Partial credit guarantee for NBFC pools: a confidence measure of symbolic value

Vinod Kothari

One of the proposals in the Union Budget, 2019 by the Finance Minister is a Government’s partial guarantee for public sector banks buying NBFC’s well-rated pools. The measure may have a substantial symbolic value, indicating the Government’s faith and support for what is currently a reality of the market – the bank-NBFC interface in form of direct assignments and pass-through certificates. The real stake of the Govt. in the so-called partial guarantee may not be much – given the fact that the guarantee has only a 6-month term; however, this may still encourage public sector banks to get more active in buying NBFC pools.

Banks’s investment in NBFC pools:

The sharp increase of NBFCs in the overall lending market in the country, particularly in context of small borrowers, personal finance and auto financing, has been happening in collaboration, and not competition, with banks. NBFCs have much stronger distribution abilities – they have wider geographical outreach, strong interface with borrowers, faster turn-around time, etc. On the other hand, banks are strong warehouses of money. Therefore, there is a clear case of collaboration.

The so-called collaboration is currently happening, largely, in two ways – direct assignments, and securitisation. Direct assignment is a case of transfer of proportional share in a pool, without any credit enhancements by the selling NBFC. On the other hand, securitisation is credit-enhanced, and mostly in form a security called “pass-through certificates”.

There is, now, an additional window- co-lending between the NBFC and the bank, where the NBFC becomes a minimum 20% co-lender.

Direct assignments: a great liquidity route for NBFCs

As direct bank lending dried up for NBFCs in the recent few months, direct assignments have been the way of life for NBFCs. Last financial year 2018-19 saw an over-100% spike in the volumes of securitisation, mostly in form of direct assignments.

If bank lending dries up, and the direct assignment route is not available, NBFCs will face several asset-liability mismatches, as most of them took the continuous availability of bank lending as almost assured.

Currently, NBFCs were undergoing that threat of asset-liability mismatches, hitting their ability to sustain business.

The Finance Minister’s proposal

Para 90 of the Budget Speech says:

For purchase of high-rated pooled assets of financially sound NBFCs, amounting to a total of Rupees one lakh crore during the current financial year, Government will provide one time six months' partial credit guarantee to Public Sector Banks for first loss of up to 10%.

While the actual details may be studied only when the scheme is launched, the following features appear to be relevant:

·       The scheme seems relevant in case of direct assignments, and not securitisation. In case of securitisation, the first-loss is anyways taken by the assignor, by way of subordination or other forms of credit enhancement. In case of direct assignments, as the sharing of the risks is pari passu, the need for a first loss support may arise.

·       The amount of Rs 1 lac crore seems to be the pool size. As per relevant regulations, there has to be at least 10% retention by the selling NBFC. Whether the amount of Rs 1 lac crore is after considering the 10% retention, or before, remains to be seen.

·       The government guarantee is only to the extent of loss taken by the acquiring bank. That would mean, the loss must be distributed pari passu between the NBFC and the bank first, and then whatever is the share of loss of the bank, will stand compensated by the first loss support given by the Govt. There is no support for the loss taken by the NBFC itself.

·       Also, while one needs to see the fine print of the scheme, but the scheme may potentially provide for loss of principal invested by the bank. The question of any loss of principal arises only if the spreads are completely exhausted by the losses.

·       Most importantly, the partial guarantee is only for the losses suffered by the bank for first 6 months. Generally, in case of any pools, losses are back-heavy – losses take place towards the later part of the life of a loan.

·       Also, the tricky part may be – there may be a loss or shortfall in collections, but the same may get recovered later. If the performance of the defaulted loans results into recovery, the investing bank may recover its losses. Quite likely, in that case, there will be no financial stake for the Govt.

For all these reasons, the actual financial burden of losses on the exchequer will be quite small. However, as an exercise of confidence building on the NBFC sector, the proposal is sound and welcome.