Shadow banking in India stirs concerns

Recent defaults have deepened concern over mismatched asset-liability durations in non-banking lending.

Fears that non-bank financial companies (NBFCs) are continuing to mismatch asset-liability durations have deepened, with a Mumbai-headquartered infrastructure development and finance company having defaulted recently.

The Indian firm, Infrastructure Leasing & Financial Services (IL&FS), disclosed from 17 September onwards that it had failed to meet a series of interest payment  and had not serviced its debt obligations.

The firm has released statements regarding a resolution plan and its implementation process, which is in line with orders from the National Company Law Tribunal in Mumbai to replace board members of the firm and those on IL&FS subsidiaries.

ICRA, a Moody’s-affiliated credit rating agency, released two credit reports after assessments during August and September on  IL&FS, which signaled a deteriorating long-term credit rating of the group to ‘[ICRA]BB’ from ‘[ICRA]AA+’.

A further drastic downgrading of the firm’s creditworthiness was seen among other credit agencies, to ‘D’ from ‘BB’, in just over a week, according to four reports provided by India Ratings and Research, a subsidiary of Fitch Group, from 11 September to 18 September. The rating agency’s latest report shows that IL&FS held a long-term credit rating of ‘AAA/ Stable’ on 27 November 2017.

PDI’s requests for comment on the state of the resolution plan to IL&FS were not returned by publication time.

Institutional investors in non-bank lenders have spotted an issue relating to duration risk, which is seen as an inherent aspect of NBFCs’ lending practices.

Mark Konyn, group chief investment officer at AIA, a Hong Kong-headquartered insurance company, said at the FT-AIIB Summit 2018 in Hong Kong on Tuesday that the latest example exposes a problem of mismatching the underlying term-structure.

“In the past, most of our participation has been through a corporate bond issuance or equity [commitment] around a project, rather than direct lending,” Konyn noted, adding that, “I feel that the banks pulling back in long-term lending to a large extent, …, there will be more opportunities for long-term investors. But critically, matching the underlying assets and liabilities is a key concern, of course.”

An industry source who is familiar with NBFCs in India told PDI that it is not a good thing to the industry participants whenever a large institution like IL&FS goes through a crisis. However, he thinks that it is a positive sign that the government acted on the distressed situation decisively to make sure to organize a resolution process and implement it.

In fact, the Reserve Bank of India (RBI) categorises NBFCs into two types based on their liability structure: NBFCs-D (Deposit-taking NBFCs), NBFCs-ND (Non-deposit taking NBFCs).

As per RBI’s sub-classification criteria based on systemic importance and asset size of an entity, the regulatory body also distinguishes NBFCs-ND-SI (Non-deposit taking systematically important NBFCs), and Other NBFCs-ND (Other non-deposit taking NBFCs). Those with an asset sized over five billion Indian rupees ($68.2 million; € 59.9 million) are considered as systematically important.

At end-March 2017, there were 11522 NBFCs registered with the RBI, of which 220 were NBFCs-ND-SI and 178 were NBFCs-D, according to the latest report from the central banking institution, Report on Trend and Progress of Banking in India.

Notably, NBFCs’ credit to the infrastructure sector has shown a robust growth, especially credit by NBFCs-infrastructure finance companies (NBFCs-IFC). This is in line with the infrastructure financing companies’ mandate as they have to deploy at least 75 percent of their total assets in infrastructure loans.

The NBFCs-IFC constitute as much as 40 percent of credit extended by NBFCs-ND-SI, according to the RBI report.

IL&FS is registered with RBI as a systemically important non-deposit accepting core investment company, which means the firm lends to and invests in IL&FS’s group companies.

Among infrastructure project developers, Sumant Sinha, a chairman and managing director of ReNew Power, a Gurugram-headquartered renewable energy producer in India, argued that the recent default of IL&FS is ‘a one-off situation’ as they do not see much of the distressed signs among its peer in the infrastructure sector.

“Because once a project is signed up and financed, they (infrastructure developers) are normally able to finance their debt,” Sinha added, speaking at FT-AIIB Summit 2018.

NBFCs’ credit growth was 14.9 percent year-on-year as of end-March 2017, about seven percentage point higher than that of the previous year as against bank credit growth of 6.2 percent in the same period, the report shows.

As NBFCs have played a role in the credit expansion of the country’s capital market, the regulatory environment of NBFCs has turned to a new phase. Now that the RBI has adopted Basel III, aiming to improve the capital framework and liquidity ratios, it has also been aligning the regulatory and supervisory frameworks for NBFCs.

Shobhit Agarwal, a managing director and chief executive officer at Anarock Capital, said in a statement that the liquidity crisis plaguing NBFCs is likely to hit stake sale and fund-raising plans for these lenders in the near term now that NBFCs are struggling and their loan disbursals to developers have slowed down significantly as of 23 October.

Despite the environment, insurance firms, including AIA, are exploring lending opportunities in the NBFC market. “It is an early stage for us in terms of exploring lending opportunities in the NBFC market, but we are currently discussing on various projects,” added Konyn, AIA’s group chief investment officer.