Reality Check

Even as the government has been making consistent efforts at enhancing infrastructural capacity, bank lending to the sector has shown sharp contraction over the past two years. The increasing level of non-performing assets (NPAs) has severely affected the banks’ potential to extend more funds to the infrastructure sector. From lax lending practices to poor execution of infrastructure projects, a myriad of reasons are responsible for the piling up of NPAs. Currently, the banking sector’s exposure to infrastructure stands at 11.52 per cent of gross bank credit.

Size and growth

During the period 2013-14 to 2017-18, year-on-year growth in bank credit to the infrastructure sector declined sharply from 15 per cent in 2013-14 to a negative growth rate of 1.72 per cent in 2017-18. This is the second consecutive year in which the sector’s credit growth slipped into a negative zone. As of September 2018, bank exposure to the infrastructure sector as a whole stood at Rs 9,367 billion. A sector-wise analysis shows that the power sector accounts for more than half, that is, 59 per cent of bank credit lending to infrastructure, followed by the road sector at 19 per cent. Although lending has increased in the current fiscal year so far, banks continue to remain risk averse and cautious towards long-term funding, particularly after the Reserve Bank of India (RBI) released the revised framework for stressed asset resolution.

The power sector has been one of the major contributors to the country’s total stressed assets. Muted power demand from distribution companies and the resulting lack of new power purchase agreements have been the primary reasons for the stress. Meanwhile, low thermal plant load factors and limited new capacity additions have further resulted in a decline in loans to the power sector. However, in the current fiscal year, there has been a marginal improvement in bank credit allotted to the sector. It has increased from Rs 5,196 billion as of March 2018 to Rs 5,318 billion as of September 2018.

The decline in loans to the road sector is not in keeping with the government’s enthusiasm with respect to constructing new roads. Over the past three-four years, growth in bank credit to the sector has decelerated. In 2017-18, credit growth for the sector turned negative on account of mounting stress on the banks’ books. However, the current fiscal year saw a marginal pickup in bank lending to the road sector as the hybrid annuity model has renewed the confidence of banks. Despite the positive signs, bank lending to the sector remains selective and slow as banks are still cautious in lending to engineering, procurement and construction contractors.

The signs in the telecom sector too have not been very encouraging. Reportedly, all telecom debt in the country is owed by companies that have an interest coverage ratio of less than one. This indicates that these companies are not generating sufficient revenues to satisfy the interest expenses on their outstanding debt. Another area of concern is the ability of telecom companies to pay their spectrum payment obligations from earlier auctions. Given these factors, bank credit to the sector has also been dwindling since 2016-17. However, the first half of 2018-19 witnessed a marked increase in bank lending to the sector.

  Cost of borrowing

The Indian financial system remains bank dominated, though the share of non-banking financial companies (NBFCs) and the markets (corporate bonds, commercial paper, equity, etc.) in total financing in the economy is steadily rising. Hence, the overall efficiency of monetary transmission in India primarily depends on the extent to and the pace at which banks adjust their deposit and lending rates in accordance with the policy repo rate. According to RBI, the pass-through of policy rate changes to bank lending rates has been slow and muted.

Even before the Monetary Policy Committee raised the policy rate in June 2018, banks had been increasing their term deposit rates (from December 2017) in response to the waning surplus liquidity in the system. The rise in term deposit rates exerted an upward pressure on the cost of funding of banks in the first quarter of 2018-19 and fed into the marginal cost of funds-based lending rates (MCLR) of banks. This, coupled with a reduction in the share of current account and savings account deposits of banks, also exerted upward pressure on the cost of funding by them. Consequently, the weighted average lending rate (WALR) on fresh rupee loans increased. The WALR on outstanding rupee loans, however, continued to fall till May 2018 as the rise in interest rates on fresh loans was more than offset by the fall in interest rates on MCLR-linked loans that had been contracted in the past and reset at lower rates. Of the various tenors, the transmission of the policy rate hikes in June and August this year was the highest for lending rates of one-year tenor, with foreign banks in the lead.

Role of NBFCs

As providers of infrastructure finance, NBFCs and banks play a complementary role. Over the years, the massive bad loans problem faced by the banking sector has been one of the prime growth drivers for NBFCs. The inclusion of infrastructure finance companies (IFCs) as a new category of NBFCs was an important step to ensure long-term funds for infrastructure projects. Some of the key NBFC-IFCs are India Infrastructure Finance Company Limited, the Housing and Urban Development Corporation (HUDCO), the Power Finance Corporation (PFC), the Rural Electrification Corporation (REC), Infrastructure Leasing and Financial Services (IL&FS), Srei Infrastructure Finance, and L&T Infrastructure Finance.

