Will NBFC liquidity squeeze snowball into a crisis? Financial Express 30th October 2018

NBFCs carrying higher risk perception and 11 banks under PCA; Will NBFC liquidity squeeze snowball into a crisis?

By: Madan Sabnavis | Updated: October 30, 2018 4:19 AM

A liquidity issue has surfaced in the financial market given the challenge faced by NBFCs in raising funds.

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The question, however, is whether or not banks are willing to lend to specific NBFCs? Besides, this will hold only till December and isn’t a permanent measure.

A liquidity issue has surfaced in the financial market given the challenge faced by NBFCs in raising funds. There are three questions here. Firstly, whether or not it is serious. Secondly, whether this can be addressed by the system. Thirdly, whether this will affect the growth path.

It is necessary to understand the concept of liquidity which is being talking about. There is one path endogenous to the system where money flows to various financial intermediaries in the normal course of activity. The flow of funds comes in the form of bank deposits, mutual funds, insurance, provident and pension funds at the retail end.

At the wholesale side, it is money put in bonds and some money market instruments. The latter is limited as it is more a channelling of funds in the secondary stage as investments in bonds and CPs is done from the funds collected at the retail end which can also have some bulk deposits.

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Here it can be seen that growth in bank deposits for the first half of the year at `3.7 lakh crore is more than double that of what was there last year at `1.6 lakh crore. Bank credit increment this year is, however, at `3.6 lakh crore and investments are at `1.3 lakh crore, leading to a liquidity issue with banks which has been supported through the LAF window where there are around `1.3-1.5 lakh crore in net repos (overnight and term). Add to this the exogenous impact of RBI coming in with periodic OMOs and liquidity to the banking system is well balanced.

Bond issuances have been lower, but it is hard to find out whether it is a supply issue or demand one. Mutual funds flows have increased, while small savings could have gone up given the higher rates being offered. The listed insurance companies and EPFOs show higher inflows.

Put together, this indicates that flows are steady. It looks like investors and lenders have become more discerning.
Now, when it comes to NBFCs, sentiment has changed. Funds normally flow from banks and bonds for long-term purposes and banks, CBLO and CPs for short-term requirements. If there is a slower flow of funds then it is more a case of willingness to lend by the concerned lenders/investors in these instruments. The problem as stated by RBI is actually not acute across the industry but more specific to a handful of these entities.

Institutions like insurance companies or provident and pension funds do have funds to invest as there is data to suggest that the investible corpus has increased for insurance companies as well as EPFO. While it is possible that any increase in small savings would have gone to GSecs, the others have the option of investing in bonds issued by these NBFCs. How about banks? RBI data on sectoral distribution of credit suggests that, up to August, there was a fall in outstanding loans to NBFCs.

Here, it may be conjectured that this component could have come down further in the following two months. There are two issues here. Firstly, banks have been eager to expand on their retail loan book and hence may choose not to lend to NBFCs as there is a higher risk perception. Secondly, with 11 banks under PCA, the overall ability of banks to lend has come down. Hence, while these banks continue to receive deposits, they tend to get invested in GSecs as narrow banking takes over.

Two announcements have been made which can alleviate the situation to an extent. The first is by RBI, where it has allowed another 0.5% of NDTL, which is held under SLR of 19.5%, to be permitted for calculation of high quality liquidity assets under LCR within the category of FALL (facility to avail liquidity for LCR) to the extent of incremental lending to NBFCs.

The question, however, is whether or not banks are willing to lend to specific NBFCs? Besides, this will hold only till December and isn’t a permanent measure. Therefore, banks may be cautious to extend lending.

The second is statements made by some banks that are willing to buy some of the loans of NBFCs. But this will only mean the churning of existing funds as a purchase of, say, an auto loan book from a NBFC will result in banks probably lending less directly to customers on their own account. For the financial system as a whole, this may not matter.

A way out could be to do what the Fed did with QE wherein it purchased commercial loans and generated liquidity. This is an option which has been vetoed by RBI which does not believe this problem is pervasive to opening a window for NBFCs, although the reference is more like allowing NBFCs to join the repo window and offer their holdings of GSecs (which they are already using at the CBLO market). Therefore, there would be no assistance coming from RBI as of now.

It has been suggested that RBI should dilute the PCA principles so that these banks can lend more, but this would mean going back to the old days of compromise which should be eschewed. Therefore, this does not make too much sense. Another piece of advice has been to make RBI announce the lowering of risk-weighted norms for reckoning capital on loans to NBFCs. This will be imprudent and is not something which one can recommend to enable easier flow of credit to this sector.

Will the ongoing problems come in the way of growth? If the supply of funds to NBFCs has been hindered on account of unwillingness of banks to lend due to risk-profile issues, then there would be a movement for those borrowers of NBFCs to the banking system. Here, the SMEs, automobiles, tractors, real estate and housing industries would be the affected parties. They would have to either look for better funded NBFCs to source loans or the banking sector. Such a transition would be visible when data on bank lending is released for the months of September and October.

However, to the extent that lending is hindered because of the inability of the financial system, RBI has been proactive with OMOs as well as relaxing of the norms for reckoning the liquidity coverage ratio under Basel III to ensure that the funding power of banks is enhanced.
Therefore, while there definitely is an issue on the liquidity front, it is localised to a specific segment and not pervasive. To the extent that there is a shortfall, it is being addressed by RBI through some fine tuning. But, if liquidity is not forthcoming due to risk perception issues, then the specific segment would be impacted.

However, it is not expected that this will snowball into a crisis-like situation as substitutions in funding can take place over time. Presently, one can confidently be agnostic in the view of the situation’s impact on economic growth, but monitoring the developments would still be advisable.