Diary of a time traveler
April, 2023
Three years ago, it was the hot summer of April 2020, streets were empty, factories were no longer humming, when the Prime minister of India had locked the country down for almost 2 months to stop the spread of Covid-19. Human interaction for the first time in history became lethal to mankind. Some were suffering, some were enjoying life with their loved ones, some were living in fear of their livelihood. It was a time of despair. Hope was a rare commodity found, alas, that all people had. Among the crisis, banking and financial sector, one of very few was working under the tag of essential services. Sector had been reeling with a myriad of issues since last year be it high NPAs, lower liquidity, trust deficit amongst retail investors and depositors. Covid came as a double whammy in this sector. Staying true to “Survival of the fittest”, very amongst them have gotten out of unscathed and stronger.
It was year 18-19 which woke up Indian banking regulator and drew attention to the hole in the NBFC sector. Defaults like IL&Fs and DHFL shook the financial sector of India, investors and bankers alike. What came after this were a series of after effects which saw 20% decline in commercial paper borrowing. Cheap source of funding, which resulted in huge Asset liability mismatch, was no longer the preferred route. NBFCs were reducing their outstanding exposure in the market to pay off their debt, resulting in lesser liquidity in the market. Debentures issued by financial institutes, 75% of them were undersubscribed during these times. NBFCs became more dependent on bank borrowings which came at a premium. Lesser liquidity resulted in increase of stressed assets of finance companies. Substandard and doubtful assets grew by 10 % in 18-19. For a thin margin business of finance, it was too much to handle. Their GNPA rose to 6.1 % from 5.3 %, a 15 % increase, when industry operated on RoA(Return on asset) of 1.5 %.
Alas, our regulator and government, having foresight of Sahadev from Mahabharata, came to rescue faster than the speed of Arjit Singh songs. Slew of measures which included liquidity pumping of 1 lakh crore to sector in form of co-lending, cancellation of licenses of non-compliant institutes, and most importantly, a mandate to maintain LCR from 30% to start with and taking it to 100% in following 7 years. What rest of the world had implemented by 2015, we were running behind schedule, waiting for a crisis to happen?
In famous words of John Kennedy “The time to repair the roof is when the sun is shining” Coming out of clutches of liquidity crunch, NBFCs mending their ways to manage Asset liability mismatch, got infected in clutches of deadly virus in first quarter of 2020. Like ailing patients with less immunity, finance companies were at most risks by unforeseeable circumstances. Our own talented and vigilant regulator made an outstanding move by suggesting to give moratorium for end users and expected fin companies to magically raise capital to service their own obligations, stretching an already poor cash flow. Borrowers now had reason not to pay back to these companies even in case of availability of cash. Situation was dire, nobody in the market was raising new funds except a select few. Rather no one was ready to lend fresh funds due to uncertainty.
After lockdown was lifted, all these companies started giving top-up loans to their existing customers. Even if market conditions were bad, finance companies didn’t have any but this option. They were expecting to get paid by borrowers by giving them extra money(Evergreening?) This dangerous cycle was bound to find roadblock somewhere.
By the start of 3nd quarter, 2020, news of defaults of some finance companies surfaced. It was IL&FS all over again, may be even worse. Efforts to raise capital for NBFCs from debentures or banks became futile as very few wanted to lend to stressed assets. Equity investors didn’t want to part with their capital in already sinking ships. Consumers were putting money in FDs in anticipation for tougher times. Banks were preserving cash in anticipation of slow down and were critically choosy in lending to NBFCs. Unsecured lenders were hit harder than secured ones. Sector as a whole now eagerly waits for a hefty stimulus package for industry. But they were one of many sectors who suffered badly. GNPA of the sector increased by 30% compared to previous year. RoA of the sector returned to negative.
As swiftly as police in Hindi Cinema, our government again came to the forefront, by the end of 4th quarter of 2020. Government declared a 2 lakh crore fund for the sector(double than the time of IL&FS), where money would work as a first loss default guarantee for banks to lend to NBFCs. Government decided priority sectors as infra, agriculture and micro finance. Banks could lend to NBFCs working with priority sectors and with AA ratings. NBFCs could choose to either use funds for repayment of old debt or could use it to fund in priority sectors. Despite a liquidity crunch in general infrastructure focused NBFCs were increasing their assets by 4%. Government even opened the economy allowing free flow of FDIs in various sectors to boost consumption, this measure would take a few months to actually show some positive results. Among these, there were few companies which had humongous liquid cash either due to the nature of liquid assets or strong funding round pre-covid crisis. When a lot of stressed assets were put on fire sale to raise capital to service debt, few of the cash surplus companies managed to buy these stressed assets for pennies on dollar, boosting their profitability to the roof. Last quarter of 2020 saw lot of these mergers and fire sale, which effectively brought reduced total operating NBFC number by 20%
First quarter of 2021 ended growth on par with pre-covid times for the sector. Liquidity had kicked in, most NBFCs had revamped their underwriting criteria to reduce funding to leverage businesses. This year would be amongst the best by most standards for NBFC sector. FY 2021 ended with a market cap increase of 30% and assets growth of 22% for the NBFC sector.
Coming to 2023, a lot of these NBFCs, which survived the crisis of their lifetime, were starting to take heavy debts compared to their liquid assets. RBI seemed to have relaxed their criteria on LCR maintenance. Are they headed for another bubble? Only time will tell.