Non-banking financial companies (NBFCs) have been struggling with a liquidity crisis in the aftermath of the fiasco at infrastructure lending conglomerate Infrastructure Leasing & Financial Services (IL&FS).

In order to ease the pressure on NBFCs, Union finance minister Nirmala Sitharaman in the recent Union Budget had said fundamentally sound NBFCs should continue to get funding from banks and mutual funds (MFs) without being unduly risk-averse. She acknowledged that these firms are extremely important in "sustaining consumption demand as well as capital formation in the small- and medium-industrial segment".

Sitharaman proposed: “For purchase of high-rated pooled assets of financially sound NBFCs, amounting to a total of ₹1 lakh crore during the current financial year, the government will provide one-time six months’ partial credit guarantee to public sector banks (PSBs) for the first loss of up to 10%.”

This initiative, according to global credit rating agency Fitch Ratings, comes amid significant pressure on NBFCs' wholesale funding due to lack of appetite from debt capital markets. "The guarantee is more than enough to cover typical losses, which will cover up to $14.5 billion of issuance,” Fitch said in a note. “We estimate that this will cover the NBFC sector’s liquidity needs for about six months,” it added.

However, the government’s provision refers only to financially sound issuers, which may suggest that weaker entities in the need of funds may still have to fend for themselves. “It is not yet clear what will constitute a sound issuer,” Fitch noted.

“The funding stress has been most severe for wholesale financiers, smaller NBFCs, and fintechs, which have struggled to get even bank funding, while large NBFCs still have good access to funding, albeit at a rising cost,” the note added.

In Fitch’s opinion, there is a lack of clarity about the duration of the guarantee. The government has referred to a six-month period but it is not clear whether this relates just to how long the scheme is open for (covering transactions that are done within a six-month period) or also to the duration of coverage for each transaction. “A guarantee for only the first six months following a transaction would do little to encourage buyers. We, therefore, assume that the guarantee will apply for the full life of the assets purchased,” Fitch noted.

These uncertainties aside, the initiative, in the rating agency’s view, signals the government’s intent to support the NBFC sector, which has been struggling for liquidity. “The sector has become increasingly important for driving consumption growth and accounts for almost 20% of credit to India’s economy, compared with about 15% five years ago,” Fitch highlighted. “However, it has struggled with funding pressure as a result of investors’ risk aversion following the default of IL&FS last year, a situation exacerbated by Dewan Housing’s default this year.”

In her maiden Budget, Sitharaman also proposed PSBs recapitalisation to the tune of ₹70,000 crore. Fitch believes the NBFC sector will benefit from the exercise, which will increase PSBs’ capacity to provide funding. She also said that the Reserve Bank of India (RBI) is the regulator for NBFCs, albeit with limited regulatory authority over these firms. “Appropriate proposals for strengthening the regulatory authority of the RBI over NBFCs are being placed in the Finance Bill,” Sitharaman had mentioned in her speech.

Going by RBI’s measures for tackling the non-performing asset (NPA) menace in the banking sector, regulatory tools like asset quality review can be taken up the RBI. Fitch is of the view that investor confidence in the NBFC sector could be boosted by a potential asset-quality review of wholesale non-banks, leading to greater transparency and more robust capital requirements.

“However, if an asset-quality review uncovers large under-reporting of asset-quality problems, like in the case of banks, it might end up bringing things to a head by making clear to investors which entities have the biggest issues,” Fitch warned.

While there is no formal announcement of such reviews, market speculation about the possibility of one has increased with housing finance companies moving under the regulatory ambit of the RBI.

Overall, there seems to be no near-term respite for NBFCs; apart from liquidity woes, now they are grappling with ambiguities.

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