Note_NBFC_December.pdf

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I CRA Li m i t ed P a g e | 1

Background and O ut look

The Reserve Bank of India (RBI) has on December 12, 2012 publ ished dr aft guidel ines for non-banking f inance com panies (NBFCs) based on the

recomm endations of the U sha Thorat-chaired W orking Group o n t he Issues and Concerns in t he NBFC Sector.

The guidel ines propo se, among ot her t h ings, t ighten ing of th e non-perfo rm ing asset (NPA) recognit ion and provisioning norm s for NBFCs so as tobr ing them on a par with those appl icable for banks. Whi le th is is in general a posit ive step, some NBFCs offer ing products with annual or

quarter ly repayments may f ind their asset qual i ty turn volati le because of th is change. Further, increasing the Tier I capita l as wel l as the r isk

weight s for som e asset classes, w hi le not a l igning (reducing) the same f or som e ot her asset classes in w hich banks enjoy low er r isk w eights (suchas loans for comm ercial vehicles, construction equipm ent, and hom e loans etc), would reduce th e NBFCs leveraging capacity vis--vis banks. At

the sam e tim e, the lack o f access to Securi t isation and Reconstruct ion of Financial Assets and Enforcement of Securi ty Interest Act (SARFAESI Act)as wel l as any l iquidi ty back-up l ine w ould continu e to weigh on t he perform ance of NBFCs.

The draft guidel ines could im pact the leveraging capacity and earnings of NBFCs signif icantly. The pro posed enhancement of Tier I capita l from7.5% to 10% of risk weighted assets (12% for captive NBFCs and NBFCs in sensitive sectors) and increase in risk weights for certain asset classes

wil l require N BFCs to raise addit ional Tier I capita l of aroun d Rs. 20 bi l l ion (around 2.4% of the industr y net w orth). W hi le the pro posed revision in

the NPA recognit ion norm to 90 d ays (vs. 180 days), a long with t he adoption of h igher provisioning requirement s for NPAs and standard assets ( inl ine with that for banks) could lead to a dip in NBFCs' profi tabi l i ty by 15-20 basis points (bps) over the medium term, the higher Tier I capita l

requirem ent could t ranslate into a decl ine of around 115 bps in the sectors retur n on equit y (ROE).

ICRA COM M ENTS ON RBIs DRAFT GU IDELIN ES FOR N BFCs

Tighter norm s a posi t ive, but no m ove on p ar i ty vs. banks

DECEM BER 2012

ICRA RESEARCH SERVICES

Contacts:

Vibha Batra

+91 124 4545 302

[email protected]

Karthik Srinivasan

+91 22 3047 [email protected]

Jaskirat S. Chadh a

+91 124 4545308

ja ski ra t c@ icr ain di a.com


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Key Chan ges and Im pact

The fol lowing are t he key changes propo sed by t he RBI to t he existing regulatory fr amew ork for NBFCs.

1. Increase in Capital Requirem ents and Risk We ightsThe fol lowin g are the proposed RBI capita l adequacy requirem ents and r isk w eights appl icable to NBFCs:

Captive NBFCs1 and NBFCs engaged in lending to sensit ive sectors (viz. capita l m arket, comm odities and real estat e)2 to m aintain Tier I capita l of 12%. Other NBFCs to maintain Tier I of 10%, as against 7.5% currently. Risk w eights increased for comm ercial real estate (CRE) exposures from 100% to 125% and f or capita l m arket exposures from 100% to 150% f or d iver sif ied NBFCs

wit h Tier I capita l at 10%.

Table 1: Current m inimum capital requirem ent v/ s proposed by RBI

Type of NBFC Current Regulations Proposed Regulations

M in imum T ier I % Risk W eight M in imum T ier I % Risk W eight

Captive NBFC 7.5% 100% 12% 100%

NBFCs focu ses on sensitive sectors 7.5% 100% 12% 100%Gold loan companies 12%^ 100% 12% 100%

Infr astruct ure finan ce com panies (IFCs) 10.0% 100% 10% 100%

Ot her NBFCs 7.5% 100% 10% 100%

of wh ich exposures to comm ercial real estate 7.5% 100% 10% 125%

of wh ich exposure to capital ma rket 7.5% 100% 10% 150%

of which exposure to other assets 7.5% 100% 10% 100%

^w i th e f fec t f rom Apr i l 1 , 2014Source: RBI

In ICRAs view, the higher level of Tier I capita l proposed is a credit p osit ive for t he NBFC sector . Based on the pr oposed revised Tier I capita l requirem ents and t he

higher r isk weights on certain t ypes of exposure, ICRA estim ates that n ine to t en NBFCs would need t o augment their Tier I capita l by a total of around Rs. 20 bi l l ion(2.4% of the industry net worth), assuming that the NBFCs maintain a cushion of 2% over the regulatory minimum Tier I requirement. In ICRAs view, these NBFCs

should be in a posit ion to m obi l ise the addit ion al capita l over the three-year per iod proposed for th e purpose under the new n orms.

