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RBI’s New NBFC Rules: Increased Disclosures May Help Reduce Investor Risk

Apart from increased disclosures, the RBI has also proposed strengthening the governance framework at NBFCs.

Security guards stand at the entrance to the reception of the Reserve Bank of India (RBI) in Mumbai. (Photographer: Prashanth Vishwanathan/Bloomberg)
Security guards stand at the entrance to the reception of the Reserve Bank of India (RBI) in Mumbai. (Photographer: Prashanth Vishwanathan/Bloomberg)

The collapse of Infrastructure Leasing and Financial Services and the subsequent fallout on non-bank lenders caught many investors off-guard. Not only had these firms been billed as high-growth opportunities but also as a low-risk option for investors.

The crisis, however, revealed a series of hidden risks beginning with poor liquidity management in some cases.

The Reserve Bank of India is now hoping to correct this by prescribing rules for liquidity management but also far more detailed disclosure requirements for non-banking financial companies and core investment companies.

In draft rules released on Friday, the RBI said that the following items must be disclosed by deposit-taking NBFCs and non-bank lenders with assets of over Rs 5000 crore:

  • Funding Concentration based on significant counterparty
  • Top 20 large deposits (amount and percentage of total deposits)
  • Top 10 borrowings (amount and percentage of total borrowings)
  • Funding concentration based on significant instrument/products
  • Ratio of commercial paper, non-convertible debentures and other short term liabilities to total liabilities

The disclosures will make it easier for investors and financiers to differentiate between different NBFCs and prevent mis-perceptions, said Gagan Banga, vice chairman of Indiabulls Housing Finance in an interview will BloombergQuint. The strengthened disclosure norms will be an extremely important input into the structural stability of the sector, Banga said.

The draft rules are putting these requirements out in the public domain. This can help lenders differentiate between NBFCs with high buffers and others that are operating just around the regulatory norms.
Gagan Banga, Vice Chairman, Indiabulls Housing Finance

Apart from increased disclosures, the RBI has also proposed strengthening the governance framework at NBFCs.

Non-bank lenders will need to set-up an asset-liability management committee to ensure the organisation adheres to the the risk tolerance limits set by the board. In an earlier notification, the RBI had also asked NBFCs to appoint a chief risk officer and ensure that this official has adequate independence.

Together, these measures will bring more comfort to investors, said Krishnan Sitaram, senior director at CRISIL Ratings Ltd.

With more granular information available going forward, investors and lenders can take a more informed decision by analysing the liquidity position of entities. Its always good to have such information in the public domain, Sitaraman told BloombergQuint.

Limited Material Impact?

The RBI is also proposing to introduce a liquidity coverage ratio (LCR) for NBFCs in a staggered fashion. The LCR will start at 60 percent in 2020 and move up to 100 percent by 2024. The LCR is the proportion of highly liquid assets that a lender has to maintain against short term outflows.

Analysts believe that most large NBFCs will be in a position to meet the new norms comfortably. For smaller NBFCs, the rules may entail an additional cost.

In a noted dated May 27, Kotak Institutional Equities said that most NBFCs maintained 5-8 per cent of liquid assets on their balance-sheets as of March 30, 2018. Therefore, maintaining liquid assets of about 1-8 percent of assets under management, as proposed by the RBI, would be broadly manageable, the brokerage house said.

With these guidelines, NBFCs will need to stick to ALM (asset liability management) and liquidity discipline at all times. More importantly, this will provide comfort to debt market participants that NBFCs will always be prudent on liquidity.
Kotak Institutional Equities

Macquarie Capital Securities, in its note, also said that all six of the NBFCs which are covered by the company, are fully-compliant with the 60 percent liquidity coverage norm.

But the same may not be true for smaller NBFCs.

Piyush Khaitan, founder, NeoGrowth Credit Pvt. Ltd. said there is a ‘negative cost of carry’ associated with maintaining a certain amount of liquidity but added that the measures is prudent. “The new norms should facilitate rating agencies in evaluating the liquidity position of the company better in factoring rating upgrades,” he said.

Margins, which have already been impacted by the credit crisis, may be further impacted by the RBI’s rules, the cost of raising equity will come down, said Sachindra Nath, chief executive officer at U Gro Capital.

The smaller and lower-rated NBFCs have faced the brunt of the ongoing credit crisis. Funding costs have risen and banks and mutual funds have been reluctant to increase their exposure to these firms.

Data provided by credit rating agencies, ICRA Ltd and Crisil Ratings Ltd, shows that there are 32-34 NBFCs with a AAA rating and around 15-35 with a BBB rating.

Highly rated NBFCs can access capital markets for borrowings whereas smaller NBFCs, that have weaker credit ratings, depend more on bank borrowing. The new rules will give more visibility on the quality of these lenders and help them achieve scale without a build-up of liability side risks, said Sitaraman.

Nath added that the next two years will see the emergence of two categories of NBFCs — those specialising in one product line and those that offer all kinds of credit. Over time, the latter will see regulations converge with banks, he said.