Reduce excessive reliance on short-term wholesale papers: RBI
MUMBAI: The Reserve Bank of India (RBI) is likely to tighten the Commercial Paper (CP) regime – the biggest contributor to the asset-liability mismatch malaise that inter alia has played a key role in downing the fabled IL&FS, according to market leaders.
Dr Viral Acharya (seen in the picture), the deputy governor of the Reserve Bank of India (RBI) urged all financial firms to place greater reliance on equity and other modes of long-term financing for funding of long-term assets rather than relying excessively on short term wholesale paper.
“Chasing lower marginal cost of funding in order to retain or acquire market share in lending is a myopic strategy,” Dr Acharya said adding that it is best to avoid this in order to safeguard financial firms’ own balance sheet as well as the overall financial stability.
Another deputy governor of RBI, NS Vishwanathan also flagged the danger in the short-term nature of the funding base that is used to build long-term asset book by NBFCs.
The last couple of years saw the rapid growth of NBFCs when they used diverse sources of funds for their expansion, and in the process they tapped the market, and some of them moved into market borrowing in the form of CPs, and this has led to asset liability-mismatches especially for those who were active in the financing of long-term assets like infrastructure.
“So now we are planning to strengthen them so that they can avoid the roll-over risk,” said Vishwanathan.
With the long-term fund becoming a ‘scarcer material’ to access for the financial services industry in general, and particularly for NBFCs, deploying short-term funds to finance long-term projects has become a rule rather than the exception in the lending space.
And to fill this gap, most NBFCs have been relying on short-term instruments like CPs also. Many deploy such short term funds with the comfort of credit lines they enjoy from banks as backstops and this allowed them to enjoy the interest rate arbitrage, albeit for shorter periods.
“But, with disruptions taking place in these arrangements with the banks, the whole asset-liability management goes into a tailspin as has happened in many cases,” said financial controller of a Kerala-based NBFC.
“The short-term funds pose significant rollover risk in the medium term and this practice appears to have led to a form of maturity rat race in financing in the sector,” the top RBI official noted while elaborating on the risks of growing asset-liability mismatches in the financial services industry.
The recent liquidity crisis was triggered when IL&FS defaulted on payment obligations to the tune of thousands of crores of rupees on short-term and long-term borrowings. This was followed by downgrades by credit rating agencies in the past two months.
On September 17, the domestic rating agency ICRA downgraded IL&FS’s credit rating to default, after it failed to meet repayment obligations of Rs12,000 crore.
RBI reminded that the increasing mismatch in this manner can be a particularly imprudent policy in the time of global and domestic tightening conditions.
Referring to the IL&FS debacle that not only shook the NBFC industry but drained several trillions of rupees from the country’s capital markets, Dr Acharya also said the central bank along with the government of India and SEBI have been closely monitoring the situation now.
NBFCs play an important role in meeting the credit needs of the economy, especially the informal sector. Noting that the regulatory framework for NBFCs is strong, Vishawanathan said the capital to risk weighted assets ratio (CRAR) for the sector is as high as 15 per cent and moreover they have high density of 100 per cent risk-weighted assets as NBFCs as a class have not been allowed differentiated risk weighting of assets as in the case of banks.