The Non-Banking Finance Companies (NBFC) sector is an integral part of Indian Financial System, providing large infrastructure financing to small microfinance, while innovating over time to address the debt requirements of every segment of the economy. For a large and diverse India, the NBFC is a key contributor to the financial inclusion program. The sector has evolved from being fragmented and informally governed to being well regulated and in many instances, adopted best practices in technology, innovation and risk management as well as governance. NBFCs in India have recorded marked growth in recent years.

There were 9,642 NBFCs registered with the Reserve Bank as on September 30, 2019, of which 82 were deposit-accepting (NBFCs-D) and 274 were systemically important non-deposit accepting NBFCs (NBFCs-ND-SI). NBFCs operate through a network of 28,878 branches spread across the country. NBFCs-D and NBFCs-ND-SI are subject to stricter prudential regulations such as capital adequacy requirements and provisioning norms along with reporting requirements.

NBFCs witnessed stress in their asset quality during H1 of 2019-20. The gross NPA ratio of the NBFC sector increased from 6.1% as at end-March 2019 to 6.3% as at end-September 2019. The net NPA ratio, however, remained steady at 3.4% between end-March 2019 and end-September 2019. As at end-September 2019, the CRAR of the NBFC sector stood at 19.5%, lower than 20% as at end-March 2019.

While the importance of NBFCs in credit intermediation is growing, the IL&FS episode brought the focus on the asset liability mismatches of NBFCs, which poses risks to the NBFC sector as well as the financial system as a whole. To address such concerns, the Reserve Bank introduced the liquidity coverage ratio (LCR) requirement for all deposit-taking NBFCs and non-deposit taking NBFCs with an asset size of Rs 5000 crore and above (constituting 87% of the total assets of the NBFC sector). The new regulation mandates NBFCs to maintain a minimum level of high-quality liquid assets to cover expected net cash outflows in a stressed scenario. NBFCs are required to reach a LCR of 100% over a period of 4 years commencing from December 2020.

Benefits for affordable housing: Additional tax breaks for construction of affordable / low-cost housing units should further boost loan demand in the affordable housing loan segments. Speedy implementation of ‘Housing for all' would be positive for housing finance companies. 

Credit flow to MSME: The budget may focus on improving credit flow to MSME (Micro, Small & Medium Enterprises). Allocation towards MUDRA scheme - interest subvention for MSMEs to further aid small and medium entrepreneurs may be enhanced. This will help financial inclusion into the country aiding the MSMEs to finance their business needs and NBFCs to improve their credit offtake.

Hike in NHB refinancing limits: NHB refinancing limits for housing finance companies may be raised to help housing finance companies to lower their cost of funds and improve business.

Liquidity support for NBFCs: The crisis in the NBFC sector adversely affected the liquidity condition in the economy. While steps have been taken by the RBI and the government to resolve the liquidity problem, there is a need to take steps towards strengthening the financial system in entirety by addressing the structural problems.

Incentives for digital transactions: The government has continued to provide significant support for digital transactions, while further supports are expected in budget. This would promote the use of technology, while providing operating leverage to the banks. Greater incentives for digital payment would be positive for the finance sector as it would boost efficiencies in cost structures.

Refinancing of Small and Medium NBFCs by MUDRA: Small and Medium size NBFC which constitute more than 90% of the sector in numbers are totally dependent on banks for fund raising as they do not access capital market or external borrowings. For them, availability of refinance is a major need MUDRA is required to provide refinance to small NBFCs.

A direct liquidity window from RBI for NBFCs: RBI has come out with Draft Guidelines on ‘Liquidity Risk Management Framework for NBFCs and Core Investment Companies'. It is important to have a broader framework that would enable NBFCs to tap funds from RBI against their High-Quality Liquid Assets during periods of stress.

Key stocks to watch

HDFC, LIC Housing Finance, L&T Finance Holding, Bajaj Finance, Shriram Transport Finance

Outlook

The NBFCs sector has always been expecting budget to provide more and more parity with the banking system. The NBFC sector would also watch for benefits for housing and MSME sectors. More importantly, the sector has witnessed some improvement in liquidity conditions, while the sector is awaiting further measures on liquidity support for NBFC sector from the budget.