MAY 9-MAY 15

The NBFC sector might be on course to hit choppy waters given multiple headwinds caused by ; 

• RBI’s sudden rate hike on May 4th
• Lapses in credit portfolios coming to light post the pandemic era liquidity measures
• Increasing compliance costs  given RBI’s push for scale based regulation for NBFCs

RBI’s rate hike 

The 40 bps rate hike during the first week of May and the impending hikes to tackle spiraling inflation have spooked the NBFC sector with fears of: 

• Disproportionate increase in borrowing costs and shrinking margins

Following the 40bps increase in repo rates, it is expected that NBFC’s cost of borrowings will immediately increase by at least 20bps. However, the issue is that the regulator is under pressure to tackle the monster called inflation and more hikes are just around the corner. Repo rates are expected to go up to 5.15% which could result in an increase in cost of funds by another 50-60bps for the NBFCs. Given that some of these players would not want to immediately pass on the increased cost to their borrowers, the next 2 to 3 quarters are expected to witness some margin compression for NBFC players. 

• Deterioration of credit quality of weak borrowers

However, banks have started to pass on the rate hike to their borrowers. HDFC, the biggest mortgage lender, raised its retail prime lending rate by 30 bps, increasing the cost of borrowing for all floating rate home loan customers. ICICI Bank, Bank of Baroda and Bank of India have raised interest rates on new loans by 40 basis points. At some point in time, NBFCs would also need to pass on the increased costs to their customers. If the repo rate pushes above 6%, the risk premium for certain segments of borrowers would move up, pushing them towards default, especially for those borrowers who are yet to recover from the blow dealt by the pandemic.

Irregularities in credit & restructuring processes- hint of a systemic problem?

Startling irregularities in credit portfolios have been coming to light within NBFCs amongst the ongoing withdrawal of covid-era liquidity measures. Last week, Indostar Capital  and mortgage lender Can Fin Homes disclosed that they have detected some irregularities in their books. For Indostar, preliminary findings of consultancy firm EY have found deviations in the loan approval, foreclosure and restructuring in the company’s commercial vehicle loan accounts. It also found that for restructured loans, it did not follow all the necessary steps. Additional provisions to cover credit losses arising out of the affected exposure are estimated between ₹557 crore and ₹677 crore.  Can Fin, on the other hand, disclosed that it had unearthed 37 loan accounts ( ₹3.93 crore) with fake income-tax returns and declared them as fraud and non-performing assets (NPAs).

Concerns have begun to emerge given the aggressive loan disbursements during the pandemic. More non-banks could make such startling discoveries in their loan books, primarily owing to bad loan management techniques like evergreening and unrationed debt recast. Some lenders would have used top-up loans, disbursed government-guaranteed loans to small businesses and offered a moratorium to temporarily aid stressed borrowers.

India has already seen how audit lapses and inability to course-correct led to an array of defaults by Infrastructure Leasing & Financial Services (IL&FS) in 2018, creating a prolonged liquidity squeeze. The Boards of NBFCs need to be more vigilant, take corrective measures and stop future lapses so that the sector remains robust.

Increasing compliance costs

The RBI has been trying to harmonise regulations between banks and non-banks. Last October, RBI announced scale-based regulations for NBFCs, with effect from October 2022. Since then, it has also aligned large exposure norms, among other measures. For instance, in February 2022, the RBI announced that NBFCs in the middle and upper layer having more than 10 brick-and-mortar offices serving as a customer interface (staffed by employees or outsourced agents) must implement Core Financial Services Solution (CFSS) by September 2025. CFSS will be similar to the Core Banking Solution used by banks. It will provide a digital interface for customers to access products and services and enable better record-keeping for internal and regulatory purposes. While smaller players (such as non deposit taking  NBFCs with a book size below Rs.1,000 cr) will be subject to light-touch regulations, larger NBFCs will be much more strictly regulated with increasing supervision and disclosure requirements. All this is likely to increase compliance costs, further impacting margins and putting a check to growth and diversification (for instance into FinTech) ambitions of large players.  

Way forward – cautious optimism

Only time will tell if the sector successfully manages to tackle the increasing costs and if these irregularities are temporary setbacks or are indicators of systemic lapses. For now, overall collection efficiencies have improved and margins are strong. Hopefully the sector will continue to play a big role in delivery of last mile financial services including digital credit