Tighter Prudential Norms and Focused Supervision: A Credit Positive for NBFCs
November 2014
Impact Assessment
The Reserve Bank of India (RBI) on November 10, 2014 has revised the regulatory guidelines for Non-Banking Finance Companies (NBFCs) to
better address the risks in the business, enhance regulatory coverage, standardize regulations and improve governance standards. The revised
norms are to be implemented over the next three financial years, financial year (FY) 2016 to FY2018. The new guidelines are likely to impact the
NBFCs in several ways, including the following:
Retail NBFCs that have not implemented the 90-day NPA recognition norm so far would see a change in their Gross NPAs. Such NBFCs
currently account for 63% of the total managed advances of Rs. 3.7 trillion, in ICRA’s estimates.
The Reported Gross NPA percentage of the affected NBFCs is likely to increase by 100-220 basis points (bps) from 2.9% (excluding captive
financiers, including these gross NPA% would be 4.5%) as on June 30, 2014 once the guidelines are fully implemented; the impact would
be lower in the short term because of the long transition period.
The Returns on Assets (ROAs) of NBFCs as a whole could drop by 20 bps, which would translate into a 1.1-1.3% dip in Returns on Equity
(ROEs).
The higher Tier I prescribed under the new guidelines is unlikely to have much of an impact on the NBFC sector as its current Tier I is
around 15.9%.
Reduction in maximum deposit acceptance limit from 4 times Net Owned Funds (NOF) to 1.5 times NOF unlikely to have an impact, as no
major entity has deposits exceeding 1.5 times NOF. Deposit mobilization restricted to NBFCs with minimum investment grade rating.
ICRA RESEARCH SERVICES
Contacts:
Vibha Batra
+91 124 4545 302
vibha@icraindia.com
Karthik Srinivasan
+91 22 61796365
karthiks@icraindia.com
Jaskirat S. Chadha
+91 124 4545308
jaskiratc@icraindia.com
AM Karthik
+91 44 45964308
a.karthik@icraindia.com
The guidelines propose, among other things, tightening of the NPA recognition and provisioning norms for NBFCs so as to bring them on a par
with those applicable for banks. In ICRA’s estimates, retail NBFCs covering 63% of total managed advances (Rs. 3.7 trillion as on June 30, 2014)
classify NPAs on the basis of the existing 180-day norm, while NBFCs with 20% advances are already on the 90-day norm. Thus the change in norm
is likely to lead to a rise in the reported Gross NPA percentage from 4.5% as on June 30, 2014 to 6-8% once the norms are fully implemented,
thereby increasing incremental credit provisioning. However, in ICRA’s view, over the medium term, delinquencies could settle at a lower level as
NBFCs realign their monitoring and recovery systems to the 90-day format and as the operating environment improves, alleviating the pressure
on the credit profiles of borrowers. While NBFCs had an NPA provisioning cover of 42% as on June 30, 2014, the percentage is likely to drop as the
stock of Gross NPAs increases. Despite the possible drop in provisioning cover, incremental credit cost could increase because of higher Gross
NPAs. In the first year of transition, i.e. FY2016, ICRA expects the ROAs to dip by 20-25 bps, which would translate into a 1.5-1.8% dip in ROEs. This
impact is expected to soften subsequently.
The guidelines have also announced an increase in the minimum Tier I capital requirements from the current 7.5% to 10% by March 2017. Most
NBFCs maintain a favourable capital structure, and this would enable them to meet the enhanced capital requirements. In ICRA’s estimates, only
two or three NBFCs would need to be mobilize additional capital (of around Rs. 5 billion, i.e. 8-10% of their net worth) to maintain a 2% buffer
over the revised Tier I capital requirements. At the same time, increasing the Tier I capital for NBFCs while not aligning (reducing) the risk weights
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with what is allowed to banks would reduce the NBFCs’ leveraging capacity vis-à-vis banks. For instance, the risk weights are lower for banks for commercial vehicle,
construction equipment, and home loans, among others.
