- Taking stock of the NBFC crisis, the Finance Industry Development Council (FIDC), a NBFC lobby group, has suggested a slew of reforms for the NBFC sector to the Reserve Bank of India (RBI) and the government.
What are NBFCs?
- Non-banking financial companies (NBFCs) are financial institutions that offer various banking services, but do not have a banking license.
- Generally, these institutions are not allowed to take deposits from the public, which keeps them outside the scope of traditional banking regulations.
- NBFCs can offer banking services such as loans and credit facilities, retirement planning, money markets, underwriting and merger activities.
NBFCs in India
- NBFCs in India includes a wider group of companies that are engaged in investment, insurance, chit fund, nidhi, merchant banking, stock broking, alternative investments etc. as their principal business.
- NBFCs being financial intermediaries are supposed to play a supplementary role to banks.
- NBFCs, especially those catering to the urban and rural poor (including the micro-finance institutions (NBFC-MFIs) and asset finance companies) have a complementary role in the financial inclusion agenda of the country.
- Further, some of the big NBFCs( infrastructure finance companies) are engaged in lending exclusively to the infrastructure sector, and some are into factoring business, thereby giving a fillip to the growth and development of various sectors.
Background: NBFC Crisis
- The NBFC sector has been recently facing a crisis.
- The Infrastructure Leasing and Financial Services Ltd (IL&FS) defaulted on its loan last year, which created panic among Mutual fund investors.
- Since then, many NBFCs came under severe liquidity pressure, resorting to high cost borrowings.
- This led to a series of downgrading of their ratings and banks were averse to lend to the sector, resulting in liquidity crisis in the NBFC sector.
- In this context, the need for a stronger asset liability management (ALM) framework in the NBFC sector was felt.
Main reasons for the crisis
- Misadventures by some large entities like the IL&FS group.
- Credit squeeze due to slowdown in lending by banks to NBFCs.
- Asset-liability mismatch i.e. these firms borrow funds from the market (example: for 3 or 5 years) and lend for longer tenures (example: for 10 to 15 years).
- In a scenario where interest rates are rising, this hurt the NBFCs as their margins came under pressure and sourcing of funds became tough.
- Sharp losses in NBFC stocks triggered a vicious cycle as losses in leveraged positions led to selling in other stocks, which in turn fuelled further losses in markets.
Dedicated liquidity window for NBFCs
- Creation of a dedicated liquidity window for NBFCs through banking channels for a one year period.
- A liquidity window for NBFCs will not only help the sector come out of its woes to an extent, it will also infuse confidence among lenders and borrowers thereby pushing consumption demand in the economy.
On-lending to Priority Sector treated as Priority sector lending
- Banks lending to NBFCs for on-lending to the priority sector, should be treated as priority sector lending (PSL by banks). This, will have dual benefit as it will allow banks to achieve their PSL targets and the NBFCs will get funding at reasonable costs.
- Restore this feature that existed earlier:
- Since 1999, the RBI had allowed all banks lending to NBFCs for on-lending to the priority sector to be treated as priority sector lending by banks.
- This gave a huge incentive to banks to lend to NBFCs.
- While it ensured sufficient bank funding to NBFCs at a reasonable cost, it also facilitated banks to meet their PSL targets.
- However, this was abruptly withdrawn in 2011.
- The same arrangement may be restored urgently.
Dedicated Refinance window
- A dedicated ‘refinance window for NBFCs’ on the lines of National Housing Bank which provides refinance to housing finance companies.
- The Parliamentary Standing Committee on Finance in their 45th report dated June 2003 (relating to the Financial Companies Regulation Bill, 2000) had also recommended setting up of a new refinance institution for NBFCs.
Change in eligibility norms for availing refinance from MUDRA
- For small & medium sized NBFCs, eligibility norms for availing refinance from MUDRA should be made favourable by allowing all RBI registered NBFCs to avail refinance.