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Funding costs for the larger Indian non-bank financial institutions (NBFIs) could rise after the guidelines on securitization and direct assignment of loan receivables were released by the Reserve Bank of India (RBI) earlier this week.
The guidelines may force NBFIs to virtually abandon the popular "direct assignment" route that has accounted for 10%-40% of their funding, and move to more capital-intensive securitization deals or more costly senior debt.
The guidelines come at a time when other regulatory tightening may result in a slowdown in the flow of funds from the traditional sources - commercial banks and debt mutual funds. It may consequently be difficult for NBFIs to maintain their above-average loan growth compared with the banks, and instead force them to maintain greater liquidity on their balance sheets in the face of weaker funding flexibility.
The heaviest impact could be on Shriram Transport Finance Co. Ltd. ('Fitch AA(ind)'/Stable) and Magma Fincorp Ltd., whose off-balance sheet assets were 34% and 40%, respectively, of assets under management at end-March 2012. The effect on reported ROA and Tier 1 capital ratios could be significant, assuming that the off-balance sheet assets ultimately migrate to the originator's own books.
Shriram Transport's adjusted Tier 1 capital ratio and adjusted ROA at end-March 2012 remained comparable with its similarly rated NBFIs, which explains the Stable Outlook on its rating. Magma Fincorp's reported ROA fell steeply in FY12 to 0.9%, from 2.2% in FY11, after it stopped front-loading the profit from direct assignments.
The other large "asset financing" NBFIs are less reliant on off-balance sheet funding, and should therefore suffer less of an immediate impact. However, the reduction in funding flexibility for the sector would still affect all players in the long term. Many of these companies have licences to accept public deposits, and may step up their reliance on this source.
NBFIs may react to this new era of lower profitability by searching for higher-yielding loan segments.This strategy may be fraught with greater-than-anticipated risks, given that such segments may not have a credit track record or well-established cash flows. The larger NBFIs in India, however, have a history of managing the traditionally riskier customer segments, and maintaining steady credit costs through business cycles.
NBFIs' dependence on wholesale funding has been a traditional weakness, partly mitigated by matched-funding of assets and also a widening creditor base among banks and capital markets participants. This was facilitated by the steady asset quality and (in the case of banks) attractive regulatory benefits of meeting lending targets to weaker sections of the economy (the "priority" sector).