NBFCs: Backs To The Wall
As many small and large non-banking finance companies (NBFCs) are now reeling from a liquidity squeeze, a vast number of small borrowers such as Rajesh Shah, an SME businessman, are still awaiting their loans to be disbursed. Shah reached out to a large NBFC well-versed in dealing with SME loans in the hope that his loan would be released quickly to tide over the working capital required to execute a large export order he had secured.
Despite all his papers being in order, Shah has till now not received any loans, with NBFCs tightening their purse-strings. “I have submitted all documents and collateral, but keep getting an answer that my loan is being released, but it never comes,” laments Shah.
Hundreds of non-banking customers find themselves in more or less a similar situation as financiers are taking stock of resources, particularly, their asset-liability mismatches.
NBFC head honchos have announced that growth could be curbed as financiers struggle to deal with the liquidity squeeze. The slump is due in part to the woes gripping the debt market in the wake of financial institution IL&FS defaulting on late August commercial paper repayments and small-term loans for other institutions.
End of Easy Money
One of the chief funding taps fuelling the growth of finance companies in the past few years has been commercial paper (CP). But for some NBFCs that is now running dry. Those unable to borrow to tide over their short-term liquidity needs are in limbo if not dire straits.
The liquidity squeeze among NBFCs generally has brought to the fore how many of them were living on the edge: borrowing short term, lending long. For a long time, many flouted the basic rules of asset-liability matches and now suddenly find themselves at the receiving end. The unstated rule mandated that financiers that lend long term should balance that with equally long-term liabilities. 
The NBFCs, though, would borrow from the low-end of the market through instruments such as commercial paper where tenures range from seven days to a year. Commercial paper is an unsecured money-market instrument in the form of a promissory note, introduced in 1990 in India, where corporate bodies, primary dealers and financial institutions, can raise money to fund lending.
Commercial paper now accounts for at least 30 per cent of NBFC borrowings, with most expected to be up for redemption in the next 3-6 months. Many NBFCs are now looking for ways to stave off a crisis by conserving cash, cutting back lending, and averting default.
The NBFCs are quasi-banking channels relying on three major funding sources: banks, debt markets and private placements. They look for ways to cut borrowing costs; hence, the low-end of the debt market made excellent resources available. Further, demonetisation meant that the banking system was for long awash in liquidity.
Much funding for NBFCs has come from mutual funds, some from banks. Jefferies, a research outfit, says, “Overall outstanding CPs on July 18 were Rs 6.4 trillion (rising 96 per cent year-on-year). Of this, the banks’ share was 20 per cent, mutual funds a whopping 75 per cent.”
Says Jaspal Bindra, Chairman, Centrum Capital: “There is a structural shift in how NBFCs will operate. Mutual funds may shy away from the CP market for some time. It is also likely that the RBI could impose some asset-liability-match guidelines. The combination will make it likely that CP does not become an obvious or as large a choice for NBFCs. It will be a smaller part of the funding mix.”
Margins to shrink
The NBFCs tapped commercial paper to reduce their cost of borrowing — and compete with larger operators as interest rates had slid. Research shows that NBFCs reduced such costs from 11 per cent in December 2015 to roughly 8.5 per cent in March 2018, largely due to commercial papers. This also meant that NBFCs had long years of superlative growth, with profits growing 25-50 per cent in many cases.
Now, as liquidity evaporates, NBFCs will be unable to borrow as easily from the commercial paper market; this will considerably curtail growth rates — and shrink profit margins. Some of the bigger NBFCs, of course, could sail through the rough weather, probably even tap the capital markets for some long-term capital.
“There is no fundamental concern. Most NBFCs are well-capitalised. No one is planning to raise equity; on the debt side, liquidity is a bit tight, which may result in a little slower growth. The kind of growth we saw for NBFCs and HFCs (30-40 per cent) will slow down a notch. People will be more cautious, underwriting standards will be tightened, and tight liquidity will decide whom to lend to. These factors will slow growth for a while,” says Prabodh Agrawal, Group CFO, IIFL.
Agarwal also allays fears of liquidity. “In fact, at end-September we redeemed commercial paper of about Rs 3,000 crore. Also, the good thing is that banks are lending. Their ability to lend will go up in the next few months.”
