Can RBI Measures 2.0 ease the pain of NBFCs/MFIs and spur lending?

After the first set of measures announced three weeks ago, the RBI came out with a slew of announcements on Friday, mainly to ease the pain of NBFCs and MFIs grappling with liquidity issues and to induce banks to lend more.

While the measures are welcome and can help iron out the challenges faced by some NBFCs/MFIs, the RBI has once again put the onus on the banks to provide funding to small businesses and vulnerable sectors.

True, providing ample liquidity is imperative at this juncture. But deploying the funds would depend on the risk appetite of banks. The heightened risk aversion and weak capital position of many banks remain a big roadblock in providing funds to small and stressed corporates.

While the RBI has mandated banks to deploy the new TLTRO funds in investment grade bonds of NBFCs (minimum 50 per cent to small and mid-sized NBFCs/MFIs), many banks may still be reluctant to lend to small players, as the RBI’s dispensation for such bonds (classified as held-to-maturity) is for mark-to-market (MTM) risk and not credit risk.

The RBI has also mandated additional provisioning on accounts under the moratorium. Clarity is awaited on whether this pertains to all loans (even standard accounts) under moratorium. If so, then this could imply a huge provisioning burden for banks.

Above all, the RBI failed to address the risk of rising yields of government bonds, which is having a cascading effect on other financial market instruments, impeding transmission. An MTM dispensation on the lines of TLTRO, for banks investing in government bonds, could have helped bring down yields on government bonds.

Here, we take a deep dive into the RBI’s first set of measures announced on March 27 (RBI 1.0 measures), their impact, and whether the latest measures (RBI 2.0) address the missing gaps.

Rate action

RBI 1.0 measures: Aside from the sharp cut in repo rate, the RBI had widened the policy rate corridor by reducing reverse repo rate by 90 bps to 4 per cent. Reverse repo rate is the rate at which banks lend short-term funds to the RBI. The idea was to dis-incentivise banks from parking their excess funds with the RBI.

Did it work? Given the heightened risk aversion of banks, the reduction in reverse repo has not really nudged banks to lend. On April 15, the amount absorbed under reverse repo operations was ₹6.9-lakh crore, according to the RBI, indicative of the still excess liquidity with banks.

RBI 2.0 measures: The RBI has now reduced the reverse repo rate further by 25 bps to 3.75 per cent.

Will it work? While the significant reduction in reverse repo rate is a huge disincentive for banks to park money with the RBI, heightened risk aversion to lending, and scarce capital, are still big dampeners. Having funds is one thing, but deploying it would depend on the amount of risk a bank can take. Many banks could still remain wary of lending to stressed sectors and companies, which is the need of the hour. What’s more, the liquidity is highly skewed, with very few banks having surplus liquidity, while the others continue to borrow money from the RBI, according to bankers.

Liquidity measures

RBI 1.0 measures: The RBI had announced targeted long term repo (TLTRO) of ₹1-lakh crore of three-year tenure, at repo rate. Banks were to deploy these funds in investment grade (BBB rated and above) corporate bonds, commercial paper and non-convertible debentures and classify them as held to maturity (HTM). This means that banks need not MTM these investments.

Did it work? The MTM leeway (banks were otherwise wary of investing in these bonds, fearing treasury losses on account of rising yields) has resulted in good response for TLTRO auctions — the bid to cover ratio (amount of bids to notified amount) was at 2-4.5 times for the past three auctions. But the funds have not flowed into the much-needed vulnerable small and mid-sized corporates and NBFCs and MFIs. The deployment of TLTRO funds has largely been to bonds issued by public sector entities and large corporates, especially in primary issuances.

RBI 2.0 measures: The RBI has decided to conduct TLTRO 2.0 for an aggregate amount of ₹50,000 crore. These funds will have to be invested by banks in investment grade bonds, commercial paper, and non-convertible debentures of NBFCs, with at least 50 per cent towards small and mid-sized NBFCs and MFIs. The RBI has also provided refinance facilities of ₹25,000 crore to NABARD for refinancing regional rural banks (RRBs), cooperative banks and MFIs; ₹15,000 crore to SIDBI for small industries; and ₹10,000 crore to NHB for housing finance companies (HFCs). The funds will be provided at the repo rate of 4.4 per cent.

