Non-banking finance companies (NBFC) constitute around 9% of total assets of the Indian financial sector. So, insulating them from potential bankruptcy has become imperative for the Reserve Bank of India (RBI) to ensure financial stability. And last week, the RBI unveiled a scheme aimed at improving the liquidity condition of NBFCs.
The RBI announced that SBI Capital Markets Ltd, a subsidiary of State Bank of India, will set up a special purpose vehicle (SPV) to purchase short-term paper, maturing within three months and rated as investment grade, from NBFCs and housing finance companies (HFCs). The central bank operationalized Rs 30,000 crore for this scheme.
This SPV will buy investment-grade commercial paper and non-convertible debentures of NBFCs and HFCs until September 30, 2020, and is expected to recover all dues by December 31, 2020.
The scheme aims to prevent any potential financial or systemic risks in the finance sector and ensure economic stability. However, the RBI lays out stringent requirements for beneficiaries under the scheme.
These conditions include that the NBFCs and HFCs must be registered with the RBI and that they must have been profitable in at least one of the two preceding years 2017-18 or 2018-19.
Also, the NBFCs and HFCs must fulfil the requirements related to capital to risk-weighted assets ratio, capital adequacy ratio, non-performing assets and special mention accounts. Moreover, the NBFCs and HFCs must be rated by an investment grading agency approved by the Securities and Exchange Board of India.
Solution or slump?
The shadow financing sector was already struggling with funds in light of the IL&FS crisis when COVID-19 hit, jeopardizing the survival of the sector at large.
NBFCs and HFCs are compelled to sit on bad debts for an extended period with provision of EMI holidays to debtors on one side and an embargo on legal remedies on the other, thereby slowing down recoveries.
In cognizance of this twin pressure, the RBI’s notification aims to improve the liquidity position of NBFCs and HFCs.
At the outset, this scheme acts as an enabler for NBFCs and HFCs to get investment grade or a better rating for the bonds issued, thereby augmenting the flow of funds from the shadow financing sector.
Moreover, the scheme would be a one-stop arrangement between the SPV and the NBFCs without having to liquidate their current asset portfolio and merely transfer their financial risks. The advantages bring the government closer to its objective of eliminating or mitigating any potential systemic risks in the financial sector.
However, these measures lack concerted and concrete action.
First, statistics from an RBI report on NBFCs suggests that the total borrowings by the NBFCs exceed Rs 1 lakh crore and thereby, the efficacy of a SPV, active till September 30, 2020 has been vociferously criticized and questioned.
This move is a three-month short-term liquidity shot as opposed to the industry requirement of about two-three years. The sector is in dire straits for long-term funds so that they don’t run into an asset-liability mismatch.
However, the present move may lead to a vicious cycle of extending loans. For instance, if somebody were to draw three months’ money, they will have to create another liability at the end of 90 days to be able to repay this.
Second, the high thresholds and requirements set by the RBI for NBFCs and HFCs means many entities in dire need of financial support and liquidity will be left out of this scheme, thereby providing a lopsided-cushion to the sector.
Third, the number of NBFCs and HFCs availing of this scheme will be contingent on the rate and amount they receive. This will be a determining factor of whether the scheme is a true liquidity potion or just another half-baked solution.
What remains to be examined is whether this scheme will provide cheaper and easier funds to even those NBFCs and HFCs which are not in dire need for emergency funds as long as they meet the eligibility criteria. The answer to this dilemma shall judge the extent of success of this announcement.
In order to mitigate the gargantuan effects of the pandemic-induced depressionary forces on the shadow financing sector, the government must introduce a dark horse to soothe its long-term woes and not a mere quick fix.