RBI proposes new liquidity norms for NBFCs. How it may impact you

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  • Norms on liquidity management at NBFCs were awaited post the IL&FS incident in September 2018
  • Company fixed deposits (FDs), unlike bank FDs, don’t come with insurance

MUMBAI: The Reserve Bank of India (RBI) has issued draft guidelines on liquidity management for the non banking finance companies (NBFCS) and proposed a liquidity coverage ratio for large NBFCs covering all deposit-taking NBFCs and non-deposit taking NBFCs with an asset size of ₹5,000 crore and above. Here is a look at what it means and how it will impact you:

THE NEW RULES

The key takeaway from the draft guidelines are that a bank-like liquidity coverage ratio (LCR) for NBFCs to be put in place, granular management of asset liability mismatch and board-led liquidity policies or monitoring. “The guidelines require NBFCs to hold adequate level of high quality liquid assets (to cover the estimated net cash outflows in case of a severe liquidity stress scenario over the next 30 calendar days). This is to ensure NBFCs have enough liquid assets that can be converted to cash to fund the outflows for 30 days in a scenario of acute liquidity stress. With these guidelines, NBFCs will need to stick to ALM and liquidity discipline at all times. More importantly, this will provide comfort to debt market participants that NBFCs will always be prudent on liquidity,” said Kotak in a note.

Analysts note that it will also have an impact on margins. “The need to hold liquid assets will be a drag on margins and may also push some of them to consolidate even more and increase desperation to securitise. Those NBFCs with ALM gaps, lower ratings, and higher funding cost are worse off. NBFCs with better ratings, balanced ALMS, and diversified funding mix are better off,” said CLSA, a capital markets and investment group, in a recent report.

Norms on liquidity management at NBFCs were awaited post the IL&FS incident in September 2018, which exposed the gaps in funding profile at NBFCs. Analysts said the draft rules will improve transparency. “We believe these guidelines are a positive for overall liquidity management of NBFCs, which will make the sector stronger,” said JM Financial in a note.

HOW DOES IT IMPACT YOU?

Company fixed deposits (FDs), unlike bank FDs, don’t come with insurance. Also, it is slightly riskier than bank FDs. Hence, there have been multiple incidents of defaults in company FDs offered by NBFCs. The recent draft guidelines are likely to be beneficial for depositors. “Deposits are one of the important resources for NBFCs to raise money. With focus on LCR and high quality liquid assets, it will benefit all stakeholders including depositors. In the near term, there will be impact on interest margin. However, in the long run it will be good for industry,” said Deo Shankar Tripathi, managing director and chief executive officer of Aadhar Housing Finance Ltd.

The impact of the guidelines if it comes into effect for retail deposits would be higher interest rate and since they have to keep a check on the quality, the defaults are likely to go down. “The company will have to raise more deposits and hence they will have to give higher rates to attract depositors. For depositors, it is a good move. On one hand, they will be offered higher interest rate and on the other hand, the balance sheet of NBFCS will get stronger. The changes of defaults on the depositors’ money will go down,” said Hatim Broachwala, analyst at IDBI Capital Ltd. The RBI is seeking public comments till June 14 on the draft framework for before issuing the final guidelines.

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1) How do interest rates of banks look since the beginning of 2019?

Two different interest rates need to be considered. First, the rate at which banks have been borrowing and second, the rate at which they have been lending. The weighted average interest rate on term deposits of banks was 6.91% in January. By April, it had fallen by six basis points to 6.85%. One basis point is equal to 0.01. During the same period, the weighted average lending rate of banks has risen by four basis points from 10.38% to 10.42%. What this tells us is that in terms of outstanding loans of banks, the interest rates of both borrowing and lending have barely moved.

2) Why is that the case with banks?

Since January, the credit to deposit ratio of banks has been 77% or more, except on one occasion—the fortnight ending 10 May—when it stood at 76.9%. Banks need to maintain a cash reserve ratio of 4% with the central bank. They also need to maintain a statutory liquidity ratio of 19% by investing in approved government securities. After adjusting for cash reserve ratio and statutory liquidity ratio, it is clear that banks are lending out almost all the deposits they have. Hence, they are not in a position to reduce interest rates on their deposits as they need fresh deposits to keep funding their loans.

3) What does this mean?

With banks not being in a position to cut interest rates on their deposits, the question of reducing interest rates on their lending does not arise. Deposit growth stood at 15.3% in 2016-17 due to demonetization. It fell to a more than five-decade low of 6.2% in 2017-18. Deposits gathered in 2016-17 helped banks for a while. After that, the deposit growth slowdown started to hurt and that has primarily led to a situation where banks have not been able to cut down their borrowing and lending rates despite RBI’s repo rate cuts. To enable banks to cut rates, deposits need to grow faster, so as to bring down the credit-deposit ratio.

4) How has deposit growth fared in the recent past?

In 2019, deposit growth of banks has been close to 10%, much better than in 2018. The annual deposit growth needs to increase a little more and reach around 12-13% before banks feel confident about cutting interest rates. In 2017-18, interest rates on deposits had crashed in the aftermath of demonetization, leading investors to look at other avenues.

5) Are lending rates likely to be reduced?

One impact of the crisis at non-banks is that more money will now move into banks. This should help in faster deposit growth. But this will take time. Banks need to hold on to the interest rates on their deposits for the next few months, so that their deposit growth is robust enough to get the credit-deposit ratio below 75% and help them cut interest rates after that.