Banks have indeed been lending a helping hand. SBI announced it would purchase loans of Rs 40,000 crore from NBFCs, providing some much-needed relief. That means, though, that NBFCs are selling or securitising some of their marquee assets to banks, thus losing out on precious margins. Longer-term funds almost always come from banks and NCDs or term loans.
Of course, the best business model for an NBFC is to have a corresponding asset book that is repaid in one or two years, much in line with CP repayments. But, for most infra, housing and SME lending, NBFCs have longer repayment profiles. Analysts reckon that trending NBFCs such as Bajaj Finance, which have lower loan maturities, are well set to ride the liquidity squeeze. 
A smaller impact is expected on the micro-finance sector. Even here, though, growth is expected to slow down. Says Vivek Tiwari, CEO and MD, Satya Micro Capital: “The potential for growing micro-finance institutions in India is high; but, in a revised scenario, it will be modest or even stagnant for the next 3-6 months. Growth had apparently been significant till the last (September) quarter, but the industry will see modest growth for another six months; hopefully, after that there should be remarkable growth in this sector. Following the IL&FS crisis, banks are turning selective in lending. While larger micro-finance institutions depend on banks and the money market for funds, mid-size and smaller MFIs depend on NBFCs.”
For some larger lenders, particularly to SMEs, the pain will be acute. MSMEs were anyway reeling from the double punch (demonetisation and GST). Most MSMEs have struggled with GST filings; hence, loans in the last few quarters were difficult to come by. Now, with the liquidity squeeze, MSMEs will continue to struggle to find resources to fund working capital and business needs. Says Tiwari: “SME lending is going to weaken in coming quarters, and this could take time to recover, perhaps even a year.”
No Ramping Up Now
On their part, NBFCs have experienced a scorching pace of growth in the last few years. Their loan books expanded furiously, propelling their outstanding credit to nearly 16 per cent in FY18 from 10 per cent in FY14.
Most of them saw an opportunity to rapidly grow their lending franchise as traditional financiers — banks — shied away from lending due to their own huge NPAs of over Rs 9 lakh crore. NBFCs, on their part, cater to a large proportion of retail lending and command market shares of over 50 per cent in gold loans, micro loans, MSME loans, and loans for two-wheelers and commercial vehicles.
In the last few years, many also ramped up operations, adding huge resources and staff to handle their swelling businesses. Most NBFCs almost doubled staff and operations. Bankers reckon that if the liquidity squeeze does not ease quickly enough, the larger NBFCs may find the going tough. Says Tiwari: “There is a chance of a market slowdown; therefore, increments may be challenging if the market scenario does not change. Investors and lenders may tighten their grip, and raising funds will be more challenging as funding costs and operational expenditures will climb. Retention, too, can be a challenge and people can be eased out by large NBFCs.”
Of course, it is early days and much hinges on the central bank’s reaction to the situation. The RBI has been easing liquidity through open-market operations, but market experts say it can do more given the situation, like further reduce the cash reserve ratio. Some remedial measures can go a long way to loosen the credit stranglehold, say experts.
NBFCs are here to stay, though. They are now a vital cog in the wheels of growth. Some will have to fine-tune business models in the next few quarters and factor in lower growth and higher costs. The cost of borrowing, too, is expected to rise as they increase the proportion of longer-tenure borrowing. This would further squeeze margins and growth. Says Karthik Srinivasan, Senior Analyst, ICRA: “NBFCs cost of borrowings will increase, and growth rates fall from 20 per cent or thereabouts to about 17 per cent or so. In the long haul, though, there’s nothing really to worry about. NBFCs will emerge from the hold.”
Even as they connect to end-users, one side-effect of all that the sector is traversing is it will kick-start a long-awaited consolidation in a segment that seems overcrowded at present. In the last two years, more than 60-odd NBFCs registered as housing financiers. “Whether MFI, tractor loans, education loans or others, NBFCs play an important role. That will continue. But there will be a shakeout. Today, there are 11,000 NBFCs, of which 300 are large. That number will shrink,” says Bindra.
“There will be some consolidation, some shakeout; but, then there will be opportunities and a role for NBFCs,” notes Bindra.
They say a good crisis should never go to waste, and NBFCs should now learn a few basic invaluable lessons on sensible lending. They have to re-evaluate business models even if they sacrifice short-term margins to balance assets against liabilities. In the long run, that’s the only way the NBFC model is viable.
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