By: Vidushi Gupta and Vinita Choudhury
The IL&FS crisis, which was caused due to multiplicity of factors such as default on short term borrowings and disputes over contracts, had usurped a state of panic amongst various stakeholders. It led to speculations around the market of a similar situation being faced by other companies and inception of the so called ‘liquidity crunch’ in the financial services sector.
While absence of a quick strategy by the regulators and the government led to an initial deterioration of the market perception of the issue and of the NBFC sector in general, ever since then, all stakeholders have extended relentless support to submerge the crisis. The key reforms introduced by the regulators in this regard are:
- On 21 September 2018, RBI issued guidelines on co-origination of loans for priority sector lending and allowing banks and NBFCs to contribute credit jointly and share risks and rewards to align their respective business interests.
- On 27 September 2018, RBI amended the Basel III regulatory framework to incentivise banks to increase fund flow to NBFCs and HFCs. RBI allowed banks to reckon government securities held by them, up to an amount equal to the incremental outstanding credit disbursed by them to NBFCs and HFCs between 19 October 2018 and 31 December 2018, as level 1 high quality liquid assets, within the mandatory statutory liquidity ratio requirement. This move enhanced lending by banks to NBFCs and HFCs to meet their own statutory requirements.
- On 19 October 2018, RBI increased the single borrower exposure limit for NBFCs, which do not finance infrastructure, from 10% to 15% of capital funds till 31st March 2019. This step permitted banks to lend more to healthy NBFCs without breaching the regulatory limit.
- On 2 November 2018, RBI allowed banks to provide partial credit enhancement (partially stand-in as guarantors) to bonds issued by NBFCs and HFCs. This relaxation is subject to the tenor of such bonds being less than 3 years and the proceeds of such bonds being used for re-financing the existing debt of the NBFCs or HFCs. Further, the exposure of a bank to such credit enhancement has to be limited to 1% of the capital funds of the bank within the applicable single/group borrower exposure limits.
- On 19 November 2018, in a meeting of the central board of the RBI (Board) several points for upliftment of the financial services sector were discussed such as:
- ‘Economic Capital Framework’ (ECF) of RBI: ECF is essentially a framework that determines the share of RBI’s reserves and surplus to be passed on to the Government. On 26 December 2018, the RBI constituted an expert committee in consultation with the Government, to review the extant ECF. This committee has representations from the RBI as well as the Ministry of Finance and has been mandated to, amongst other things, review the status and justification of various provisions and reserves provided by the RBI, suggest adequate level of risk provisioning that the RBI must maintain and propose a suitable profits distribution policy. The committee will submit its report within 90 days from the date of its first meeting.
- Basel regulatory framework: On the Basel regulatory framework, while the Board decided to retain the existing capital adequacy reserve ratio at 9%, it has extended the transition period for implementing the last tranche up to 31 March 2020. This implies that banks will now have more time to implement the capital adequacy reserve target. This move is aimed at reducing cost of borrowing and releasing more capital in the system.
- Restructuring scheme for stressed micro, small and medium enterprises (MSMEs): The Board decided to allow RBI to consider a scheme for restructuring stressed assets of MSME borrowers with aggregate credit facilities of up to INR 250 million.
Relaxation of Prompt Corrective Action (PCA) norms: The Board decided to allow the Board for Financial Supervision of RBI to examine the issue related to PCA norms which imposes operational and lending restrictions on certain weak banks.
- On 29 November 2018, in connection with securitization / assignment of loans by NBFCs, RBI relaxed the minimum holding period requirement for loans having maturity period of 5 years or more (until May 2019). RBI permitted the minimum holding period for such loans to be receipt of 6 monthly instalments or 2 quarterly instalments, subject to originating NBFC retaining a minimum of 20% of the book value of such loans or 20% of the cash flows from such loans.
- On 12 December 2018, SEBI, in its board meeting approved the exemption of specific HFCs (deposit taking HFCs and HFCs with asset size of more than 500 crores) and systemically important NBFCs from disclosure requirements under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Regulations). Under the Takeover Regulations, shares taken by way of encumbrance are treated as acquisition and shares given upon release of encumbrance are treated as disposal and both these actions require disclosures to the stock exchanges and the target companies. HFCs and NBFCs have been exempted from such disclosure requirements.
- On 14 December 2018, another meeting of the Board was held for discussions on the way forward on the NBFC liquidity issue. In the wake of appointment of a new governor of the RBI, no significant decision was taken. However, extensive discussions were held on the existing liquidity status of NBFCs and the governance framework.
Apart from the aforementioned steps taken by the regulators, a few public sector banks have also proposed to increase purchase of assets standing on the books of NBFCs. This move (commonly referred to as the portfolio buyout route) is expected to go a long way in bringing about liquidity in
this sector. Further, apart from aid from regulators, certain NBFCs have approached large private equity players for funding, which are ever hungry for low cost capital.
These persistent and timely measures by all concerned stakeholders have provided a great impetus to the financial services sector. The efficacy of these measures is evident from the fact that the market perception of low confidence on NBFCs is on the verge of disappearing. However, most of
these steps were reactive short term in nature and were taken with the objective of solving the immediate problem, rather than focusing on a long-term solution. The real impact of these measures on the economy of the country will only be apparent with time. Meanwhile, we look forward to seeing how these short term measures are transformed into more elaborate, durable and long-term policies to avoid any similar crisis in the future.
Authors are Associates from Khaitan & Co