RBI’s recommendations for NBFCs ::CLSA

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RBI’s recommendations for NBFCs
RBI’s committee has recommended narrowing of arbitrage between
banks and NBFCs largely by capping the latter’s leverage. The new
norms will require NBFCs to maintain Tier I ratio of 12% versus 6%
for banks. In a worst case, the ROE impact of the new Tier I
requirement could be up to 600bps. The other important
recommendations are on setting of liquidity norms, aligning asset
classification and provisioning norms with banks and raising
standards of supervision and governance. Stringent asset
classification and provision norms could impact PFC and REC more
than others; IDFC and HDFC are less affected.
Higher Tier I ratio will lower arbitrage and cap ROE
The RBI committee has targeted capital adequacy norms to narrow the
regulatory arbitrage between the business models of banks and NBFCs. The
committee has recommended raising the Tier I CAR from 10% (applicable
from Mar-12) to 12% over a three year period, which will be twice that of
banks. As per RBI, this is likely to moderate growth rates and ensure well
capitalised balance sheet to absorb the risk of asset quality pressures. While
most of the large NBFCs are well capitalised with Tier I CAR +16% and
committee has recommended period of 3 years to improver Tier I CAR, LIC
HF has lower Tier I of 9% and HDFC’s Tier I ratio is at 12% (but its warrant
conversion in Aug-12 will boost tier I ratio). In a worst case, the ROE impact
of the new Tier I requirement could be up to 600bps. The risk weight on
capital market and commercial real estate exposure has been raised to 150%
and 125%, respectively.
NBFCs well placed on liquidity buffers
In order to minimise the risk of short-term liquidity crunch, the committee
has recommended that NBFCs should hold liquid assets (cash, short-term
bank deposits, G-Secs, treasury bills and money market instruments) that
cover net cash outflow over next 30 days. Our interaction with management
indicates that most NBFCs already maintain sufficient liquidity and hence this
norm is likely to have negligible impact.
Align asset classification and provisioning norms with banks
Committee has recommended that NBFCs should follow asset classification
and provision norms similar to that of banks in a phased manner. This is likely
to result in (1) shorter cut-off dates for recognition as NPA (from 180 days to
90 days) and (2) increased provisioning requirement. The impact of higher
provisioning may be partly offset if recommendation to allow tax deduction on
such provision is accepted. REC and PFC may be most impacted as they do
not make standard asset provision (we have built 25bps in our estimates).
IDFC and HDFC may be relatively less impacted.
Focus on corporate governance and supervision
Firstly, RBI has recommended (1) raising the minimum asset base of
registered NBFCs and (2) ensuring that principal activity forms 75% of total
assets and/or income. In case of large NBFCs, RBI has proposed to (1)
enhance disclosure norms and (2) enhance functions of the board.
ROE gap between NBFCs will widen; HDFC and IDFC are top picks
We believe that the new norms will increase profitability gap among NBFCsthe
ones with better quality of loans and higher core profitability (ROA) will be
able to deliver higher ROE. Our top picks in the NBFC space continue to be
HDFC and IDFC with U-PF on PFC and REC.