With asset quality risk for NBFCs/ HFCs set to rise sharply in the coming months, many medium and small-sized players are likely to face severe liquidity challenges. In a bid to help NBFCs and HFCs tide over the near-term cashflow crunch, the RBI has announced a special liquidity scheme for NBFCs/HFCs through a Special Purpose Vehicle (SPV).

SBICAP, which is a subsidiary of the State Bank of India, has set up a SPV (SLS Trust) to manage this operation. The SPV will purchase short-term papers from eligible NBFCs/ HFCs, who will utilise the proceeds under this scheme solely for the purpose of extinguishing existing liabilities. The instruments will be CPs and NCDs with a residual maturity of not more than three months and rated as investment grade.

The scheme follows the Centre’s announcement of a Rs 30,000-crore special liquidity window for NBFCs/ HFCs.

While the scheme is a good move to provide short-term liquidity to NBFCs/ HFCs that may have difficulty in paying their obligations falling due (until December), it also provides a breather to banks and mutual funds having exposures to such NBFCs/ HFCs. This will mitigate the risk of defaults by such entities in the near-term.

But this scheme will offer respite to a small section of NBFCs.

Of the 9,500-odd NBFCs and MFIs, only around 380 NBFCs and MFIs are investment grade (BBB and above rating). Of the investment grade entities, only those that have minimum CRAR/CAR of 15 per cent and 12 per cent, respectively (as on March 31, 2019), net non-performing assets not exceeding 6 per cent, and have reported profit in at least one of the preceding financial years (2017-18 and 2018-19), will be eligible under the scheme.

Also, within that, it will be crucial to see how many papers with maturity falling due by December 31, are purchased by the SLS Trust. According to ICRA data, about Rs 75,000 crore of NCDs (investment grade) of non-banks mature between July and September this year and about Rs 50,000 crore between October and December. Hence, how many NBFCs are able to avail of the RBI facility (limited to Rs 30,000 crore) needs to be seen.

In short, the measure only addresses the short-term liquidity crunch faced by certain NBFCs. The window until September (till when such bonds can be purchased by the SPV) may also be inadequate as NBFCs are likely to see collection challenges and asset quality deterioration even after the moratorium granted to borrowers is lifted in September. Importantly, it fails to address the long-term funding issue of NBFCs/HFCs, which has become a big concern amid banks’ high risk aversion to the sector.

Above all, even players with sufficient liquidity can use this window. According to information put out on the SBI Caps website, “the Trust will have an arrangement with Reserve Bank of India to fund any purchase of securities under the scheme.” Hence, there is no way of assessing the liquidity requirement or stress of the NBFC/ HFC. Also the RBI circular on the SBI Caps website is silent on the limits around group exposure. Can a bank holding paper of its group NBFC entity avail of liquidity under this window? If yes, what are the group limits? Addressing all of this will be critical to avoid misuse of the facility by a few players.

Why inadequate?

Loans under moratorium for many of the NBFCs and HFCs are as high as 50-70 per cent. With not all banks extending moratorium to NBFCs/ HFCs (who have borrowed from banks), many players face liquidity challenges in the near term. As such, banks have turned highly risk averse to lending to the sector. All of this has impeded many NBFCs/ HFCs’ ability to meet their near-term obligations.

Also, moratorium is not applicable for market instruments such as CPs and NCDs, which account for 35-40 per cent of the outstanding borrowings of non-bank entities according to ICRA.

Hence, banks and mutual funds having exposures to NBFCs run the risk of a sharp rise in defaults in the near term. The RBI’s special liquidity window will help address this immediate issue.

But the window is only available to purchase papers issued before September 2020, and bonds having residual maturity of three months. In effect, it offers relief for dues falling until December. But given the high level of loans under moratorium currently, even 10-15 per cent of them slipping into NPAs can spell trouble for NBFCs. Hence, cashflows may not normalise by the end of this fiscal for many players.

The scheme’s limited window period may, hence, be inadequate to tackle the sector’s liquidity issues.

Ensuring some checks

The issue with the earlier targeted long-term repo operation (TLTRO 2.0) where banks had to deploy borrowed funds (at repo rate) in investment-grade bonds of NBFCs, was that banks were wary of lending to smaller players. Hence, the earlier measures mostly helped larger or mid-sized players.

In the existing scheme, too, there does not seem to be any restriction on who can avail of this liquidity. Hence, larger players can still end up hogging this window to generate surplus funds.

While the RBI’s circular does not give details, SBI Caps’ website that elaborates the structure and functioning of the SLS Trust says that the Trust can invest not more than Rs 2,000 crore on any one NBFC/HFC. Also, the trust may have allocation up to 30 per cent to NBFCs/ HFCs, with asset size of Rs 1,000 crore or less. While these can help limit the funding given to a single entity, it does not clarify the rules around group entities.

A bank that holds a paper issued by its NBFC arm/group entity can also avail of liquidity under the scheme (as appears from the information available so far). But there are no indications on the group limits. All this will need further clarity.

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