Non-banking financial companies (NBFCs), which play a prominent role in India’s infrastructure financing, are passing through a difficult phase. The Infrastructure Leasing & Financial Services (IL&FS) crisis in 2018 and the subsequent defaults by a few other companies including Dewan Housing Finance Corporation (DHFL), clubbed with asset quality concerns, have imposed liquidity constraints on NBFCs. To keep the credit cycle moving, many regulatory measures have been introduced in the past six to eight months. However, these are yet to have the desired impact, much to the NBFC industry’s dismay. The NBFC segment thus needs structural reforms to strengthen it so that it can continue providing finance for infrastructure.
In the past few years, NBFCs and housing finance companies (HFCs) have grown significantly to help bridge the funding gap emerging on account of constrained commercial bank lending. The share of NBFCs and HFCs in total credit has risen steadily from 15.2 per cent in 2014-15 to 19.2 per cent in 2017-18. With interest rates falling between 2014 and 2017, low-cost funds became easily available to NBFCs. This, coupled with further on-lending by banks, has contributed to the NBFC growth story in recent years.
However, tightening of interest rates, challenging macroeconomic factors, and the IL&FS and DHFL defaults shook confidence in the NBFC space. In the second half of 2018-19, the credit rating of select NBFCs and HFCs was downgraded due to an increase in the cost of funding, asset-liability mismatch, liquidity challenges and asset quality pressures, especially on the wholesale lending book.
Soon after the liquidity crisis in the NBFC sector (after IL&FS defaulted on its loan obligation), the State Bank of India (SBI) announced that it would buy the portfolios of NBFCs worth Rs 450 billion to ease the liquidity situation. The dependence on loan securitisation increased, particularly in the second half of 2018-19, to tide over the liquidity crunch faced by NBFC microfinance institutions.
The government and the Reserve Bank of India (RBI) have been taking several steps to ensure discipline and ease liquidity woes in the financing ecosystem:
- The Insolvency and Bankruptcy [IBC] Rules, 2019, were notified on November 15, 2019, bringing NBFCs into the ambit of the insolvency and liquidation proceedings (IBC Code).
- RBI increased the loan exposure limit of banks to a single NBFC (excluding gold loan companies) from 15 per cent to 20 per cent of its capital base.
- In a bid to keep credit flowing to select sectors, RBI tweaked priority sector lending norms. On-lending by registered NBFCs towards the agricultural and housing sectors up to prescribed limits will now be treated as priority sector loans.
- RBI extended the minimum holding period requirement for NBFCs to raise funds via loan securitisation to help them overcome liquidity shortages. NBFCs have been permitted to securitise loans of over five-year maturity after holding them for six months on their books, as against the earlier holding period of at least a year. The dispensation has been extended till December 31, 2019.
- For purchase of highly rated pooled assets of financially sound NBFCs amounting to a total of Rs 1 trillion during 2019-20, the government will provide a one-time, six-month partial credit guarantee to public sector banks for the first loss of up to 10 per cent.
- RBI has eased risk weightage norms for banks for the rated loan exposure they have in NBFCs. The move will not only free up more capital for the banks, but also make it easier and cheaper for select NBFCs to receive funds from the banks.
Infrastructure financing through NBFC-IDFs
At present, there are four infrastructure debt funds (IDFs) via the NBFC route. As of March 2019, these four IDF-NBFCs had an outstanding loan of over Rs 220 billion in operating infrastructure projects. The bulk of this is constituted by projects in the road and renewable energy sectors.
In October 2018, the National Investment and Infrastructure Fund (NIIF) acquired close to 59 per cent equity stake in IDFC Infrastructure Finance Limited. The other shareholders are IDFC (30 per cent) and HDFC (11 per cent). The IDF has a loan book of Rs 46.85 billion (as of March 2019) which is well diversified across various infrastructure sectors – hospitals, transmission projects, airport infrastructure, etc.
IDF as a financing product has grown in scale over the past four to five years, albeit at a rate slower than anticipated. In order to accelerate offshore investments in IDFs, the government waived the three-year lock-in period on investments made by non-resident Indians in IDFs. The impact of the move is yet to be felt. The government also allowed IDF-NBFCs to raise funds through shorter-tenor bonds and commercial papers from the domestic market to the extent of up to 10 per cent of their total outstanding borrowings.
According to ICRA, the tight regulations helped these entities manage the recent liquidity stress as they had negligible commercial paper outstanding as on September 30, 2018. Going forward, with a number of operational road and renewable energy projects becoming eligible for refinancing, the product mix of IDFs will continue to be dominated by these two sectors, with greater inclusion of the power and telecom sectors as well. As the product’s penetration is still modest in the infrastructure sector, the growth potential is immense.
Challenges still persist
A series of measures taken by the government to provide some relief to NBFCs from the ongoing liquidity crunch has met with limited success so far. The high cost of funds and poor liquidity transmission from banks continue to weigh down the NBFC industry. Prior to the IL&FS crisis in September 2018, banks charged around 40 basis points (bps) as the spread on AAA-rated NBFC papers. This increased more than 1.5 percentage points and has, in fact, remained at this level. Moreover, the cost of funds for non-AAA-rated NBFCs has risen by over 120 bps despite a rate cut of 135 bps by the apex bank since January 2019. Overall, wholesale NBFCs without strong parentage have been the worst hit. Besides, band-aid solutions such as the partial credit guarantee scheme still remain a non-starter as banks fear a risk of default in the case of long-term loans.
Credit risk perceptions have increased significantly with stock prices of listed NBFCs hitting rock bottom. Meanwhile, asset quality pressures are likely to persist for the wholesale segment, due to which the construction finance and infrastructure sector could face some headwinds.
There has been increasing competition in the refinancing market from sources such as bonds and infrastructure investment trusts (InvITs). Post operationalisation, projects are able to secure a higher rating of AA+/AAA which allows them to access the bond market. Meanwhile, the emergence of InvITs has also widened financing avenues for developers.
On the liabilities side for NBFC-IDFs, limited depth and volatility in debt capital markets pose challenges in raising long-term debt (over five years) in a cost-effective manner. In addition, bank marginal cost of funds-based lending rates (and consequently lending rates) have not kept pace with the increase in bond rates, thereby hurting the competitiveness of these entities .
To conclude, while the peak of the recent liquidity crunch may be over, normalcy is yet to return. Promoting the growth of NBFCs is crucial for the overall economy as they complement banks as well as offer credit to those parts of the economy which banks cannot or do not lend to. w