Overall, increase in the asset-base cut-off for systemically important NBFCs from Rs. 100 crore to Rs. 500 crore could facilitate focused supervision by the RBI while
allowing the smaller players the flexibility to innovate and cater for niche segments. The credit profiles of large NBFCs could improve with tighter NPA recognition norms,
higher Tier I capital, greater disclosure and better corporate governance standards. Even as NPAs and credit provisions could increase over the medium term, the long
transition period granted is likely to minimise business disruption. While the RBI has made some prudential norms more stringent for NBFCs brining them on a par with
banks, the NBFCs remain at a disadvantageous vis-à-vis banks on risk based capital, access to provisions of the SARFAESI Act, and liquidity back-up.
Key Changes and Impact
The following are the key changes proposed by the RBI to the existing regulatory framework for NBFCs:
1.
Systemic Importance
Definition of the Systemically Important non-deposit taking NBFCs (NBFC-ND-SI) has been revised to entities with a total asset size of Rs 500 crore and above (as
against Rs. 100 crore earlier). Accordingly RBI has categorized NBFCs into 3 broad groups
o
o
o
NBFC –D : NBFCs permitted to mobilize deposits
NBFC- ND : Non Deposit accepting NBFCs with asset size of under Rs. 500 crore
NBFC-ND-SI: Non Deposit accepting NBFCs with asset size of under Rs. 500 crore
The asset sizes of all NBFCs in a group would be viewed on a consolidated basis to ascertain Systemic Importance; deposit accepting NBFCs (NBFC-D) with the group
would continue to be governed by guidelines to the extent applicable for that category.
2.
Prudential Requirements- NBFC –ND
NBFC-ND with asset size below Rs. 500 crore and accessing Public funds (including debentures, commercial papers, inter-corporate deposits and bank funds) and
having customer interface would be subjected to limited prudential requirements and conduct of business regulation
NBFC-ND with asset size below Rs. 500 crore is exempted from regulatory capital adequacy requirements and compliance on credit concentration norms. A max
leverage ratio (total outside liabilities as a proportion of net owned funds) of 7 times has been introduced for these entities.
3.
Prudential Requirements- NBFC- SI and NBFC –D
RBI proposes to align the asset classification norms for NBFC-ND-SI and NBFC-D with those applicable to banks in a phased manner. NBFCs presently recognize
exposures which are overdue for 6/12 months as Non Performing Assets (NPAs); these are to be tightened to 3 months as per the following schedule:
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Table 1: Revision in the NPA recognition policy
Period ended
Lease Rental and Hire Purchase
Other Asset Classes
March 2016
NPA if overdue for 9 months (12 months presently)
NPA if overdue for 5 months (6 months presently)
March 2017
NPA if overdue for 6 months
NPA if overdue for 4 months
March 2018
Source: RBI
NPA if overdue for 3 months
NPA if overdue for 3 months
RBI has permitted a one-time adjustment of the repayment schedule on loans which would not be considered as restructuring
Standard asset provisioning of NBFC-ND-SI and NBFC-D to be increased to 0.40% by March 2018, with interim targets of 0.30% in March 2016 and 0.35% in March
