Does The RBI Need To Lend More Support To India’s Non Bank Lenders?
India’s non-bank lenders, which are feeling the strain of tighter financing conditions, have become a point of friction between the government and the Reserve Bank of India. While the regulator has stepped up cash infusions into the system and eased some norms to allow non-bank financial companies more room in fund raising, the government feels that more needs to be done.
The issue is likely to be part of a long list of items on the agenda at the next meeting of the RBI’s central board on Nov. 19.
Is the central bank behind the curve in dealing with the crisis? Analysts argue that while the RBI can ease liquidity further, it should stay away from taking any steps to bailout NBFCs.
Liquidity Remains Tight
The central bank infused Rs 36,000 crore in October through open market operations. It will pump in Rs 40,000 crore in November, of which, Rs 12,000 crore has been infused through an auction on Nov. 1.
Despite this, system liquidity remains in deficit. Average borrowings from the RBI’s repo window have moved back towards Rs 80,000 crore, according to data from the central bank. To be sure, some of the liquidity tightness seen in recent days may be due to higher demand for currency during the festive season and may normalize in the coming days.
“We think the RBI will need to step up open market operation bond purchases to Rs 50,000 crore per month between December and March,” said Indranil Sengupta, chief India economist at Bank of America-Merrill Lynch. In a report dated Oct. 29, the research house called for a cut in the cash reserve ratio, arguing that tight liquidity is at the heart of the stress in credit markets.
At the root of the stress in credit markets is tight liquidity that can only be alleviated by RBI OMO/CRR cut, in our view. We do not think that a RBI lending window will help as mutual funds aren’t facing panicky redemption but reportedly cutting exposure to NBFCs.Bank of America-Merrill Lynch
Flow Of Liquidity Constrained
Even if the RBI were to ease liquidity, it's uncertain whether the flow of that liquidity, particularly from mutual funds to NBFCs, would go back to levels seen before September.
While inflows into liquid mutual funds picked up in October, investors of mutual funds remain cautious about investing in commercial paper issues by NBFCs. Commercial paper volumes picked up to Rs 1.75 lakh crore in October but remained below the Rs 2.23 lakh crore issued in September, shows RBI data.
“We still worry about the liquidity situation, and think this is more of a medium-term problem, not just a near-term issue,” said Nomura Global Market Research in a report dated Nov. 10. “While companies have so far been able to manage liquidity needs so far given the large quantum of maturity of short term paper in Nov. 18, any defaults could potentially trigger another freeze.”
A mechanism is still needed to get liquidity to flow to NBFCs at a reasonable cost, said Anil Gupta, head of financial sector ratings at ICRA. Gupta, however, acknowledged that it is not easy to come up with such a mechanism since the RBI cannot lend directly to NBFCs. The fund flow would have to be via banks or mutual funds.
Easing The Refinancing Pain
To ease refinancing pain for NBFCs, the RBI has so far taken two steps.
First, it has allowed for partial credit enhancement of NBFC bonds. This could, theoretically, help smaller NBFCs improve their credit rating and raise more funds. The decision will boost confidence of mutual funds and debt investors in NBFCs although a large volume of such credit enhancements is unlikely, said Kotak Institutional Equities in a note on Nov. 5.
Other steps taken by the RBI include a loosening of the single party exposure limit for NBFCs to 15 percent from 10 percent earlier. This will ensure that banks still have some room to buy loan portfolios from NBFCs.
According to rating agency ICRA, securitisation volumes surged to Rs 18,000 crore in October. This compares to Rs 66,300 crore in securitisation transactions in the first half of the year.
But the liquidity is also coming at a high cost both from the markets and from banks.
Banks are squeezing NBFCs on pricing and demanding higher returns on the loan portfolios they purchase, said a market participant who spoke on condition of anonymity. For example, if banks were willing to invest in a non-priority sector loan pool at a rate of 9 percent earlier, they are now demanding close to 10.5 percent.
Those who have liquidity are charging a price for it, said Gupta.
Meanwhile, commercial paper rates for NBFCs remain high, even though short-term rates on government securities have moderated after a spike in early October.
What More Can The RBI Do?
Most analysts believe that easier liquidity conditions, which could also help bring down rates to some extent, is the most the RBI can do. Beyond that, the RBI should stay away from anything that resembles a bail-out, said a senior analyst speaking on condition of anonymity.
The RBI didn’t intervene when NBFCs were growing their books rapidly using short-term financing, said this analyst, while adding that it’s now up to these firms to manage the change in environment. They don’t want to create a moral hazard by bailing out these lenders, the analyst said.
While the RBI may want to take a hands-off approach to business risks of NBFCs, it will need to be mindful of the economic fallout of a protracted crisis in the non-banking sector finance sector.
Non-banking lenders, which are using most of the liquidity they generate for refinancing, will see significantly slower growth in the next few quarters. This, in turn, will slow down the flow of financial resources to the economy and hurt segments such as retail, real estate and small and medium enterprises.
We believe the ongoing liquidity crunch led by non-bank financial institutions could result in further slowdown in India’s discretionary consumption, thus derailing overall growth momentum over the next few quarters.UBS Global Research (November 9).