August 26, 2019
Business

New RBI guidelines are a shot in the arm for NBFCs

Indeed, as will be seen in the calculation given below, interest rate for rated NBFCs is expected to fall by at least 50 basis points, or 0.50 percent. For the financially stronger banks enjoying a lower cost of capital, the savings in cost and reduction in interest rates would be lower, whereas for weaker banks with higher cost of capital, the said reduction would be higher. For example, if the cost of capital is 5 percent, the minimum rate reduction would be 0.38 percent and if the cost of capital is 8 percent, the interest rate reduction would be a minimum 0.60 percent.

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Sample calculation: In this sample case, even when the banks reduce their lending rate by 1 percent, the Risk‐Adjusted Return on Capital increased to 30 percent from 18 percent. The calculation below shows that due to significant savings on the capital front, bank would be able to make a higher return even at a much lower interest rate.

Scenario Earlier Now
Borrowed Amount 100 100
Lending Rate 12.00% 11.00%
Cost of Fund for bank 10.00% 10.00%
Spread Charged by bank 2.00% 1.00%
Risk Weight 100.00% 30.00%
Capital Required 10.88% 3.26%
Risk Adjusted Return on Capital 18.39% 30.65%

When risk weights were uniform at 100 percent, the better-rated NBFCs were deprived of their just rewards for achieving better asset quality and following prudent risk management practices. This change by RBI will not only reduce the cost of borrowing for such better-rated entities, it would also allow capital constrained PSU banks to lend more to the sector.

At the same time, unrated large NBFC-CICs having aggregate exposure from banking system of more than Rs.200 crore would now attract 150 percent risk weight against earlier risk weight of 100 percent. The large unrated NBFCs now have a solid incentive to improve their game and get themselves credit rated at the soonest. Clearly, this is a well-intended measure but it does impose a higher borrowing cost in the period of transition to credit rating.

 

 

To conclude

There are several existing anomalies pertaining to NBFC regulations which need to be addressed by the policy makers to unleash the growth engine of small and micro sectors, who primarily depend on NBFCs for their credit requirement. With these latest measures, the RBI has addressed some of the long standing demands of NBFCs. We now look forward to the RBI taking more such steps to enable NBFCs to reach their true potential.

Author:

(V.P. Nandakumar is MD & CEO of Manappuram Finance Ltd. Views are personal)

Photo Courtesy : Google/ images are subject to copyright

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