NBFCs’ liquidity woes

Boxed into a corner by the liquidity crunch that has dogged them since last year, Non-Banking Finance Companies (NBFCs) were looking forward to the central bank throwing them a liquidity lifeline as soon the general elections were over. But RBI has thrown a googly at them instead, by proposing new rules that seek to more tightly regulate NBFCs’ asset-liability and risk management framework. As the current troubles of many NBFCs can be traced to their over-reliance on short-term borrowings to fund long-term loans to real estate and infrastructure players, RBI’s decision to bridge asset-liability mismatches (ALM) and insist on more disciplined liquidity management at NBFCs is a welcome one to ward off future repeats of this episode. But without ideas to help struggling NBFCs get over their immediate liquidity hump, it is unclear how they will survive to implement these measures.

There are three key aspects to RBI’s proposed guidelines which should help NBFCs better manage their liquidity. Requiring all non-deposit taking NBFCs with over ₹5,000 crore in assets to maintain a liquidity coverage ratio (LCR) to service their dues for the next 30 days and to restrict negative ALMs to 10-20 per cent in the short term, will ensure that they don’t rely on hand-to-mouth arrangements to meet near-term market obligations. NBFCs will have to adjust to narrower spreads and lower profits if they adhere to these rules, but they will pose fewer systemic risks to market participants such as mutual funds and banks. RBI also plans to allow a long runway, from April 2020 to 2024 for NBFCs to fall in line. But while these changes tackle liquidity issues, the other structural issues that precipitated this crisis remain unaddressed — be it the role of rating agencies in papering over ALM mismatches, the lack of funding sources for NBFCs or poor bond market liquidity for lower rated paper.

The RBI and the Centre also seem to be having second thoughts on opening up the long-awaited special liquidity window to help NBFCs to tide over this crisis. There is of course some merit in the view that regulators should do nothing to bail out NBFCs as it was their frenetic pursuit of growth ignoring ALM risks that led to this situation. But if this is their stance, the Centre and RBI may need to be prepared for systemic consequences from an NBFC shakeout. Public confidence in the debt markets may be shaken if retail investors who have exposure to troubled NBFCs by way of public deposits, NCDs or debt mutual funds face a string of defaults. The consumption slowdown can prolong if home loan or consumer finance NBFCs shrink their books. NBFCs have also been key providers of commercial credit to under-banked sectors in the last few years and credit flow to small businesses could be interrupted. Whether the economy can afford all this amid the ongoing deceleration is really the moot point.

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