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NBFCs creating liquidity cushion to tide over next few months, says Rashesh Shah 

Bloomberg Quint , Nov 04, 2018

Indiaís non bank lenders are not out of the woods just yet. The next two months will see significant redemption of commercial paper, which non banking financial companies will need to refinance or replace.

Against that backdrop, Rashesh Shah, chairman of Edelweiss Financial Services sees this as a period of Agni Pariksha for the the industry. To get through this, NBFCs have been using bank credit lines, repayments and portfolio sales to garner liquidity. ďPeople are ensuring that every ounce of liquidity used goes towards either creating more cushion or repaying,Ē Shah told BloombergQuint in an interview.

Shah acknowledged that there is liquidity available but called it a ďthreshold levelĒ of liquidity, which may allow repayments but could restrict growth for the NBFC sector. Everyone is holding more cash but it is not getting circulated because for liquidity to circulate it needs confidence in the system, Shah added.

Edited excerpts of the interview below:

Are the next few days very crucial? We hear a lot of CPs (commercial paper) are coming up for renewal. Funds may or may not be inclined to roll over some of these and if that doesnít happen then what happens to system at large?

There is lot of anticipation. Coming three weeks are going to be important. What we hear, see and experience in the market is that most people have made arrangements.

In fact, most of them have got money for November, December, January. They have kept it aside so that even if there is no fresh borrowing or roll over, people will meet their obligations. People have liquidity, assets.

Couple of weeks ago there was a lot of apprehension that there could be another default after IL&FS. That default was the starting point and the entire confidence got shaken up because of it. When it gets shaken up, then you will see everything with a jaundiced eye. Last couple of weeks things have started improving. Banks have been giving lines (of credit), mutual funds are also investing in CPs, the volumes are not back to usual, but we are at 50-60 percent of normal.

Given all of this, I donít see a big dislocation in market. After the next two weeks, investors will breathe a sigh of relief. In a way, I call this as Agni Pariksha for the industry, whether we have our liquidity management, ALM (asset liability management) tools in place to withstand this kind of stress test.

The good ones wonít have an issue but if a bad one is not able to fulfill its obligations, then it would become a system wide issue?

It could. But RBI, SEBI and government, everybody is on top of it. Because this is the hottest topic. I was talking to someone in the government and he said that he gets up in the morning and sees how much CPs are going to get redeemed in the day and he goes that night seeing how much CPs had got redeemed. So,the government, the RBI and SEBI are acutely aware. Currently, the feeling is there is no systemic weakness which will force somebody to default. That is the assumption.

I think that liquidity arrangements have been made and it has been made sure that the whole system doesnít see contagion and dislocation. That is hopefully the good news. People are watching. Analyst, fund managers, everybody has studied everybodyís liquidity...The current consensus is that there should not be an accident.

What is the recourse being used with markets still not back to normal? Is it bank funding lines?

There are three-four sources of liquidity. One is replacement where you redeem your commercial papers and you draw bank lines. The other is that most of the NBFCs also gets customer repayment every month. Because the customers are also paying money, interest, repayment and EMIs, which are coming every month. People are also using that for liquidity, they also have that liquidity cushion. People used to maintain undrawn credit lines, cash on hand. Fourth is, people are selling portfolios which anyway were getting securitized and sold to banks, especially the priority sector.

Combination of all these have allowed people to raise the liquidity that they needed. For instance, at Edelweiss, we always maintain a liquidity cushion which is about 10-12 percent of our borrowings. So, you always have that liquidity cushion for a rainy day. It is expensive to maintain a liquidity cushion. So, you have your liquidity cushion, your customer inflows that you are getting, you also have some assets that can easily be sold to banks who are buying.

In the first half of the year, banks bought about Rs 64,000 crore worth of portfolios from NBFCs. I think, in second half, banks will buy another Rs 75,000-80,000 crore worth of portfolios. So, that will also release liquidity. Liquidity has come from various sources and some rollovers have also happened.

All of this has allowed the liquidity to continue but not in a comfortable way. So, people are ensuring that every ounce of liquidity goes towards either creating more cushion or repaying. The good news is that the industry has managed it well until now. Industry has managed liquidity from the multiple sources. This is a good Agni pariksha which everyone is going through right now.