During 2017-18, NBFCs, both public and private, together disbursed Rs 2,175.7 billion, an increase of 21.45 per cent over the previous year. Disbursements grew at a compound annual growth rate of 15.96 per cent during the period 2013-14 to 2017-18. The share of public NBFCs in providing funds for infrastructure projects has been much greater than that of private NBFCs, highlighting the key role played by the public sector in undertaking infrastructure development in the country. For 2017-18, the share of public NBFCs in infrastructure funding stood at around 71 per cent, while the remaining 29 per cent was provided by private NBFCs. In terms of the amount disbursed during 2017-18, the maximum disbursals were made by PFC at Rs 644.14 billion, followed by REC at Rs 617.12 billion and L&T Infrastructure Finance  which disbursed Rs 396.55 billion.

Unfolding of a crisis

Following IL&FS’s failure to service its commercial papers on due dates and its default on payments, there have been concerns about the viability of India’s shadow banking sector. The company’s default was triggered by the fact that it had piled up too much debt that had to be repaid in the short term while revenues from its assets were skewed towards the longer term. Reportedly, IL&FS has a debt obligation of Rs 910 billion. As more than 40 per cent shares of the company are held by government-owned firms, the government stepped in to ensure financial stability in the country. It has replaced the IL&FS board with six selected nominees and a resolution plan has been drafted to solve the crisis.

Concerns about the cascading effects of the IL&FS default have triggered a liquidity crisis across NBFCs. As they cannot raise retail deposits from the general public, NBFCs depend on wholesale lending for their capital requirements, resulting in a higher cost of funds as compared to banks. The majority of NBFCs ventured into long-term lending and into underwriting loans with very long-term repayment tenors. As a result, the NBFCs’ short-term borrowing is channelised towards financing long-term loans. They are heavily dependent on banks, mutual funds and private placements to meet their capital requirements as well as for refinancing of loans. However, after the IL&FS default, these banks and mutual funds have stopped refinancing the loans of NBFCs and have also stopped the disbursal of loans sanctioned to them, as there is still no clarity regarding the spillover effect of the IL&FS default.

The difficult market conditions induced by the IL&FS crisis and the rising borrowing costs are likely to make the survival of small and less capitalised NBFCs difficult. It is also likely to drive consolidation amongst the NBFCs in order to create a stronger and diversified asset base and ensure diversification of risks, thereby driving benefits of scale and operating leverage, and lower funding costs. This move is expected to gain further traction after PFC’s acquisition of REC was recently granted in-principle approval by the Cabinet Committee on Economic Affairs.

Policy response

RBI continues to provide system-wide liquidity at an augmented quantum and accelerated pace. In addition, and specifically for NBFCs, it has increased the liquidity that banks can raise against their G-Sec holdings as collateral, specifically for on-lending to NBFCs and housing finance companies (HFCs). RBI has also relaxed the concentration limits on banks for lending to individual NBFCs and HFCs, increasing the limit from 10 per cent to 15 per cent.

Further, RBI has allowed banks to provide partial credit enhancement on bonds issued by NBFCs/HFCs. This will help raise the credit quality of these bonds and, thereby, attract mutual funds towards providing greater rollover funding to NBFCs. The rules for securitisation by NBFCs have also been relaxed, and this will allow the risks to be transferred to better-funded bank balance sheets.

Given the problems associated with infrastructure projects, banks are shying away from lending to the sector. Therefore, they are cashing in on the opportunity opened up in the NBFC sector by lending to them instead. Through this, NBFCs get the required liquidity while banks get attractive assets. However, banks are cherry-picking the portfolio that they want to buy. A case in point is the State Bank of India’s recent announcement to buy loan portfolios of NBFCs struggling with asset-liability management issues.

The way forward

The crisis in the NBFC domain is likely to shrink sector growth, resulting in contraction in margins and lower disbursements. The sluggish growth of bank credit to the infrastructure sector and the crisis unfolding in the NBFC segment highlights the need for them to develop in-house capabilities for credit appraisal so as to be able to raise a red flag in case of early signs of delinquency on the part of borrowers. Also, given the importance of NBFCs in the Indian financial system, they have to focus on their core strengths while improving on weaknesses in order to survive. They will have to be very dynamic and constantly endeavour to search for new products and services in order to survive in this hyper competitive financial market. Further, redesigning the regulatory framework for NBFCs such as the introduction of an asset quality review is the need of the hour. However, the long-term opportunity for the NBFC domain still remains large and attractive, especially given the huge unmet credit demand from micro, small and medium enterprises.




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