The IL&FS crisis and the subsequent Dewan Housing Finance Company (DHFL) debacle have triggered much wider concerns over the liquidity problem at NBFCs (non-banking finance companies) over the past year. In a bid to address some of the structural issues that came to light on the asset-liability front, the RBI had in May proposed some guidelines on the liquidity risk management framework for NBFCs. On Monday, the RBI issued final guidelines on the liquidity framework, which will help restore confidence in the sector over the long run.

The impact of these norms in the near term would, however, vary across players, depending on their existing ALM (asset liability mismatch) and liquidity situation.

What are the norms?

The RBI’s final guidelines on the liquidity framework for NBFCs, has only minor tweaks, from the draft guidelines issued in May. Essentially, the timeline for implementation of the norms has been extended (earlier, it was April 2020 onwards; now it applies from December 2020). For smaller non-deposit taking NBFCs, there is a little more leeway on the implementation. That aside, the broad guidelines remain the same as proposed earlier.

The liquidity framework is applicable to all non-deposit taking NBFCs with asset size of Rs 100 crore and above, systemically important Core Investment Companies, and all deposit-taking NBFCs irrespective of their asset size.

The first key norm is on the maturity buckets for cash flows and tolerance limit. The RBI has broken up the up to one-month bucket into smaller buckets and set tolerance limits for mismatches. The first 30-day bucket has been divided into 1-7 days, 8-14 days, and 15-30 days, and the net cumulative negative mismatches should not exceed 10, 10 and 20 per cent, respectively, of cumulative cash outflows.

The second key aspect of the liquidity framework is the introduction of Liquidity Coverage Ratio (LCR). The main objective of the LCR is to ensure that NBFCs maintain sufficient liquid assets to meet obligations in a 30-day stress scenario. NBFCs will be required to maintain a stock of liquid assets equal to 100 per cent of total net cash outflows over 30 days. This will be implemented in a phased manner.

All non-deposit taking NBFCs with asset size of Rs 10,000 crore and above, and all deposit taking NBFCs irrespective of their asset size, have to maintain LCR starting from December 2020, at 50 per cent, increasing progressively by 10 per cent every year until December 2020 (70 per cent); 85 per cent by December 2023 and reaching 100 per cent by December 2024.

For all non-deposit taking NBFCs with asset size between Rs 5000-10,000 crore, the LCR requirement will start at 30 per cent in December 2020 and reach 100 per cent by December 2024.

What is the impact?

From a long-term perspective, the norms will restore confidence in the NBFC sector.

Remember, the aggressive growth over the past few years, increasing over-reliance on short-term funds and wide asset liability mismatches — had impacted the NBFC sector. Banks and NBFCs can run into liquidity issues mainly because of asset-liability mismatches — loans and borrowings do not come up for payment at the same time. Wide mismatches in the short term — six months to one year bucket — had hurt many NBFC players.

Hence, the RBI’s liquidity framework will help bring in better discipline and structure in the management of liquidity among NBFCs.

So what does this imply for NBFCs?

In the near term, the impact could vary across players. For larger NBFCs that already have a good ALM profile, the impact of the new norms would not be significant. Many players also maintain an ample liquidity buffer (in the form of liquid investments or undrawn credit lines from banks) and, hence, complying with the LCR requirement may not be difficult. Post the crisis, many listed NBFCs sport a healthier ALM profile than in FY18.

But for NBFCs with wide asset-liability mismatches in the past, there could be some impact on their profitability. LCR will require NBFCs to maintain liquid investments and, hence, this will reduce the funds available for lending to some extent and add pressure on their net interest margins (NIMs), as investments in government bonds and other high quality bonds earn lesser interest.

Also, a structural shift of moving away from short-term borrowing to longer term funds can increase the borrowing cost -- though the shift has already happened for most players over the past year.

Comfortable for most NBFCs

After the turmoil over the past year, most NBFCs are comfortable on the ALM and liquidity front. Many players have already seen the impact of a rise in cost of funds due to a shift to long-term borrowings and a higher liquidity buffer. For instance, as of June 2019, Cholamandalam Investment and Finance Company, has a well-matched asset-liability, with no cumulative negative mismatches in the less than one-year buckets. The company’s net interest margins (NIMs) had fallen by 60 bps YoY in the June quarter, owing to a rise in cost of funds and higher liquid assets (about Rs 5,300 crore as of June 2019, to mitigate the tight liquidity conditions).

Bajaj Finance also has a favourable ALM, with substantial positive gaps (inflows less outflows) across time buckets, as of the latest September 2019 quarter. The company’s relatively shorter tenure on loans also helps. The company has consolidated free cash and equivalent of Rs 7,978 crore as of September. Shriram Transport Finance, too, has a well diversified funding mix. The annual report for FY19 suggests that its ALM position is sound, with cumulative positive gaps across all maturity buckets. For Mahindra & Mahindra Financial Services, too, the ALM is well-matched, with cumulative positive gaps as of September 2019. Sundaram Finance, too, is comfortably placed on the liquidity front.

While for now these guidelines apply to NBFCs, the liquidity norms are also likely to become applicable for housing finance companies soon. Market leader HDFC’s diversified funding base and superior credit ratings is a key positive. For CanFin Homes, according to ICRA, the company has as an adverse ALM profile given the long-term nature of home loans. But the company enjoys substantial undrawn overdraft facility from banks, including the parent bank, which can be utilised if needed. The company (according to its presentation), expects to have a surplus of Rs 1,300-1,700 crore over the next three quarters. The liquidity buffer mitigates the concerns on ALM to some extent.

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