimum of 60 per cent of LCR as high liquid assets starting April, 2020 which will be increased gradually to 100 per cent by April, 2024.

It also asked non-deposit-taking NBFCs with an asset size of Rs 100 crore and above, systemically important core investment companies and deposit-taking NBFCs (irrespective of their asset size), to measure their liquidity in a granular manner, measuring as minutely as one to seven days’, 8-14 days’, and 15-30 days’ buckets with asset-liability mismatches not exceeding 10-20 per cent in the buckets running up to a year. This has to be reported to the RBI, the draft guidelines mentioned.

They have also proposed to introduce a stock approach to liquidity—as opposed to a cash flow approach—to ensure asset adequacy to repay debt.

Atul Pandey, Partner, Khaitan & Co, said the measures coming in the backdrop of recent crisis that has plagued the Indian NBFC sector are aimed at overhauling the entire legal framework pertaining to NBFCs.

“This new asset liability management framework would ensure that the NBFCs are not entirely dependent on external debt to repay their maturing debt as such a scenario leads to cyclical debt,” he said.

Pandey added that adoption of stock-approach to liquidity, as opposed to cash flow approach, would ensure that NBFCs have assets available at their disposal to repay their debt.

“A new asset liability management framework would lead to increase in compliances and the costs attached with it as the penalties associated with non-compliances with RBI regulations are significant. These measures would provide NBFCs with a robust legal framework and the long-term benefits would outweigh the short-term ramifications such as compliance costs and time associated with implementation,” he said.

Dr Rajendra K Sinha, Professor and Chairperson at Centre of Excellence in Banking, IFIM Business School, said the quarterly disclosure of the liability profile will bring transparency for the investors, and thereby improve the liability management of NBFCs.

“These regulatory measures would necessitate for NBFCs to put in place comprehensive and robust liquidity risk management architecture, which is essential for healthy growth of NBFCs,” he said.

Sinha also dismissed criticism of putting banks-akin granular liquidity management structure for NBFCs and said such a ciew was not tenable considering “flagrance violation of basic liquidity risk management aspects by NBFCs”.

However, he admitted that the implementation of the measures may lead to some pain in the beginning since the RBI guidelines require the public disclosure on liquidity risk on quarterly basis by NBFCs.

“The NBFCs will have to furnish details on top 20 large deposits, top 10 borrowings, stock ratios and other short-term liabilities, this will further bring transparency in the system relating to NBFCs. In medium and long term this will bringing good results for NBFCs, though in short term they will feel pinch of these measures,” Sinha said.

Sameer Mittal, Managing Partner at Sameer Mittal & Associates LLP, said that maintaining LCR would reduce margins for NBFCs as their interest earning would reduce on the amount that they are required to maintain in form of high quality liquid assets.

However, he said, the RBI has given enough time to prepare for LCR norms.

“These norms shall provide more clarity, transparency and confidence to the lenders about the actual position of the borrower. This shall result in the problems for NBFC’s having liquidity mismatch but shall provide an opportunity also to them to work on the pain areas and start the corrective mechanism to avoid crisis situations,” Mittal said.

Dr. Joseph Thomas of Emkay Wealth Management said while not all NBFCs are prepared to adhere to the norms at present, they need to re-hash the existing portfolios as once RBI introduces the norms they would have no choice but to follow it.  

“So, they have some time before RBI converts these draft norms into guidelines for NBFCs. The earlier they start preparing for the changeover, the better it is,” he said.

“For the NBFCs who are on the cusp, RBI is giving them ample time to push for scalability. It is time for sink or swim for NBFCs with low capitalization to either pivot their business models or seek investors who believe in their vision,” said Hardika Shah, Founder and CEO, Kinara Capital.