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India's nonbank lenders to face further funding challenges in 2020, analysts say

For nonbank lenders in India, access to funding will likely remain one of the biggest challenges in 2020 following a few high-profile defaults.

Once a beacon of hope for driving India's financial inclusiveness and loan growth, nonbank financial companies, or NBFCs, have become a new source of systemic risk since mid-2018. Despite the government's efforts to improve liquidity and transparency for lending activities outside the formal banking system, recent defaults by large players such as Infrastructure Leasing & Financial Services Ltd., Dewan Housing Finance Corp. Ltd. and Reliance Capital Ltd. have made banks less willing to lend to the sector, or charge a risk premium on loans, creating a vicious cycle that leaves NBFCs more fragile than before.

Still, as of September 2019, NBFCs were the largest net borrowers of funds from the financial system, with gross payables totaling 8.295 trillion rupees, up from 7.458 trillion rupees in the prior-year period, according to the Reserve Bank of India's latest financial stability report released Dec. 27, 2019.

NBFCs' overall asset quality worsened modestly in the six months ended September 2019, with gross nonperforming asset ratio rising to 6.3% from 6.1% as of March 2019. The ratio was higher than the 3.9% for private-sector banks, but much lower than the 12.7% for state-owned banks.

Investors are more concerned with the asset quality of the so-called wholesale-oriented NBFCs, which focus on lending to property developers and distressed assets, than the retail-oriented ones that focus on consumer lending, according to a research note by CRISIL, an S&P Global company, on Dec. 11, 2019.

"The retail-oriented nonbanks are faring relatively better and funding challenges are abating here. However, wholesale-oriented ones — primarily, real estate developer financing and structured credit — remain affected more in terms of access to funds," according to the note.

The diverging risk appetite is reflected in the widening spread among the yields on the three-month commercial paper sold by these NBFCs. The RBI's December 2019 report expected the spread to continue widening, which "points to better screening capabilities" by lenders.

Muted property market

Although NBFCs are still a major source of funding for both property developers and home buyers outside the formal banking system, delays in new property launches in a weak market have left many developers in cash crunch.

Moody's said Dec. 13, 2019, that real estate companies were under "a lot of stress," with developers dealing with a large inventory that will take several quarters to clear. Data from Knight Frank Research show that, as of 2019-end, there were 445,836 unsold apartments, with the "age" of unsold inventory at 15.9 quarters.

"Despite the government's measures to infuse liquidity, in the backdrop of subdued market conditions, expectations of price adjustments are keeping consumer demand muted, which is adversely impacting real estate activities," according to the RBI report.

Dewan Housing Finance, which mainly lends to developers, has defaulted on its commercial paper since June 2019. Later in December, the central bank appointed an administrator and bankruptcy proceedings began. As of Dec. 17, financial creditors and bondholders claimed dues totaling 868.92 billion rupees. State-owned banks such as State Bank of India and Bank of India are among some of the largest creditors.

Nidhesh Jain, research analyst covering the Indian financial sector at Investec India, told S&P Global Market Intelligence: "The one segment where there is a lot of apprehension is commercial real estate exposure. So for NBFCs which are having exposure to commercial real estate, they are still not able to get funding from the markets."

While state-owned banks are among some of the biggest creditors to NBFCs, recent stress tests conducted by the central bank showed even if one of the largest NBFCs collapsed, no additional bank will fail because of that, according to the RBI report.

Corporate governance issues

The default of Dewan Housing Finance was also partly brought about by lapses in corporate governance. Accounting company KPMG conducted an audit and alleged that billions of rupees worth of funds were diverted to private entities of its promoters.

"Investors don't have confidence in the quality of the books of NBFCs. And I think the government can do limited things to deal with that," Jain said.

Since IL&FS defaulted, the central bank has started strengthening its oversight over the sector.

RBI Governor Shaktikanta Das told Mint on Dec. 17, 2019, that regulations on NBFCs were not as strong as the rules on banks. Recent new rules that aim at boosting corporate governance at nonbank lenders include a mandatory requirement of appointing chief risk officers. The central bank was also considering a prompt corrective action framework for weaker NBFCs, as well as a different supervisory system for the sector by 2022, according to the central bank's medium-term strategy.

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Asset-liability mismatch

Like many shadow lenders in other geographies such as China, asset-liability mismatch is often behind the failures of many Indian nonbank lenders, as that leaves them limited or no buffer in times of liquidity crunch.

IL&FS, for instance, failed to make short-term payment on commercial paper, as its borrowers are mostly infrastructure builders which operate on a much longer time horizon than the short-term loans that fund them. The same goes for Dewan Housing Finance, when developers were sitting on unsold units and unable to service their debt.

India's government is trying to fix this problem. One of the new policies was for NBFCs to hold a minimum level of highly liquid assets to cover cash outflows in a stressed scenario, which the RBI introduced in November 2019. This so-called liquidity coverage ratio should rise to 100% by end-2024.

Other policies aim at improving liquidity includes an increase of the single borrower limit of banks to NBFCs to 20% from 15% in September 2019. The central bank also allowed nonbanks with loans of maturities over five years to sell their loan books or securitize them on easier terms. The Ministry of Finance also offered to provide a partial credit guarantee of 1 trillion rupees to public sector banks to purchase pooled assets of financial sound NBFCs.

"It is only a matter of time, if things remain stable, investor interest can come back. Government cannot push a particular investor if they have so many doubts."

CRISIL and S&P Global Market Intelligence are owned by S&P Global Inc.

As of Jan. 7, US$1 was equivalent to 71.85 Indian rupees.