Why in News:

• The central bank has released draft norms on liquidity risk management for deposit taking and non-deposit taking NBFCs.

Details:

• RBI in its draft circular on “Liquidity Risk Management Framework for NBFCs and Core Investment Companies (CICs)” has proposed certain guidelines for dealing with the Liquidity and IL&FS type of debt crisis in NBFCs.
• Liquidity Coverage Ratio (LCR) rule would be introduced in all deposit taking Non-Banking Financial Companies (NBFCs) and non-deposit taking shadow banks with an asset size of Rs 5,000 crore and above.
• NBFCs would have to comply with a higher liquidity coverage ratio (LCR), which is the proportion of assets that an NBFC needs to hold in the form of high-quality liquid assets that can be quickly and easily converted into cash.
• The new norms, which are expected to be implemented by the RBI over four years starting from April 2020, would likely put significant pressure on the margins of NBFCs.
• Under these norms, NBFCs would have to maintain their LCR at 60% of net cash outflows initially, and improve it to 100% by April 2024.
• Mandatory holding of Government Securities by NBFCs in the form of high-quality liquidity assets needs to be ensured.
• Comprehensive Risk Mitigation Policies: Board of all NBFCs with assets of more than 5,000 crore are required to ensure an Asset liability management committee, asset risk management committee, and an asset-liability management support group in NBFCs for implementing Liquidity risk mitigation policies.
• Asset-Liability mismatch cannot be more than 10% of the total outflows of NBFCs.
• NBFCs are required to formulate their Contingency Funding Plan as a liquidity crisis management tool that will help them with alternative sources of funding in liquidity crisis and will prevent over reliance on single source of funding like it is suspected that over reliance of NBFCs over commercial papers can bring them to default of over 1 lakh crore commercial papers issued by them in the past.
• A granular maturity bucket system has been proposed to keep a check on mismatches across tenures. Under new norms, the 1-30 days bucket would be bifurcated into 1-7 days, 8-14 days, and 15-30 days buckets. Also, NBFCs will need to monitor their cumulative mismatches (running total) across all other time buckets up to 1 year by establishing internal prudential limits with the approval of their boards.

Liquidity Coverage Ratio (LCR)

• LCR is a requirement under Basel III whereby banks are required to hold an amount of high-quality liquid assets (HQLA) that’s enough to fund cash outflows for 30 days.
• HQLA are liquid assets that can be readily sold or immediately converted into cash at little or no loss of value or can be used as collateral for borrowing purposes.

Non-Banking Financial Companies

• A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities.
• A non-banking institution which is a company and has a principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner is also a non-banking financial company.
• It engages in the business of
• • Loans and advances
• • Acquisition of shares/stocks/bonds/debentures/securities issued by government or local authority or other marketable securities of a like nature
• • Leasing, hire-purchase, insurance business, chit business, etc

• It, however, does not include any institution whose principal business is that of
• 1. Agriculture activity
• 2. Industrial activity
• 3. Purchase or sale of any goods (other than securities)
• 4. Providing any services and sale/purchase/construction of immovable property
• NBFCs largely depend on market-based funds.
• They aim at bridging the gap in pricing inefficiency based on perceived risk.

About IL&FS Debt Crisis

• IL&FS Financial Services, a group company, defaulted in payment obligations of bank loans (including interest), term and short-term deposits and failed to meet the commercial paper redemption obligations. Consequent to defaults, rating agency ICRA downgraded the ratings of its short-term and long-term borrowing programmes. The defaults not only adversely affected hundreds of investors, banks and mutual funds associated with IL&FS but also resulted into Liquidity Crisis in NBFCs.