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Why throw baby with bath water?

Several NBFCs provide credit for certain sectors not served by banks and financial institutions. They act as a last mile delivery channel for the banks.

THE CURRENT REGULATORY framework does not distinguish between NBFCs providing vital credit to useful sections of society vis-à-vis other NBFCs that provide big ticket lending to corporates.

The regulations imposed by RBI on  NBFCs have been so rigorous that the number of deposit accepting NBFCs has reduced steeply. For example, when the requirement of minimum NoF and compulsory registration was introduced, there were 37,000 NBFCs operating. However, only around 650 companies were registered as deposit accepting NBFCs and 8400 as non-deposit accepting NBFCs. The applications of the rest were rejected. From 650 deposit accepting NBFCs in 1999, there are only 250 in 2013.

Further, while public deposits of NBFCs during this 14 year phase rose marginally from Rs 10,000 crore to Rs 10,600 crore, those of banks rose exponentially from Rs 771,130 crore to Rs 7,429,500 crore.

The RBI’s restrictions on acceptance of deposits and bank financing have choked the NBFCs’ access to funds.

 

Capital Adequacy Ratio

RBI has been mandating NBFCs to maintain a minimum capital adequacy ratio. This is to make sure that NBFCs do not borrow recklessly. Prior to 1997, NBFCs were required to maintain a CAR of 8 per cent; hence its overall borrowing would be 12 times its owned fund. Currently, the CAR prescribed is 15 per cent which means that the NBFC can borrow only around 6 times its owned funds. On a comparison between 1997 and the current period, there is almost a 50 per cent reduction in the borrowing limits for NBFCs (from the earlier limit of around 12 times to the current limit of around 6 times). This has reduced credit made available to the segments, which are dependent on NBFCs, namely small transport operators and small businessmen. This makes them turn to the unorganised lenders who charge usurious rates of interest.  Given the risks involved in financing the Non Corporate MSME sector the CAR for NBFCs engaged in financing them can be capped at 10 per cent.

 

Provisioning norms

Currently, for all NBFCs, the provisioning norms in respect of loans granted by NBFCs is 180 days past due. However, the provisioning norms for hire purchase and lease transactions entered into by NBFCs are 360 days past due. There is a proposal to align the provisioning requirements for NBFCs with that of banks (ie.) by making the  provisioning at 90 days. Further, all NBFCs are required to make additional provision for standard assets @ 0.25 per cent all the standard assets with effect from 17 January 2011. This is additional provision to be made by NBFCs apart from the regular provisions, and is on par with banks.

 

90 day limit unrealistic…

The proposal to fix the NPA provisioning norms at 90 days should not be made applicable for the NBFCs engaged in financing the Non Corporate MSME sector because the borrower segment of these NBFCs comprise small businessmen, traders and truck operators who do not have predictable cash flows and in most cases, their earnings are seasonal. These NBFCs, which have a local presence, have been able to connect closely with the borrower segment and have demonstrated excellent recoveries ultimately from this sector, even though there may be timing issues.

 

Debenture Redemption Reserve

In case of public issues the requirement of DRR has been made mandatory for all issues of debentures. The requirement of DRR is prescribed at 25 per cent. In addition, the companies are required to maintain a SLR of 15 per cent of the debentures maturing during the year. In case of private placement of debentures, NBFCs are exempt from the requirement of DRR.

NBFCs that are engaged in financing the MSME sector, issue debentures for meeting their lending requirements. The end use of these debentures is primarily for on-lending to these sectors which are backed by sufficient assets.

These debentures are essentially working capital debentures where the money gets deployed in self-liquidating assets, the proceeds of which are sufficient to meet the redemption of debentures. In case of manufacturing companies, the debenture amounts are deployed in fixed assets which can never be sold for meeting the redemption of the debentures and hence there may be a requirement for DRR in such cases.

 

Restriction on private placement of secured debentures

Prior to July 2013 NBFCs were permitted to issue secured debentures on a private placement basis.  Since July 2013, the RBI has restricted NBFCs from issuing debentures on a private placement basis to retail investors. However, Companies Act, 1956 (then) and Companies Act, 2013 (now), continues to exempt NBFCs from the restrictions on private placement, imposed on other types  of companies.

Companies Act provides that NBFCs would be governed by RBI regulations on private placement – if RBI does not place any regulations then, companies Act will apply. However, since July 2013, RBI has prohibited retail private issuances by NBFCs.

The flexibility which NBFCs had to issue retail NCDs via private placement is to be restored.

The case of NBFCs which are engaged in financing the non-corporate micro, small and medium segment in India should be treated differently.

 

Deposit acceptance limits

Presently, the deposit cap is restricted to 4 times net owned funds for Asset financing NBFCs and 1.5 times of net owned funds for loan-NBFCs. The Usha Thorat Committee set up by RBI, proposes to limit the deposit acceptance limits to 2.5 times the net owned funds.  NBFCs are anyway subjected to an overall cap on borrowings. Within this overall limit, they should have the flexibility to borrow in any manner permitted. NBFCs’ access to bank funding is limited, especially considering that the priority sector lending tag has now been removed.  Hence, NBFCs are dependent on the retail segment for their funds. NBFC’s access to retail borrowing is by way of deposits and secured debentures.

In July 2013, RBI has put further restriction on NBFC’s ability to issue debentures to retail customers further reducing funding availability and increasing the costs of NBFCs. A window of investment which was available to the retail customer to invest in secured liquid debentures of NBFCs has also been shut by the RBI in this process, even though there has not been any past history of default by the NBFC sector in the case of repayment of secured debentures.

 

Lending to NBFCs should be recognised as priority sector credit

RBI has been prescribing certain sectors as ‘Priority sectors’ which require credit and has been encouraging banks to extend credit to such sectors. Minimum targets too have been set. This is in furtherance of RBI’s goal for financial inclusion. The sectors which are prescribed as priority sector are rightly identified including the agriculture and SME sector.

NBFCs are significant lenders to the SME sector and have played an important role in credit extended to this sector. Till recently, bank lending to NBFCs which was used for on-lending to the SME sector, was recognised as priority sector lending by banks.

Since April 2011, only direct lending by banks to these sectors qualify under this. Certain exceptions have been made for bank lending to micro-finance institutions. This has resulted in denial of bank finance to NBFCs for on–lending to these sectors including the MSME sector.

NBFCs have been providing credit to the Micro and small enterprises sector including the small road and water transport operators and the small businessmen, who have benefited largely out of the credit provided by NBFCs.  This has helped the end borrowers by providing them easy access to credit at reasonable interest. It has also helped banks since banks are able to use the network of NBFCs to reach out and provide loans to the priority sector areas.

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