2017. Presently NBFCs make standard asset provisions of 0.25% on standard advances.
Following the RBI draft guidelines of December 12, 2012 proposing tighter NPA recognition norms several NBFCs shifted towards more conservative NPA recognition
norms as a pre-emptive measure. As on June 30, 2014, NBFCs with managed advances aggregating ~36% of managed credit have adopted more stringent NPA
recognition policies from the prevailing 180 / 360 day norm. The distribution of NBFCs based the NPA recognition norm are as follows:
Table 2: NPA recognition norms adopted by NBFCs
NBFCs adopting the 180+ day NPA recognition norm
NBFCs adopting the 150+ day NPA recognition norm
NBFCs adopting the 120+ day NPA recognition norm
NBFCs adopting the 90+ day NPA recognition norm
Source: ICRA Research
% of managed advances as on June 30, 2014
63%
7%
9%
20%
Based on ICRA’s estimates the above change in NPA recognition norms could lead to a spike in the NPA and a consequent compression in the earnings of NBFCs. The
extent of impact of the new proposed regulations however would depend upon the following factors:
o
o
o
Pace and success of NBFCs to re-align their collection processes towards the 3 month norm
Improvement in operating environment over the next few years (compared to the FY 2014 and FY 2015) could bring down overall delinquencies for the
industry and partly off-set the impact of stricter asset classification norms
NBFCs stance on creating excess provisions. Typically NBFCs maintain excess provisions over and above the minimum RBI requirement. Provisioning coverage
for retail focused NBFCs as on March 31, 2014 was about 42%. In light of stricter asset classification norms NBFCs could lower their provisioning coverage
In the case of NBFCs, depending on the asset class, 90+ days’ delinquencies are typically 1.5-3.5 times (average 2.25 times) the 180+ days’ delinquencies. While a
change in NPA recognition norm could lead to a spike in the gross NPA level in the short term, the percentage, in ICRA’s view, would settle at a lower level over the
medium term as NBFCs re-align their monitoring and recovery systems to the 90-day format and also due to higher recoveries. In the case of housing finance
companies (HFCs), which migrated to the 90-day NPA recognition norm from March 31, 2005, the gross NPA percentage increased from 3.6% in March 2004 to 6.2% in
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March 2005 and subsequently declined to 4.5% March 2006. The following table illustrates the potential one time impact on the Return on Assets (ROA) of NBFCs to
move from a 180+ days NPA recognition policy to a 90+ days NPA recognition policy, at varying levels of increase in NPA and provisioning coverage.
Table 3: One time Impact on NBFC RoA over the period FY 2016 to FY 2018
Provisioning
coverage
30%
35%
40%
45%
50%
Source: ICRA Research
Delinquency multiple-90+ days over 180+days
1.50
1.75
2.00
2.25
2.50
0.2%
0.3%
0.5%
0.6%
0.8%
0.3%
0.5%
0.7%
0.8%
1.0%
0.4%
0.7%
0.9%
1.1%
1.3%
0.6%
0.8%
1.0%
1.3%
1.5%
0.7%
1.0%
1.2%
1.5%
1.7%
2.75
1.0%
1.2%
1.5%
1.7%
2.0%
As seen above at the current average 2.25 times multiple of 90+ days delinquencies over the 180+ day delinquencies and at the prevailing provisioning coverage at
around 40% the one-time impact on ROA of NBFCs is estimated at ~1.1% over the period FY 2016 to FY 2018. However in ICRA’s view the same is expected to be lower
incase the NPA build-up follows a similar trend as witnessed in the case of HFCs.
Since the movement from a 90+ days to a 180+ days NPA recognition policy is phased over the period FY2016- FY2018 the one-time impact would be absorbed over a
3 year period; the impact on RoA in FY 2016 therefore is estimated to be in the range of 10-80 bps (average of ~20 bp, which translates to a 1.1% to 1.3% dip in ROEs)
depending upon the extent of increase in NPAs and the provisioning coverage.
Similarly in case of NBFC- Infrastructure Finance Company (IFC), overall asset quality indicators could also witness an increase with the implementation of stricter NPA
recognition norms, which along with the higher standard asset provisioning could lead to some compression in earnings for such entities.
4.
Enhanced capital requirements
RBI has revised the minimum tier 1 capital requirements for NBFC-ND-SI and NBFC-D from 7.5% to 10%.; the same is to be achieved by March 2017, with an interim
target of 8.5% by March 2016. NBFCs primarily engaged in lending against gold jewellery shall continue to have a minimum tier-I of 12%.
