While the health crisis has brought the country to its knees, the fatal blow seems to be coming our way from the economic effects of the Covid-19 pandemic. The exposure of the severely-stressed para banking industry to risky segments in these times has made it even more vulnerable to an economic slowdown.[1] With its asset quality deteriorating at an increasing rate, the liquidity in para banking industry has been squeezed off to its last drops.

The impact of the liquidity crisis across various classes of non-banking financial companies (“NBFCs”) may be analysed vis-à-vis the exposure it has towards the borrower segments whose economic activities have been severely impacted.  With the economic and consumption activities a bust in sectors such as real estate and micro-finance, the NBFCs with loan exposures in the said sectors will be hit the worst in the wave of this global pandemic. The increasing loan losses and inaccessibility to new capital is likely to exacerbate the liquidity stress.

A slew of measures have followed to rescue the para banking industry from the aggravated liquidity crisis that has been looming over the sector since the announcement of the COVID-19 regulatory relief package by the Reserve Bank of India (“RBI”) on March 27, 2020. This was supplemented with detailed instructions dated April 17, 2020 from the RBI with regard to asset classification and provisioning norms (“RBI Relief Package”) which was intended to alleviate borrower stress. As per the RBI Relief Package, the lending institutions inter alia NBFCs (including housing finance companies) were permitted to grant a moratorium of three months on payment of all instalments falling due between March 1, 2020 and May 31, 2020. Even this now stands extended by another three months i.e., from June 1, 2020 to August 31, 2020, vide the notification dated May 23, 2020 issued by the RBI. Primarily, NBFCs utilise the cash inflows from the payments made by their borrowers to repay the liability owed towards their lenders. Granting a moratorium to its borrowers on payment of loan instalments spells trouble for the sector as the NBFCs operate on very thin short-term liquidity on their balance sheets.

Asset-Liability Mismatch

For a sector that was already stressed, the RBI Relief Package has delved yet another blow leaving it with a stark asset-liability mismatch.[2] While the NBFCs are directed to offer the moratorium to its debtors, its lenders have been reluctant to extend the same relief. The challenges are even more grave for NBFCs with high share of capital market borrowings because no moratorium has been announced for capital market borrowings (such as bonds and commercial paper) and repayments on these will have to be made on time, during a period when collections would be impacted significantly.[3]

A prayer for interim relief in respect of postponement of servicing of its commercial papers and bonds was sought in the Delhi High Court in the case of Indiabulls Housing Finance vs. Securities and Exchange Board of India[4], by the petitioners, in view of the moratorium granted to its borrowers in line with the RBI Relief Package. The writ petition was subsequently withdrawn but not without bringing to light the ailing NBFC sector. In another case, Indiabulls Housing Finance v HDFC Bank Limited[5], the HDFC Bank was permitted to appropriate the fixed deposit maintained by the petitioner towards the instalment which had become due during the moratorium period. This highlights the reluctance of the banks to offer any kinds of concessions on payment/ repayment by the NBFCs in terms of the RBI Relief Package.

The concern of the banks seems to be that if moratorium is granted to NBFCs, they will use the cash-flows saved up to meet their obligations in respect of capital market borrowings instead of on-lending. The bankers have been reading the fine print of the RBI Relief Package to exclude the NBFCs from the moratorium relief, asking them to instead utilise the RBI liquidity window at repo rate to meet their needs.[6] After many a push from the RBI, certain banks have only recently started considering the proposals of the NBFCs for moratorium on a case-to case basis, after ensuring due diligence on the genuineness of the request of the applicant.

Risk-aversion of Banks

The RBI, as a part of the RBI Relief Package, had also announced the Targeted Long-Term Repo Operations (“TLTRO”). The risk-averse banks utilised the money borrowed from the RBI at the reduced repo rate to invest only in debt securities of top-rated companies which were already flushed with cash, thus deflating the purpose of the RBI Relief Package.

Accordingly, the RBI announced revised Targeted Long-Term Repo Operations (“TLTRO 2.0”) to channel the liquidity to small and mid-sized corporates.[7] Half of the liquidity under the TLTRO 2.0 was targeted towards the NBFC sector – 10% of the money being directed to be utilised towards buying securities issued by microfinance institutions, 15% for NBFCs with asset size of INR 500 crore and below, and 25% to securities of NBFCs sized between INR 500 crore and INR 5,000 crore. In the first auction under the TLTRO 2.0 for a bid amount of INR 25,000 crore, the banks put 14 bids worth only INR 12,850 crore for the three-year money offered.[8] The results of the auction under the TLTRO 2.0 confirmed that the banks have little to no appetite for fresh exposures to risky assets.

