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Event update: Financials - Liquidity circular for NBFCs; Most large NBFCs carry a comfortable liquidity buffer

To ensure adequate liquidity in the NBFC sector at all times, RBI has issued a draft circular. The two key proposals are that 1) all systematically important NBFCs will now have to maintain a liquidity cushion (liquidity coverage ratio / LCR) equal to 30 days of net cash outflows. The liquidity buffer should be in the form of highly liquid assets. 2) RBI has granulized the 1-30 day maturity bucket into 3 buckets of 7 days. The maximum mismatch allowed is 10% for 1-7 days, 10% for 8-14 days and 20% for 15-30 days against the earlier norm of maximum 15% mismatch for all buckets upto 1 year. RBI has sought feedback on these guidelines by June 14.

Applicability: Non-deposit taking NBFCs with asset size of INR 1 billion and above, systemically important Core Investment Companies and all deposit taking NBFCs shall adhere to the guidelines. The internal controls required to be put in place by NBFCs as per these guidelines shall be subject to supervisory review. Further, as a matter of prudence, all other NBFCs are also encouraged to adopt these guidelines on liquidity risk management on voluntary basis. We expect NHB to come out with similar guidelines for HFCs soon.

100% LCR over 4 years: The guidelines require banks to maintain 100% LCR in a phased manner over 4 years starting with 60% on April 1, 2020 and moving up by 10% to 100% by April 1, 2024. (Banks are required to maintain 100% LCR already). The liquidity cushion should be equal to the total net cash outflows for the next 30 days and should be invested in highly liquid assets. Total net cash outflows over the next 30 days = 115% of total outflows  minus 75% of total inflows.

Impact - Theoretically LCR is negative on NIMs, but most large NBFCs already have liquidity cushion: Theoretically the LCR requirement should lead to NIM pressure for NBFCs based on their asset maturity. The longer the duration of assets, the greater the impact. Gold loan companies and micro finance companies have shorter product durations and will be less impacted than others. CV and vehicle financiers have longer product durations of 3-5 years and would be more impacted. While housing finance companies are not covered by these guidelines, they will be the most impacted as their asset maturity is the highest at 7-8 years. This is the theoretical impact.

In practice, most large NBFCs have already started maintaining a liquidity buffer since the liquidity crunch started in September 2018 and may not be impacted materially by this guideline. NBFCs we spoke to already seem to be having a liquidity cushion. The liquid assets included in the liquidity buffer may not exactly match RBI requirements but can be easily converted to meet the requirements – for instance liquid mutual funds which are not specifically mentioned as being high quality liquid assets by RBI can be converted to g-secs without haircuts. MMFS, STFC, Bajaj Finance, CIFC already have a month or more of liquidity cushion. MMFS has a liquidity cushion of Rs20bn (AUM size 671bn), Bajaj Finance has Rs70bn of cash and cash equivalents (AUM size 987bn), CIFC has a liquidity cushion of Rs30bn to meet maturities over next 3 months (AUM size 543bn). Edelweiss Finance also has strong liquidity because the CDPQ funds have come in.

Similarly among HFCs, HDFC generally carries a liquid balance sheet (has liquidity buffer of Rs150bn). Indiabulls Housing has also publicly talked about carrying a comfortable liquidity cushion.

So as of now, these guidelines will be negative for NBFCs that are already facing a liquidity crisis, others should be fine. The only risk will be the risk of MTM on g-secs which will be part of the liquidity cushion. The big negative impact will be on HFCs when NHB comes out with a similar circular. DHFL and other not-so-highly rated HFCs will be badly impacted.

ALM guidelines less stringent than expected: The expectation was that the ALM mismatch would be tightened to 5% from the current 15%, so tightening of mismatches to 10-20% is less stringent than expected.

Real risks to NBFCs: For most well rated NBFCs, the cost of funds has come back to the pre-crisis levels which are positive. However longer-term funds of over 2 years are not easily available. Availability of long-term funds is one risk for NBFCs. The second and bigger risk is if one of the stressed HFCs / NBFCs default. That will again lead to a spike in marginal cost of funds and drying up of liquidity for the NBFC sector. We expect fundamentals to remain strong for MMFS, HDFC, CIFC, Bajaj Finance. ​