Making sense of the NBFC’s situation; What is RBI doing to support them?

Nifty's down about 15% since its year high made in August end. Nifty bank is down by 12% and NBFC stocks down by 15% on average and 74% for a company like DHFL, since their year highs.

What is the problem?

The major reason is the NBFC crisis looming over the market where the issues at hand are:

1. IL&FS fiasco: IL&FS defaulted on its payment obligations and many NBFC have huge exposure to IL&FS.

2. Maturity mismatching: Loans taken by NBFC's have maturity mismatching; in sense that they have borrowed for shorter term and extended to real estate projects for mid to long term. This has led to banks not extending new loans to NBFC's, since they fear the asset liability mismatch.

3. High bond yields have posed a big problem; as they make borrowing expensive. Problem of liquidity is inherent in the economy at this point in time and investors are compelled to sell NBFC bonds at yields as high as 11-12% as seen in the case of DSP mutual fund selling DHFL bonds.

While higher cost of funds will impact margins and growth for the sector as a whole, the impact would be particularly pronounced for a while.

What is RBI doing about the situation?

RBI kept the status quo unchanged by not changing the interest rates in its recent MPC meeting on 5th October to support NBFC’s.

RBI is keeping a watch on the NBCF's situation and is taking up all the measures to support NBFC’s indirectly instead of directly offering a bailout to their “parent” IL&FS. It has already stated that NBFCs should rely more on equity and long term financing for funding long term assets instead of the current bond and short term financing via commercial papers. In its recent circular, RBI allowed:

1) Banks to carve out additional 0.5% of NDTL from statutory liquidity ratio (SLR) securities for calculation of liquidity coverage ratio (LCR) for incremental lending to NBFCs/HFCs.

2) To increase their exposure to NBFCs from 10% of net worth to 15%.

Even SBI and other PSU banks announced an increase in portfolio buyout for the NBFCs. This, coupled with RBI’s open market operations (OMO) of Rs. 360 bn in Oct’18 and National Housing Bank (NHB) increasing refinancing limit to Rs. 300 bn from INR240b, are some steps we believe will effectively reduce the commercial papers rollover risk at the system level.

What next?

Recovery of NBFC's is essential for the economy; irrespective of how much ever time it takes. The liquidity squeeze gripping the NBFC's and mutual funds becoming cautious of rolling over their positions (which accounted for bulk of subscription for NBFC commercial papers) and also facing pressures for redemptions, raise serious concerns. But the steps taken by RBI and PSU’s should ease out short term lending rollover issue for NBFC’s.

Appropriate measures are being taken by RBI to cap the fall in the credit markets, though their actual effect is yet to be seen in the prices of the NBFC’s.

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