Taking note of how the liquidity infused under the repo operations undertaken by the RBI was inaccessible to the sectors which were the most impacted by the pandemic, the Supreme Court has directed the RBI to give effect to the RBI Relief Package in its ‘letter and spirit’.[9]

Stimulus 2.0

As a part of the five-tranched INR 20 Trillion stimulus package, the Government has stepped in to provide liquidity support amounting to INR 75,000-crore to the para banking industry. The liquidity support is proposed to be provided under two separate schemes.

The first scheme provides for establishment of a INR 30,000-crore special liquidity fund, pursuant to which the investments made would be fully guaranteed by the Government. The Union Cabinet granted its post-facto approval to the special liquidity scheme on May 20, 2020.[10] Under this scheme, the Government will set up a special purpose vehicle (“SPV”) which would issue interest bearing special securities not exceeding INR 30,000 crore to the RBI, guaranteed by the Government of India. The proceeds thereof would be used by the SPV to invest in investment grade securities of NBFCs, housing finance companies and microfinance institutions. The second measure is an already-in-force partial credit guarantee scheme amounting to INR 45,000-crore, which is now being extended to provide a 20% first loss guarantee cover for investments made in lower-rated and unrated securities of all NBFCs, housing finance institutions and microfinance institutions.

The direct debt purchase by the Government from the para banking sector is the first-of-its-kind measure adopted by the Government. Since the first auction under the TLTRO 2.0 stood as a litmus test for the banks’ risk aversion to the exposure to NBFCs, direct lending by the Government seems to be the need of the hour. However, it remains to be seen if this measure addresses the structural funding problem faced by the sector, as investment under this scheme is again restricted to investment grade securities which will make many NBFCs ineligible to borrow. One may argue that the partial credit guarantee scheme offers haven to lower-rated and unrated securities, but that argument holds little merit as the effectiveness of the partial credit guarantee will be limited when compared to direct debt purchase.

In a financial system already moth-eaten by bad debts, only time will tell how much and to what extent the sovereign guarantees will be able to provide stimulus to the banks to lend generously to the ailing NBFC sector. As the Government and the RBI aim to flush the economy with liquidity in the short-run with their stimulus packages and the repo operations respectively, the banks may still have to tread lightly by assessing the viability of their prospective borrowers in the interest of their balance-sheets in the longer run. The Bank of Baroda has taken the lead to study the NBFC loan portfolio to assess the asset quality, cash holdings, and potential stress build up in the sector. For this purpose, the Bank of Baroda has issued a tender document to the monitoring agencies empanelled with the Indian Banks’ Association to assist with the monitoring exercise. [11]

While we await the fine print of the policy to assess how swiftly funds will be made available to the NBFC sector, and to understand if the Government and the RBI have any more robust measures up their sleeve for the coming times, it may be too hopeful to expect the Government’s stimulus package to address the structural funding issues that the sector has been experiencing for a while now. If we were to live by the words of Robert Frost, we’d know that the best way out is always through. Having said that, to get through the liquidity crisis in the para banking sector, the answer really lies in such measures that aim at regeneration of demand in the overall economy leading to revival of confidence.

[1] http://www.moodys.com/research/Moodys-Indian-NBFIs-face-rising-liquidity-stress-with-risks-looming–PBC_1229754

[2] http://www.business-standard.com/article/finance/nbfc-mfis-seek-clarity-from-rbi-on-3-month-moratorium-on-loans-120040701822_1.html

[3] http://www.crisil.com/en/home/our-analysis/views-and-commentaries/2020/03/lockdown-moratorium-and-nbfcs.html

[4] This writ petition stands withdrawn vide Delhi High Court order dated May 05, 2020.

[5] Delhi High Court, W.P. (C) 3033/2020

[6] http://www.business-standard.com/article/finance/sbi-weighs-25-fresh-credit-proposals-from-nbfcs-amid-covid-19-crisis-120050601802_1.html

[7] http://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49689

[8] http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=49714

[9] Kamal Kumar Kalia vs. Union of India, WP/10955/20

[10] http://pib.gov.in/PressReleasePage.aspx?PRID=1625310

[11] http://economictimes.indiatimes.com/industry/banking/finance/banking/bank-of-baroda-to-appoint-agencies-to-monitor-rs-4-lakh-crore-nbfc-loans/articleshow/75838826.cms?from=mdr