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RBI to align NBFCs’ norms with banks, stop liquidity disruptions

Experts said the latest RBI norms will strengthen the framework of NBFC regulations even further ensuring a sound and robust risk management system to manage structural and dynamic liquidity in an efficient manner.

Written by George Mathew | Mumbai |
May 27, 2019 12:49:01 am
Reserve Bank of India, RBI, non-banking finance companies, commercial banks, NBFC, banking news, indian express The NBFC sector’s rapid growth and reliance on short-term funding sources “bubbled over” in 2018, most evident by the default of IL&FS in September last year,

The Reserve Bank of India is gradually breaking down the wall between non-banking finance companies and commercial banks with its latest proposal on liquidity coverage requirement expected to bring the regulations for struggling NBFCs in line with banks and put an end to liquidity disruptions in the sector.

With the RBI stipulating gradual shift to liquidity coverage ratio (LCR), NBFCs will, over a period of next four years, be required to hold an amount of high-quality liquid assets (HQLA) that’s enough to fund cash outflows for 30 days. The RBI had earlier made LCR mandatory for banks over the 2015-2019 period. During a period of financial stress, NBFCs like the banks will have to use their stock of HQLA. According to Deepak Mittal, MD and CEO, ECL Finance, as all the well- managed NBFCs already carry sufficient HQLA, maintaining even 100 per cent LCR should not be a problem for them. “This will not negatively impact NBFCs as ALM (asset-liability management) and liability management is a key part of credit sector. In fact it will reinforce discipline amongst NBFCs as the board would be responsible to adhere to the guidelines and internal controls would also be subject to supervisory review,” he said.

NBFCs had till recently borrowed short-term funds from banks and mutual funds for lending to long-term projects, creating a liquidity mismatch. There were growing worries over an “imminent crisis” in the NBFC sector due to credit squeeze, overleveraging, excessive concentration, massive mismatch between assets and liabilities and misadventures by some large entities like the IL&FS group. The LCR requirement will be binding on NBFCs from April 1, 2020 with the minimum HQLAs to be held being 60 per cent of the LCR, progressively increasing in equal steps reaching up to the required level of 100 per cent by April 1, 2024, the RBI said.

Experts said the latest RBI norms will strengthen the framework of NBFC regulations even further ensuring a sound and robust risk management system to manage structural and dynamic liquidity in an efficient manner. “The RBI is, via this circular, helping NBFCs to prudently manage their liabilities and the step wise approach will allow them to gradually catch up to these requirements,” he said.

LCR refers to the proportion of highly liquid assets held by financial institutions, to ensure their ongoing ability to meet short-term obligations. The introduction of liquidity coverage ratio and tolerance limits for near term granular maturity bucket will require the buffer of near term liquidity. Most of the NBFCs, post the liquidity crisis, are maintaining positive net cash flows for shorter maturity buckets. “However as the requirement grows, this could potentially have some bearing on long term structural margins. This move will increase investor confidence in the NBFC sector,” Mittal said. According to the RBI, liquid assets comprise of high quality assets that can be readily sold or used as collateral to obtain funds in a range of stress scenarios. They should be unencumbered i.e. without legal, regulatory or operational impediments. Some NBFCs and housing finance companies recently faced shortage of high quality liquid assets that could have been easily and immediately converted into cash at little or no loss of value.

On the impact on NBFCs, Madan Sabnavis, Chief Economist, Care Ratings, said, “the bigger ones will have to reassess their business models. Two related issues which confronted them were ALM mismatch and liquidity. Now from the point of view of the RBI, issues have been addressed.” But this will require fundamental realignment for NBFCs as they move towards 100 per cent liquidity coverage, Sabnavis said.

The NBFC sector’s rapid growth and reliance on short-term funding sources “bubbled over” in 2018, most evident by the default of IL&FS in September last year, a Fitch report said. Default by IL&FS translated into higher borrowing costs and reduced market access for other non-bank financial institutions, leading to domestic regulators to re-examine liquidity norms for the sector and prod banks to increase their lending to, and asset purchases from, such entities, it said. The Central Board of the RBI had last week decided to create a specialised cadre to supervise and regulate the financial sector, including banks and NBFCs. The RBI also recently asked NBFCs with asset size of more than Rs 5,000 crore to appoint chief risk officer with clearly specified role and responsibilities.

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