Will it work?: NBFCs and MFIs borrow from banks to on lend to their borrowers. The main concern for NBFCs and MFIs has been that while they have extended the three-month moratorium to their borrowers (as per RBI’s earlier announcement), most banks have not extended the leeway to them. This has led to liquidity issues. Also, banks have been wary of lending to NBFCs and MFIs, compounding the liquidity issue.

Under TLTRO 2.0, banks will have to mandatorily invest the funds in bonds issued by NBFCs and MFIs with a minimum of 50 per cent to small and mid-sized NBFCs and MFIs. This should ease the liquidity pressure to some extent for NBFC/MFIs, with the Centre and the RBI prevailing upon at least the PSBs to do the needful.

However, it would still depend on individual banks’ risk appetite and capital position. Despite the MTM leeway, some banks may remain risk averse to lend to NBFC/MFIs. Also, the TLTRO pertains to investment grade bonds. The low rated and really stressed NBFC/MFIs would continue to face a severe liquidity crunch.

On the refinancing front, it is indeed a welcome step as it will help ease out liquidity pressure for small industries, NBFCs, HFCs and MFIs. However how much of this would flow to small sized players and at what rate will be critical.

Moratorium relief

RBI 1.0 measures: The RBI had allowed lenders to provide three-month moratorium on terms loans, on payment of all instalments falling due between March 1 and May 31.

Did it work? While this came as huge respite to banks and borrowers, it also brought in lot of confusion and ambiguity. For one, it was unclear how accounts that are overdue before March 1 were to be treated — SMA1 (where payments are overdue by 31-60 days) and SMA2 (overdue by 61-90 days). While the RBI had stated that the moratorium would not result in asset classification downgrade, it was unclear how the SMA1 or SMA 2 accounts would be treated during the moratorium period.

RBI 2.0 measures: The RBI has now stated that for accounts which were standard as on March and granted moratorium, the 90-day NPA norm shall exclude the moratorium period, i.e., there would an asset classification standstill for all such accounts from March 1, 2020 to May 31, 2020. Also, banks will have to maintain a higher provision of 10 per cent on all such accounts under the standstill, spread over two quarters, i.e., March 2020 and June 2020.

Will it work?: There is still some clarity awaited on whether the asset classification freeze pertains to accounts overdue before March 1 as well. If it does then it addresses the issue of SMA accounts prior to the moratorium and these accounts will remain as SMA (not slip into NPA) during the moratorium period. While the additional provisioning is a prudent step, as it will offer some buffer to banks to tackle highly stressed accounts in future, the burden on capital could be significant.

For instance, SBI has nearly ₹20-lakh crore of domestic advances as of December 2019. Even if we assume that 30 per cent of these loans come under the moratorium, then the additional provisioning works out to about ₹60,000 crore (staggered over two quarters), which is a substantial amount.

Additional measures

The RBI has increased the Ways and Means Advances (WMA) limit of the States by 60 per cent, which will help them plan their borrowings better. WMA is a temporary liquidity arrangement with the RBI which enables the Centre and states to borrow money up to 90 days at the repo rate. State development loan (SDL) auctions have been at a high 7.5-8.9 per cent rate recently. Increasing the WMA limit will help States spread out their borrowings and bring down the yields.

The RBI has also lowered the liquidity coverage ratio requirement from 100 per cent to 80 per cent (temporarily, to be restored back to 100 per cent by next April) , to ease liquidity pressure. The LCR requires that banks hold stock of liquid assets equal to 100 per cent of the total net cash outflows over 30 days. The main objective of LCR is to ensure that banks maintain sufficient liquid assets to meet obligations in a 30-day stress scenario.

Given that many private banks have been witnessing a fall in deposits (IndusInd and RBL Bank) as a YES Bank crisis fallout, the move to lower LCR at this juncture may not be prudent. Liquidity issues could get pronounced for some banks (read https://www.thehindubusinessline.com/portfolio/news-analysis/liquidity-or-capital-which-will-prove-a-bigger-challenge-for-banks-in-2020/article31249103.ece ).

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