NBFCs remain at a disadvantage vis--vis banks with respect to capita l requirement on a part of t heir retai l lending books ( loans for comm ercial vehicles, construction

equipm ent, hom e, gold, etc). For instance, for comm ercial vehicle or construct ion equipm ent loans, banks are permit ted t o apply 75% r isk weight, w hi le NBFCs have toapply a r isk weight of 100%. Thus, the capita l requirement for banks would be 4.5% under the current norms and 6% (core Tier 8% multip l ied by 75% r isk weight)

190% and above of t otal assets (net of in tangibles) are on f inancing parent com panys products/services

2to t he extent of 75% or m ore of their t otal assets, net of int angible assets


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under Basel III , whi le NBFCs wo uld have to m aintain Tier I capita l of 10% under th e proposed norm s. Simi lar ly, for hom e loans the amoun t of capita l provided by banks

wo uld be 4% to 10% (Basel III) and in t he case of gold loans up t o 1.65%, whi le NBFCs wi l l need to keep a Tier I of 10% on t hese exposures.

2. Asset Classification and Provisioning NormsRBI propo ses to m ake the fo l low ing changes to th e existing asset classi f ication and provisioning norm s appl icable t o NBFCs:

NPA recogni t ion norm to be lowered to 90 days f rom 180/ 360 days: There would be a transit ion per iod f or the swit chover, with NBFCs moving to a 120-day NPArecognit ion norm from Apri l 1, 2014 and to a 90-day norm from Apri l 1, 2015.

Provisioning norm s: These are propo sed t o be al igned wit h the n orm s current ly appl icable for banks. Standard asset provisioning: This has been raised to 0.40% from 0.25% with effect f rom M arch 31, 2014.In the case of NBFCs, depending on the asset class, 90+ days delinquencies are typically 1.5-3.5 times (average 2 times) the 180+ days delinquencies. While a change

in NPA recognit ion norm could lead to a spike in the gross NPA level in the short term , the percentage, in ICRAs view, wo uld sett le at a low er level over the medium

term as NBFCs real ign t heir m onitor ing and recovery system s to t he 90-day form at and also due to higher recoveries. In the case of housing f inance companies (HFCs),wh ich migrated to t he 90-day NPA recognit ion norm from M arch 31, 2005, the gross NPA percentage rose from 3.56% in M arch 2004 to 6.24% in M arch 2005 andsubsequent ly decl ined to 4.49% March 2006.

Assum ing a simi lar bui ld-up in the NPA level of NBFCs, and taking into account the in crease in standard asset provisioning, the revised provisioning requirem ents ( inl ine wit h th ose for banks) and the existing provisions in NBFC balance sheets, ICRA expects the ret urn on assets for NBFCs to dip b y around 0.55% in the short term ;

over the medium term, the decl ine could be in the range of 15-20 bps. This along with the higher amount of capita l requirement could translate into an ROE drop ofaround 115 bps, in ICRAs view.

3. Acceptance of DepositsThe RBI has pro posed t hat all N BFCs-D

3, includ ing AFCs

4, be credit rated and that unrated N BFCs, including AFCs, not be perm itt ed to accept d eposits. Furt her, the RBI

has proposed that t he m aximu m permissible level of publ ic deposit for an N BFC be lowered to 2.5 t imes their net owned f unds (NOF) from the current 4 t im es. ICRA

does not expect th is change to have any signif icant bearing on th e funding prof i le of any m ajor NBFC.

4.

Liqu id i ty M anagement

The RBI has proposed that N BFCs cover any asset- l iabi l i ty m atur i t y (ALM ) mismat ch in th e less than 30-day bucket wit h high qual i ty l iquid assets in cash, bank depositsavai lable with in 30 days, money market in strum ents matur ing w ith in 30 days, and investment s in actively traded debt securi t ies with a credit rating not low er than AA

or equivalent. W hi le ICRA rated NBFCs typical ly m aintain unuti l ized bank l imits to cover for such mismat ches, the pr oposed guidel ines do not a l low t he benefi t of such

l imit s and as a result N BFCs would be required to keep higher l iquid assets, which could increase th eir cost of d oing business.

3Non-Banking Financial Corporat ionDeposit Accepting

4Asset Finance Companies


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Note_NBFC_December.pdf