Based on ICRA’s estimates, assuming NBFCs were to maintain a Tier I capital (in relation to managed assets) with a 2% buffer over the enhanced minimum regulatory
requirement proposed, two to three NBFCs with managed assets totalling around 15% of the total industry assets would need to mobilise external capital (amounting
to around Rs. 5 billion or around 8-10% of their net worth) to have a Tier I in excess of 12%, in ICRA’s calculations.
NBFCs remain at a disadvantage vis-à-vis banks with respect to capital requirement on a part of their retail lending books (loans for commercial vehicles, construction
equipment, home, gold, etc). For instance, for commercial vehicle or construction equipment loans, banks are permitted to apply 75% risk weight, while NBFCs have to
apply a risk weight of 100%. Thus, the capital requirement for banks would ~6% under Basel III, while NBFCs would have to maintain Tier I capital of 10% under the
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proposed norms. Similarly, for home loans the amount of capital provided by banks would be 4% to 10% and in the case of gold loans up to 1.65%, while NBFCs will
need to keep a Tier I of 10% on these exposures.
In the case of NBFC- IFC the regulatory minimum Tier 1 capital% is already 10% and therefore the new regulations are unlikely to have an impact on such entities.
5.
Minimum net owned fund requirement
Mandatory to have net owned funds (NOF) of Rs. 0.02 Billion by end of March 2017; milestone of Rs. 0.01 Billion NOF as on March 2016 set for the presently noncompliant NBFCs.
6.
Deposit Acceptance
NBFCs with minimum investment grade rating will be able to secure fresh deposits, irrespective of the category. To standardize regulations, the cap on the maximum
deposit acceptance by an NBFC, irrespective of the category, has been fixed at 1.5 times of the NOF, with effect from the date of the circular.
The above is not expected to have a significant impact on the performance of deposit accepting NBFCs (NBFC-D), as very few of them have deposits in excess of 1.5
times of NOF, and in case of excess observed, the limit is not exceeded substantially.
7.
Corporate governance and disclosures
NBFC-D with deposits over Rs.0.2 Billion shall constitute an Audit Committee, a Nomination Committee to ascertain the fit and proper status of Directors and
Risk Management Committee.
NBFC-ND with assets of Rs. 0.5 Billion and over shall constitute an Audit Committee, while NBFC-ND with asset over Rs.1 Billion shall constitute a Nomination
committee and Risk Management Committee in addition to the Audit Committee.
NBFC-D with deposits over Rs. 0.5 Billion shall rotate the partners in the statutory audit firm, once in every three years.
Audit Committee of the NBFCs to ensure audit of the internal systems and processes at least one in two years.
NBFC-ND-SI and NBFC-D are required to make additional disclosures in the Annual Report, including, movement in credit rating and NPAs, financing of parent
products, ALM, off balance sheet exposures etc.
8.
Exemptions
NBFC-MFIs and Core Investment Companies are exempted from the current revisions, wherever in conflict with the provision for the respective entities in the
Directions of 2011.
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Some Disadvantages of NBFCs versus Banks
While the RBI is seeking to remove some of the regulatory arbitrage that NBFCs have enjoyed vis-à-vis banks through the alignment of NPA and provisioning norms,
tighter liquidity standards and such other measures, there may be a case for providing NBFCs with some “enabling” provisions similar to those that the banks enjoy,
given that NBFCs are an important source of funds for the self-employed segment. Some such measures would include the following:
Access to SARFAESI Act: RBI has not included provisions granting NBFC access to SARFAESI Act, which has been used effectively by banks to expedite recovery and
has also served to improve credit behaviour.
Liquidity support: While banks can raise short-term funds from the RBI through the repo window, NBFCs do not enjoy any such benefits.
Lower risk weights for some asset classes: The risk weights prescribed for retail assets such as vehicle loans, home loans and gold loans are lower for banks than
for NBFCs. While banks’ balance sheets are more diversified, the credit and market risk on specific asset classes may be similar for both banks and NBFCs.
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