• The Department of Economic Affairs fears significant default from large non-banking finance companies and housing finance companies in the next six weeks if no additional liquidity support is provided to these firms, according to media reports.
• The DEA, in a letter to the Ministry of Corporate Affairs, described the financial situation as “still fragile” when discussing the financial stability impact of the Infrastructure Leasing and Financial Service Limited default, according to news website Money Control. A string of defaults at IL&FS have triggered sharp falls in Indian stock and debt markets amid fears of contagion within the rest of the country’s financial sector.
• Last month, the government took control of IL&FS to protect the financial system and markets from potential collapse, and replaced its board. The new board submitted a plan to revive the debt-laden firm this week. Nearly 2 trillion rupees of NBFC and HFC debt is due for redemption by the end of December, the DEA said in its letter. It said it estimates a funding gap of as much as 1 trillion rupees by the end of the year.

About NBFC

• A non-banking financial company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business, but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property. A non-banking institution which is a company and which has its principal business of receiving deposits under any scheme or arrangement or any other manner, or lending in any manner is also a non-banking financial company.

Major Difference Between A Bank and NBFC:

• A NBFC cannot accept demand deposits (demand deposits are funds deposited at a depository institution that are payable on demand — immediately or within a very short period — like your current or savings accounts.)
• It is not a part of the payment and settlement system and as such cannot issue cheques to its customers; and
• Deposit insurance facility of DICGC is not available for NBFC depositors unlike in case of banks.

Registration with RBI

• In terms of Section 45-IA of the RBI Act, 1934, it is mandatory that every NBFC should be registered with RBI to commence or carry on any business of non-banking financial institution as defined in clause (a) of Section 45 I of the RBI Act, 1934.
• However, to obviate dual regulation, certain category of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI viz. venture capital fund/merchant banking companies/stock broking companies registered with Sebi, insurance company holding a valid certificate of registration issued by IRDA, Nidhi companies as notified under Section 620A of the Companies Act, 1956, chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982 or housing finance companies regulated by National Housing Bank.

Challenges facing NBFC:

Questions on asset quality

• The problems first came to light when the IL&FS fiasco first broke out. Most of the NBFCs had a huge exposure to IL&FS debt paper. It opened a Pandora Box because most NBFC had lent to the real estate and the infrastructure sector in a big way. Not only were these loans stuck but were being consistently rolled over. Most of these loans also had a maturity mismatch because NBFCs were borrowing at the short end via CPs and lending to real estate projects at the mid to long end. The bigger worry is that higher fuel prices, weaker dollar and the trade war could hit the SME sector badly. This would mean defaults by SMES, which have been a traditional market for NBFC lending. This debate is likely to come back time and again to haunt us in the next few months.

Where will they borrow from?

• The big challenge for the NBFC is now about fund raising. They need a constant access to low cost funds to sustain their lending business. If the momentum is lost then overheads and size start becoming a constraint for the NBFCs.
• There are three challenges that NBFCs are facing at this point of time. Firstly, the bond yields have gone up sharply to around the 8% mark. That is making borrowing costlier even at the short end of the yield curve. Secondly, considering their recent problems, most existing investors are unable to find liquidity in the markets.
• That is forcing some of these holders to sell NBFC bonds at yields as high as 11-12%. We saw in the case of DSP Mutual Fund selling DHFL bonds. Lastly, investors are worried about a credit downgrade backlash on NBFCs. That could mean huge write-offs for investors. For now, the taps are surely running dry!

Beware of regulation

• The biggest worry is that the IL&FS fiasco may force the RBI to regulate NBFCs as stringently as the banks. That would mean stricter capital adequacy, NPA provisioning etc.
• Those who remember the NBFC crisis of 1998 would remember how Dr. Jalan’s NBFC regulations changed the face of NBFCs in India forever and led to a huge disruption. The last thing NBFCs want is a repeat of the 1998 squeeze.