I. Background
The crisis in the Non-Banking Financial Companies (NBFC) sector has been in the making for the past couple of years. While a series of default by well rated NBFCs and Housing Finance Companies like ILFS and Dewan Housing eroded trust-worthiness, a series of other events like Franklin Templeton fiasco and to top it all, the outcome of COVID-19 took a heavy toll on the non-bank sector.
This necessitated urgent measures to provide relief. Consequently, RBI announced a series of measures from the monetary side while the Government of India complemented the same through stimulus measures to this sector through its five tranche ‘Atmanirbhar Bharat’.
II. What are NBFCs? Why are they called ‘shadow banks’?
Both banks and non-banking financial companies engaged in business of lending. But, there is a crucial distinction. Not all NBFCs can accept deposits from the public like ordinary commercial banks. Out of 11,000 odd NBFCs registered with the RBI, only a handful, say 300, are authorized to accept deposits from public – only in the form of term deposits. NBFCs are called shadow banks as they cannot do full-fledged banking services.
Distinction between Banks and NBFCs
III. Reason for crisis
Asset-Liability mismatches: NBFCs depend on commercial banks, money market instruments i.e. Commercial Paper (CP) and Certificate of Deposits (CD) for their funding requirements which are of short-term in nature. But, they lend to MSMEs, real estate and consumer durable companies for long-term. This creates asset-liability mismatches.
For example – ABC (an NBFC) raises money by selling 45 days Commercial Paper and gives a car loan to a customer for three years. So, ABC has to repay within 45 days while the car loan gets repaid in 3 years only. In good times, ABC can roll over its liabilities (CP). This keeps on moving but in bad times this vicious cycle is broken. This is the basic structural issue.
Risk aversion: Moreover, there is restriction on lending by Financial Institutions (FIs) to NBFCs, post IL&FS crisis causing liquidity crunch. Trust in NBFC balance sheets have eroded and even better rated ones find it difficult to raise funds. This will get worse due to COVID-19 when real estate and consumer companies find it hard to repay NBFCs.
In short, NBFCs face crisis from two fronts:
1) Asset-liability mismatches which are already inherent.
2) NBFCs not being able to recover money lent to real estate, consumer durable companies etc. due to the COVID-19 crisis and consequential moratorium.
IV. Stimulus package—NBFCs/ HFCs (Housing Finance Companies) & MFIs (Micro Finance Institutions)
To provide relief to the crisis-hit NBFCs and HFCs, Rs.75,000 Crore stimulus package was announced as part of the five tranches.
This package has 2 parts:
- Special liquidity support of Rs.30,000 Crore
- Partial Credit Guarantee of Rs.45,000 Crore
Special Liquidity Window scheme—major features:
SPV floated: Under the special liquidity scheme, a special purpose vehicle (SPV) will be created that will invest through both primary market (direct investment when NBFCs issue bonds) and secondary market transactions (purchase of bonds from others who have already bought them) in investment grade bonds issued by NBFCs/HFCs/and MFIs.
Only junk bonds excluded: It is important to note the only condition is that bonds should be investment grade, i.e. it should not be junk. Thus, even bonds issued by those rated below AA or even unrated ones are eligible for investment.
The SPV will invest in short-term debt with residual maturity of three months.
The SPV will invest up to a ceiling of Rs.30,000 crore.
Working of the scheme
Mechanism defined:
Government cannot directly fund NBFCs/HFCs/MFIs. Hence, it authorizes a large PSU bank to create a Special Purpose Vehicle (SPV), which in turn manages a Stressed Asset Fund (SAF) to issue GOI guaranteed securities. These securities are bought by RBI. The proceeds are used to invest in short-term papers of NBFCs/HFCs/MFIs which are not junk.
The SPV issues securities up to a ceiling of Rs.30,000 Crore which will be fully guaranteed by the Government of India.
Partial credit guarantee scheme—-major features:
As the title shows, this scheme does not provide full guarantee for losses suffered on account of investment in NBFC securities.
Eligibility: Public sector banks will be permitted to invest in primary market bond issuance by NBFCs/HFCs and MFIs. These bonds should be investment grade which means those rated below AA and even unrated entities are now eligible to receive support. The bonds should not be junk. Before this scheme, public sector banks were allowed to invest in only high-rated assets from financially sound NBFCs and HFCs.
First loss of 20% covered: Under the scheme, government will provide guarantee to public sector banks for the initial 20% loss of value on securities issued by the NBFCs where these PSBs invest. This is an improvement over the earlier partial credit guarantee scheme introduced in Union Budget 2019. In the budget, Government had offered guarantee up to first loss of 10% for a value of up to Rs. 1 Lakh Crore. The ceiling under the present scheme is Rs.45,000 crore.
Together with the special liquidity support, NBFCs/HFCs and MFIs will now receive liquidity support worth Rs.75,000 Crore under the two schemes.
V. Implications of schemes:
1) Supplements RBI measures: RBI had introduced Targeted Long-Term Lending Operations (TLTRO) 2.0 to support banks. This measure is to invest in investment grade debt issued by NBFCs/HFCs and MFIs up to Rs.50,000 crore. The special liquidity facility of Rs.30,000 crore is an additional measure and provides more liquidity to these segments to tide over the crisis.
2) Special liquidity window coincides with moratorium to customers: RBI had permitted banks and NBFCs to extend moratorium to their customers for an initial period of three months. The special liquidity window for three months covers this period and helps NBFCs in meeting their short-term liabilities though money from customers are stuck. Besides, in the current lockdown environment, NBFCs are facing troubles in collections. The special liquidity will provide some relief in this context as well.
3) Short-term money may not be sufficient: In the case of special liquidity window, the SPV invests in securities with residual maturity of three months only. This exposes them to the same asset-liability mismatch issue. Since lending is for typically 2-3 years, the money received should also be of a similar duration so that cash flow problems are avoided. In the present scheme, NBFCs receiving money from the SPV will have to repay after three months which might expose them to liquidity issues. At the most, the scheme helps rollover of some commercial papers or certificate of deposits (CPs/CDs). CPs/CDs are short-term money market instruments used by NBFCs to borrow funds.
4) More lending to MSMEs: NBFCs will get access to Rs.75,000 Crore of liquidity, which will help them lend more money to the MSME segment. As of now, MSMEs find it tough to get funding on account of risk aversion by banks and liquidity woes faced by NBFCs.
5) Enhances confidence: The improved version of Partial Credit Guarantee Scheme gives banks more confidence to investment in even unrated or below rated NBFCs and HFC papers as first losses of up to 20% is now guaranteed by the sovereign.
DISCUSSION QUESTIONS
1) An NBFC has an average loan tenure of three years while its liabilities are having a tenure of 90 days. In a bad economic scenario, what crisis will this NBFC face? (Hint Point III).
2) ABC, an NBFC issued cheque book facility to its customers and offered them the facility to open a Savings Bank (SB) account. Is the NBFC legally right in doing so? (Hint: Banks vs NBFCs table)
3) The special liquidity window does not help to fully provide relief to NBFCs and HFCs from liquidity troubles. Explain (Hint: Implications point 2)
4) Can a bank availing partial credit guarantee facility invest in an NBFC paper rated BBB? Give reasons (Hint IV 2: eligibility)
5) Please explain the working of the Special Purpose Vehicle (SPV) floated to provide liquidity support to NBFCs.
6) How does the 2019 partial credit guarantee scheme differ from the Atmanirbhar partial guarantee scheme? (Hint IV2: First loss)
REFERENCES
- livemint.com
- Finance Minister’s presentation on Atmanirbhar Bharat
- CNBC TV-18 Reports
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