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NBFCs facing structural challenges, banks to benefit long term
RBI tightens policy around NBFCs
Over the last several weeks the RBI has tightened its policies over the NBFCs
as it has: (1) increased CAR to 15% from 12%, (2) disallowed banks from
classifying loans given to NBFCs as priority sector loans (PSL), (3) introduced
standard asset provisioning, (4) issued draft guidelines requiring NBFCs to
hold assets for one year before securitizing. Given the above trajectory, we
expect the draft guidelines to be implemented. In addition, the RBI has set up a
working group to provide the definition and classification of NBFCs,
addressing regulatory gaps and regulatory arbitrage.
Impact will be negative for NBFCs
The above regulatory changes are negative for the NBFC space and could lead
to: (1) increasing borrowing costs , (2) increased competition as banks are
forced to lend directly, (3) reduced ability to leverage, (4) reduced margins and
(5) sustainable RoEs for the companies. We believe this might cap sector
valuations till better clarity emerges on the likely impact of the above policies
on the NBFCs long-term business model and profitability.
No major impact near term on banks, long term neutral to positive
The banking sector exposure to the NBFC space is low at 4.8%. We believe
that less that 2 pp of these are considered as non-housing PSL. In addition,
banks have another 1 pp loan securitized/assigned both on housing and
non-housing loans. Given the change in policy: (1) Banks will now be
required to provide direct PSL. High cost of operations and NPL issues
were key reasons banks had preferred the indirect route of lending. Given
the expanding network of banks, and increasing use of technology, some
of these issues will phase out over the long-term. (2) Banks will charge a
higher interest rate to NBFCs, (3) Competition from NBFCs likely lower for
banks, increasing pricing power and yields. Given the high profitability on
products like CV, gold and tractor financing, banks that succeed in
implementing strong risk processes and bring down their expense ratios
will benefit long-term from direct lending.
Among private banks, retail banks are better placed
We believe that banks that have retail presence couldl be better placed in
meeting PSL exposure directly like HDFC Bank, Kotak, IndusInd & ICICI Bank.
These banks are already providing CV loans old and new, tractor loans and
gold loans. We are Buy-rated on IndusInd (on CL) and ICICI Bank.
Minimal impact on banks
Why is RBI tightening norms?
The RBI has been tightening norms for NBFCs and making it difficult for banks to lend to
this segment. We believe the reasons are as follows:
As per CRISIL, the non-housing retail NBFC sector has been at 27% CAGR and now
accounts for Rs2.4 trillion of AUM equivalent to 6.3% of the banking sector’s total
loan book. The RBI sees NBFCs to be a systemically important part of the financial
system.
Post the global financial crises, the RBI believed that it has to explore in detail the
risks arising from regulatory gaps, arbitrage and systemic inter-connectedness
between the two financial systems.
The RBI is concerned on the end-use of funds provided by NBFCs –i.e loans
provided for unproductive use, loans provided to Real Estate developers by NBFCs
who borrow from banks.
RBI wants banks to do direct lending and expand the priority sector loans, financial
inclusion initiative rather than depending on finance companies.
What additional changes could RBI implement? In addition to the changes made so
far, the RBI may implement some additional ones post the regulatory review by the
working group set up by RBI: “ The group will focus on the definition and classification of
NBFCs, addressing regulatory gaps and regulatory arbitrage, maintaining standards of
governance in the sector and appropriate approach to NBFC supervision".
We believe the RBI may change the provisioning norms to make this comparable
with those of banks.
Likely increase in minimum capital investment; currently NBFCs need to have a
minimum net owned fund of Rs20mn.
Likely implementation of the draft securitization guidelines. It was proposed that
there should be a minimum holding period and minimum retention requirement
before loans are sold down. For loan maturity greater than 24 months, (1)
minimum holding period was proposed at 12 months, and (2) retention amount at
5%-10% of book value of loans securitized, depending on the structure of
transaction. Key risks here could be if RBI completely disallows loan assignment
/securitization to be considered as PSLs.
Unless banks directly increase their exposure to the lower income segment, the likely
outcome of these changes could be negative to the government’s financial inclusion
initiatives.
Will this cut of credit to the NBFC sector?
The banking sector currently has 4.8% of its loans to NBFCs. We believe less than 2 pp of
these loans will be against the priority sector loan category. Post the changes, banks are
not restricted from lending to finance companies and based on our discussion with banks it
appears the differential in lending rates for loans against PSLs was around 200 bps. We
believe banks will likely charge a higher rate while lending to this segment, and the
decision to lend will be purely commercial. A number of finance companies have strong
balance sheets and profitability (even though this may likely weaken post the recent
changes), and should be in a position to borrow from the market.
What will banks do to meet the priority sector requirement?
In general, public banks lend directly to meet their priority sector norms. The private banks
resort to buying loans from NBFC and providing loans against specific assets which are
considered for the priority sector. Loans impacted by this lending are commercial vehicles,
gold loans and perhaps tractor loans.
