Lifeline for NBFCs: RBI nod to banks to back their bonds

MUMBAI: The Reserve Bank of India (RBI) has moved to help housing finance companies and large non-bank lenders refinance their short-term borrowing by allowing banks to guarantee their debt.

The relaxation comes at a time when nearly Rs 50,000 crore of commercial papers and another Rs 50,000 crore of bonds issued by finance companies are coming up for redemption and investors have turned cautious in respect of extending fresh loans. The default in infrastructure lender ILFS has highlighted how some companies are funding long-term assets with short-term liabilities.

The RBI has allowed banks to provide guarantee to up to 20% of a bond issue subject to the guarantee amount not exceeding 1% of the bank’s capital funds. “It has now been decided to allow banks to provide partial credit enhancement to bonds issued by the systemically important non-deposit taking non-banking financial companies and housing finance companies,” the RBI said in a circular to banks.

The fear that finance companies could default had led to prices of these bonds falling in the secondary market. As a result, yields have risen by almost a percentage point, making it more expensive for finance companies to borrow.

While the RBI has allowed banks to provide guarantees, it has also tried to nudge finance companies towards longer-term instruments. One of the conditions for the guarantee was that they would be in respect of bonds with a minimum duration of three years.

When a bank provides a guarantee to a finance company, the investor recognises the counter-party risk as that of a bank. Consequently, even those investors who do not have the risk appetite to put money in finance companies will be willing to invest in these bonds, which typically offer higher returns than that by banks.

The Confederation of Indian Industry (CII) has called for a coordinated approach among various regulators, stating that the financial sector is deeply interlinked. “Such a coordinated front would include key players in the regulation of the financial sector, that is, the RBI, Sebi, IRDAI, PFRDA and of course the government,” said Rakesh Bharti Mittal, president, CII.

Currently, mutual funds have sectoral limit on investment in NBFCs up to 25% of the assets under management of the particular scheme and investments in housing finance companies can be an additional 15%.

“Considering the inherent risk profile of NBFCs and HFCs, such investment norms are increasing the risk exposure of mutual funds. Therefore, CII’s first recommendation is for the RBI and Sebi to come out with a road map to reduce the exposure of mutual funds to NBFCs and HFCs from 40% to 25% in graded tranches,” the CII statement said.

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