Then why is the industry up in arms saying that more needs to be done from the RBI and government side?

You must understand this in nuanced way. It is not very binomial thing. Are things back to normal? Then the answer is no. When you get customer repayment, you are using that to repay your obligation. But are you giving fresh loans? When you sell your portfolio to a bank, at a system level you have not created new credit. The bank has grown its credit book when they are buying the assets.

Everybody is holding more cash. We are all sitting on a lot of cash. If everybody holds cash, then there is liquidity in the system, but it is not getting circulated because for liquidity to circulate it needs confidence in the system. So, it is a nuanced thing. Is there enough liquidity to meet obligations? Then, yes. But is there liquidity so that the economy is getting credit?

In the last four-five years, the banks were cleaning up their balance sheets. As a result, the banking credit growth was 8 percent per annum. Our nominal GDP growth is 12-13 percent per annum. So, we need 14-15 percent growth in credit every year just for the economy to continue growing. The banks were growing at 8 percent, the NBFCs were growing at 20-22 percent. So, if you take the weighted average between NBFCs and banks, we were managing 12-13 percent growth at system level.

NBFC growth may slowdown because of liquidity. Banks have stepped up. A lot of areas where NBFCs were giving credit, banks donít have the reach. So, overnight banks canít create the ability to reach out to SMEs, micro finance. So, the system credit has slowed down. Along with that there is a liquidity crunch in the system as a whole which everybody is experiencing.

While you can manage your obligations, managing to pay obligations is a threshold requirement. On top of it, the economy needs to continue growing. If it is going to grow at 12-13 percent a year, credit has to continue to move, everybody has to stop hoarding cash because everybody is hoarding cash. From now to March, people donít know the liquidity situation.

So you need confidence that if the liquidity is going to be there at least 80 percent of what it was, then people will at least start rotating the money. The velocity of money will come back. That is a larger crisis. It is not either or.

Over the years, the market moved from banks to NBFCs as banks were not able to lend because of burden of NPAs. It remains to be seen that whether banks can come and take that market back from NBFCs now...

I agree, but things are not either/or.

The banks were growing at 8 percent and NBFCs were growing at 22 percent. So, NBFCs come down to 15-18 percent, banks come up to 11-12 percent. There are areas where banks will replace NBFCs but there are areas where banks will still give money to NBFCs. You look at micro finance, SME credit, home loan products to self-employed individuals. Lot of NBFCs have built expertise in it.

NBFCs also bring equity to the table. Today, when a bank gives a loan to the NBFC, the bank will keep aside some equity for it. When bank gives a Rs 1,000 crore loan to an NBFC, the bank will keep Rs 100 crores aside as its equity capital adequacy. When the same Rs 1,000 crore credit is given to SME customer, the NBFC puts another Rs 150-180 crore equity aside. So, banks lending through NBFCs to end-customer, there is a double layer of equity which goes in which makes the system very safe. The same portfolio, if bought by banks, then there is only Rs 100 crore of equity and Rs 150 crore of equity is released. So, by adding NBFCs to the chain, you are also adding NBFCs risk capital to the chain.

The growth rate will be synchronized. In a way, it is good way for re-balancing the economy. Ideally, it should happen in a gradual process rather than things freezing up and then panic.

There are lot of articles around how the industry wants more liquidity coming from RBI. If RBI continues doing what it is doing right now,is it a question of survival for certain NBFCs or is it the question of growth not being at the same pace as it used to be?

The problem with liquidity is it is never static. It is either going up or down.

If the sense of caution and hoarding cash goes on till January, February, March, April, then ultimately there will be an economic price to it. There will be a slow down. Then the risk of default goes up. So, it should not continue for a long time. There is liquidity which is required. Global liquidity is getting tightened as U.S. dollar is getting stronger, FIIs are pulling money out of EMs and there is a tightening. On top of it, when the rupee was falling, RBI intervened in the market. The RBI sold dollars and brought back rupees. The entire system is operating in a deficit mode of liquidity. Because of this, everybody starts holding more cash.