We believe most of the banks under coverage that have retail lending operations will
manage to move the loans to direct loans. Other than Yes Bank ,all other private banks
under our coverage have retail exposure. It is possible that banks may explore other
options like taking loans on their own book which can be sourced by NBFC for a fee.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
NBFCs facing structural challenges, banks to benefit long term
RBI tightens policy around NBFCs
Over the last several weeks the RBI has tightened its policies over the NBFCs
as it has: (1) increased CAR to 15% from 12%, (2) disallowed banks from
classifying loans given to NBFCs as priority sector loans (PSL), (3) introduced
standard asset provisioning, (4) issued draft guidelines requiring NBFCs to
hold assets for one year before securitizing. Given the above trajectory, we
expect the draft guidelines to be implemented. In addition, the RBI has set up a
working group to provide the definition and classification of NBFCs,
addressing regulatory gaps and regulatory arbitrage.
Impact will be negative for NBFCs
The above regulatory changes are negative for the NBFC space and could lead
to: (1) increasing borrowing costs , (2) increased competition as banks are
forced to lend directly, (3) reduced ability to leverage, (4) reduced margins and
(5) sustainable RoEs for the companies. We believe this might cap sector
valuations till better clarity emerges on the likely impact of the above policies
on the NBFCs long-term business model and profitability.
No major impact near term on banks, long term neutral to positive
The banking sector exposure to the NBFC space is low at 4.8%. We believe
that less that 2 pp of these are considered as non-housing PSL. In addition,
banks have another 1 pp loan securitized/assigned both on housing and
non-housing loans. Given the change in policy: (1) Banks will now be
required to provide direct PSL. High cost of operations and NPL issues
were key reasons banks had preferred the indirect route of lending. Given
the expanding network of banks, and increasing use of technology, some
of these issues will phase out over the long-term. (2) Banks will charge a
higher interest rate to NBFCs, (3) Competition from NBFCs likely lower for
banks, increasing pricing power and yields. Given the high profitability on
products like CV, gold and tractor financing, banks that succeed in
implementing strong risk processes and bring down their expense ratios
will benefit long-term from direct lending.
Among private banks, retail banks are better placed
We believe that banks that have retail presence couldl be better placed in
meeting PSL exposure directly like HDFC Bank, Kotak, IndusInd & ICICI Bank.
These banks are already providing CV loans old and new, tractor loans and
gold loans. We are Buy-rated on IndusInd (on CL) and ICICI Bank.
Minimal impact on banks
Why is RBI tightening norms?
The RBI has been tightening norms for NBFCs and making it difficult for banks to lend to
this segment. We believe the reasons are as follows:
As per CRISIL, the non-housing retail NBFC sector has been at 27% CAGR and now
accounts for Rs2.4 trillion of AUM equivalent to 6.3% of the banking sector’s total
loan book. The RBI sees NBFCs to be a systemically important part of the financial
system.
Post the global financial crises, the RBI believed that it has to explore in detail the
risks arising from regulatory gaps, arbitrage and systemic inter-connectedness
between the two financial systems.
The RBI is concerned on the end-use of funds provided by NBFCs –i.e loans
provided for unproductive use, loans provided to Real Estate developers by NBFCs
who borrow from banks.
RBI wants banks to do direct lending and expand the priority sector loans, financial
inclusion initiative rather than depending on finance companies.
What additional changes could RBI implement? In addition to the changes made so
far, the RBI may implement some additional ones post the regulatory review by the
working group set up by RBI: “ The group will focus on the definition and classification of
NBFCs, addressing regulatory gaps and regulatory arbitrage, maintaining standards of
governance in the sector and appropriate approach to NBFC supervision".
We believe the RBI may change the provisioning norms to make this comparable
with those of banks.
Likely increase in minimum capital investment; currently NBFCs need to have a
minimum net owned fund of Rs20mn.
Likely implementation of the draft securitization guidelines. It was proposed that
there should be a minimum holding period and minimum retention requirement
before loans are sold down. For loan maturity greater than 24 months, (1)
minimum holding period was proposed at 12 months, and (2) retention amount at
5%-10% of book value of loans securitized, depending on the structure of
transaction. Key risks here could be if RBI completely disallows loan assignment
/securitization to be considered as PSLs.
Unless banks directly increase their exposure to the lower income segment, the likely
outcome of these changes could be negative to the government’s financial inclusion
initiatives.
Will this cut of credit to the NBFC sector?
The banking sector currently has 4.8% of its loans to NBFCs. We believe less than 2 pp of
these loans will be against the priority sector loan category. Post the changes, banks are
not restricted from lending to finance companies and based on our discussion with banks it
appears the differential in lending rates for loans against PSLs was around 200 bps. We
believe banks will likely charge a higher rate while lending to this segment, and the
decision to lend will be purely commercial. A number of finance companies have strong
balance sheets and profitability (even though this may likely weaken post the recent
changes), and should be in a position to borrow from the market.
What will banks do to meet the priority sector requirement?
In general, public banks lend directly to meet their priority sector norms. The private banks
resort to buying loans from NBFC and providing loans against specific assets which are
considered for the priority sector. Loans impacted by this lending are commercial vehicles,
gold loans and perhaps tractor loans.
We believe most of the banks under coverage that have retail lending operations will
manage to move the loans to direct loans. Other than Yes Bank ,all other private banks
under our coverage have retail exposure. It is possible that banks may explore other
options like taking loans on their own book which can be sourced by NBFC for a fee.
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