The NBFC sector starts the year on a fragile note, with a crisis of confidence and liquidity impacting growth and profitability. Only those firms with strong balance sheets and sound business models will prevail
Uday Kotak, Executive Vice Chairman and Managing Director, Kotak Mahindra, does not see year 2019 beginning on a very positive note for NBFCs. In fact, he opines that the sector is more ‘fragile’ than the previous year.
Kotak has been entrusted with the task of reviving IL&FS which has a debt of more than Rs 94,000 crore. Liquidity conditions in the market have tightened severely since the IL&FS group started defaulting on its payments in August 2018. A number of corporates, mutual funds and insurance firms have invested in some of the debt instruments of IL&FS like commercial paper and non-convertible debentures.
The situation has brought about a huge crisis for NBFCs in India. Another event that further sparked pessimism in the market was the offloading of Rs 200-300 crore worth of commercial paper of housing finance firm DHFL by DSP.
Banks have cut their exposure to NBFCs over the past few months. They are the largest funding source for the sector, accounting for 44% of gross payables in March 2018, followed by mutual funds (33%) and insurance companies (19%).
Moreover, the margins of NBFCs have reduced due to rising interest rates impacting their business model wherein they borrow for the short term and lend for the long term. Pessimism on NBFCs is expected to further keep potential investors away.
The government and the industry were pressing RBI to open a special liquidity window for NBFCs, but the RBI has refused on the grounds that it cannot make such an exception as it will lead to demands from other sectors as well. It has however pumped in Rs 36,000 crore through open market operations in October and further committed Rs 40,000 crore.
NBFCs have a major role to play in the Indian economy, considering that they have progressively moved into the space of commercial banking. They account for 1/3rd of the funds borrowed by Indians. Even when lending from banks slowed down, NBFC loans grew at an increased rate. There were 11,402 NBFCs registered with RBI as of March 2018, with an aggregate balance sheet size of Rs 22.1 lakh crore. Borrowings grew by 19.1% in 2017-18.
Kotak is confident that the sector will ‘weather the current storm’ with consolidations in bank balance sheets and steps to ensure stability. The government’s attempts at bailing out IL&FS could help improve sentiment in the market.
But rising funding costs and tight liquidity conditions will persist in the market for now. Growth rates of 18-20% witnessed by NBFCs over the past five years may be hit at least for the first half of 2019. NBFCs will have to maintain liquidity and try to diversify their risk profile. They need to expand their lending base and also look at new streams of borrowing including retail NCDs besides tapping more banks for funds.
2018 has seen a mini-Lehman in India with the IL&FS imbroglio, which has brought a crisis of confidence and liquidity for India’s NBFCs. Only NBFCs with strong balance sheets and sound business models will survive this period. In that sense, 2019 could be the year that truly separates the men from the boys in the space.