Why RBIs Liquidity Measures For NBFCs May Not Reach Last-mile Rural Borrowers

In a bid to ease the liquidity issues of small and mid-sized corporates, including non-banking finance companies (NBFCs) and micro-finance institutions (MFIs), the RBI recently announced a new targeted long-term repo operation (TLTRO 2.0) of ₹50,000 crore. Under this, banks have to deploy the borrowed funds (at repo rate of 4.4 per cent) in investment-grade bonds of NBFCs, with at least 50 per cent towards small and mid-sized NBFC/MFIs.

The RBI has further laid down that of the 50 per cent, 10 per cent has to be deployed in securities issued by MFIs, 15 per cent in NBFCs with asset size of ₹500 crore and below and 25 per cent in NBFCs with asset size of between ₹500 crore and ₹5000 crore.

While the RBI’s move can help some large or mid-sized NBFCs/MFIs, relief for the last-mile borrower in rural areas could remain elusive. This is because the RBI’s measures cover only about 4 per cent of the entire universe of NBFC/MFIs. A chunk of the NBFCs that have an asset size of less than ₹500 crore and do not enjoy investment-grade rating, would continue to face severe liquidity issues, with meagre funding support from banks.

Given that most of these smaller NBFCs are instrumental in providing the last-mile funding to borrowers in the rural areas, a liquidity crunch faced by these lending institutions would in turn hurt end-borrowers.

Lack of clarity over banks providing moratorium to NBFCs — for term loans granted to NBFCs — has also accentuated the problem for NBFCs that are compelled to grant moratorium to their end borrowers.

Only to a few

NBFCs, classified based on their liability structures, can be subdivided into NBFCs-D, which are authorised to accept public deposits, and NBFCs-ND, which do not accept public deposits but raise debt from market and banks. Among NBFCs-ND, those with an asset size of ₹500 crore and above are classified as NBFCs-ND-SI (Systemically Important NBFCs-ND). According to latest available RBI data, as on February 29, there were 69 NBFCs accepting public deposits and 278 NBFCs-ND-SI. But aside from these, NBFCs that are non-deposit taking and non-systemically important (assets size of below ₹500 crore) are a tidy 9,124 in number.

As regards NBFC-MFIs registered with RBI, there are 97 such entities as on February 29.

Hence, there are about 9,568 NBFCs and MFIs that are in need of funds to cater to their end borrowers who are largely non-salaried, low income borrowers in semi-urban and rural areas or MSMEs.

But, according to an SBI report, only around 380 NBFCs and MFIs are in investment grade (BBB and above rating). This implies that the RBI’s liquidity measures, wherein banks have to invest in investment grade bonds of NBFCs and MFIs, will cover only about 4 per cent of the NBFC/MFI universe.

Higher risk-weights and capital crunch

Of this 4 per cent too, many NBFCs/MFIs (nearly half) just about make the investment grade mark (have rating of BBB). While the bonds of these NBFCs are allowed for investments by banks under RBI’s TLTRO, banks may prefer to stick with a minimum rating of A.

This is because regulations around banks’ capital adequacy require them to have capital commensurate with the risk they take — that is in relation to their risk-weighted assets. RBI assigns different ‘risk weights’ to different types of banks’ loans or exposure based on the possible defaults for each category. Hence, riskier the borrower, higher the risk-weight and higher the capital needed.

Exposures to all NBFCs, (excluding Core Investment Companies) is risk weighted in a manner similar to that of corporates. Hence, AAA-rated NBFCs carry a 20 per cent risk-weight, while A-rated carry 50 per cent risk-weight. BBB-rated NBFCs carry a 100 per cent risk weight, which implies that banks investing in the bonds of these NBFCs will have to set aside higher capital.

Given the weak capital position, many banks would continue to be wary of lending to low rated NBFCs. As such banks have to make a provision of 10 per cent on all overdue loans where moratorium is extended. This could add significant pressure on earnings (even pushing certain PSU banks into losses). The higher the burden on capital in the coming quarters, the more cautious the banks will turn towards lending to smaller NBFCs, who provide last-mile funding to borrowers in rural areas.