We are hoarding more cash now than we were holding a month ago. We are keeping cash in banks, but it is not getting circulated. As we learnt in economics, that it is not just liquidity but velocity of money, the multiplier effect which gets created. We need to unlock the system, we need to inject some liquidity so that there is flow of money. It will not go back to 100.

The rebalancing between banks and NBFCs will continue to happen. I donít think NBFCs will grow at the pace which they grew. Banks will take over part of it. The rebalancing should happen in gradual way so that there are no accidents. If the liquidity remains so tight, it is bad for economy as a whole.

There is trust element to that velocity. IL&FS created a trust issue. That will resolve over time. Call money market rates donít suggest there is a liquidity shortage at a system level.

Call rates have not moved because banks are flush with cash. But the cash is not getting circulated.

It is a trust issue but how do we unlock it? Time is one. But it is like saying that when I fall ill, time will cure it. But sometimes you need antibiotics. Time will clear things up, but the liquidity injection will make it easier to cure itself. It gets cured easily if there is more liquidity. In a tight liquidity situation, everybody is holding cash and thatís why call money rates are not going up. Nobody is borrowing money because there is no use of money for lending. But it is not good for the economy. If the system is frozen like this, the risk of something going wrong will go up.

We donít know the future. In the last two weeks, we have seen a clear improvement. Hopefully, after 4-5 weeks when commercial papers redemption happens, the trust will start coming back. But there is risk that if there is any dislocation again, then it will be much harder one to fix.

What about the asset quality within the system? There are some serious fears about books that have exposure to real estate, loan against securities...

There is fear in the market and it anticipates. Because of the IL&FS issue, there is a trust deficit. Everybody wants to imagine what will go wrong.

Do you think it is just imagination?

No. Everybody wants to imagine what can go wrong. It is hard to say. You can argue that any part of the credit system, whether it is the MFI, SME, real estate, home loans, or any one of them and there are enough arguments for each one to say that if the home loan market is tight, if interest rates are going up, EMI payments are going up, there could be more NPAs in it. It could have more NPAs in SME because SME also needs circulation of money all the time. The MFI industry works on making sure that the small entrepreneurs or small borrowers keep on getting money. If you take that money away, then will the defaults go up?

Same thing on real estate. There are lot of projects which need financing for completing the projects. Idea is to look at it in a holistic way. We donít know what will happen. Real estate, loan against shares, already the market has fallen. You can imagine the pain by looking at individual books like how much loan they have, how much cushion they have, the risk management systems they have.

But if a housing project is under construction and if it gets completed, it will get sold because the underlying economy is there. The sales are happening, people are buying homes. India, even in worst crisis of 2012-14, about 2-2.5 million houses were bought every year. In first half, the home loan sales have gone up. October was a good month for home sales. Home loans are also available. Banks are giving home loans. HDFC, PNB housing are still giving home loans. So, home loans are available, demand of homes is there. If one project gets completed, it wonít become an NPA. If the other is struggling to get money or if it has some other issue, it will become an NPA. That will not happen to the sector as a whole but project by project. In infra projects too, some have got completed and some infra projects didnít get completed. But does it mean all infra project become NPAs? Then, no.

If NBFC growth slows down, which segment will the growth slow down for?

If people are not doing fresh real estate loans then the new projects will not happen. But even 80-90 percent of real estate loans are all for housing projects. Housing projects are good as there is an end user demand. It is a self-liquidity asset. Unlike infrastructure projects, even if I complete the road there is no liquidity at the end of it. In an apartment building, if it is completed there is liquidity at the end where the people will buy. For last five years, the prices have not gone up. In fact, it has come down by 8-10 percent and there is inflation. In real terms, the prices have corrected.

Overall, it wonít be in a particular sector as a whole but it will be very tactical. People will rebalance their books. I donít think it will be a huge change. For next one year, NBFCs will recalibrate their growth rates and banks will step in. But ultimately the economy has to work. I always believe that if there are good borrowers, in India, the credit should come in some form or the other. For NBFC and banks, for good borrowers, we have enough credit availability.