The RBI recently allowed banks to provide partial credit enhancement (PCE) to bonds issued by systemically important non-deposit taking NBFCs registered with the RBI and Housing Finance Companies (HFCs) registered with the National Housing Bank.
Provide partial credit enhancement or Credit enhancement means improving the credit rating of a corporate bond. For example, if a bond is rated BBB, credit enhancement, which is basically an assurance of repayment by another entity, can improve the rating to AA. This is done to provide an additional source of assurance or guarantee to service the bond.
The move comes at a time when NBFCs and HFCs have requested the government and regulators to ensure that confidence returns to the market.
FACT: Provide partial credit enhancement (PCE), which was introduced in 2015, is expected to help NBFCs and HFCs raise money from insurance and provident or pension funds who invest only in highly-rated instruments.
Current problems with NBFCs | UPSC – IAS
Multiple regulatory bodies: RBI doesn’t regulate all the NBFC. Other institutions such as NHB (National Housing Bank), SEBI, Insurance Regulatory and Development Authority (IRDAI), etc. are also involved depending on the type of NBFC.
Difficulties in access to credit
There is a reversal of interest rate cycle as interest rates are now going up both domestically and also in the
international market. The RBI has steadily hiked interest rates in the recent months.
Another fundamental issue is the asset-liability mismatch in the operations of NBFCs as these firms borrow funds from the market — say for 3 or 5 years — and lend for longer tenures — 10 to 15 years. It has led to a situation where the NBFCs are facing a severe liquidity crunch in the short term.
The mutual fund is among the biggest fund provider to NBFCs via commercial papers and debentures. These investors are getting reluctant to lend post the IL&FS crisis.
(UPSC IAS)
Riskier Lending Pattern:
Unlike banks, NBFCs are less cautious while lending. For example NBFCs have grown their portfolio of small and micro loans in a big way where there are risks of lack of credit history, scale and historically high NPAs.
The unsecured loan segment is also on the rise in the NBFC segment.
Cascading effect of Infrastructure Leasing and Financial Services (IL&FS) default: Default followed by downgrade of IL&FS recently has created a liquidity squeeze for the entire non-banking financial company (NBFC) sector.
Delayed Projects: Many infrastructure projects financed by NBFCs are stalled due to various reasons like delayed statutory approvals, problems of land acquisition, environmental clearance, etc. which has impacted their financial health.
Suggestions and Solutions | UPSC – IAS
RBI must encourage non-banking financial companies to securitise their assets that can be purchased by banks.
RBI must revisit lending restrictions placed on banks under Prompt Corrective Action and consider allowing them lending to NHB.
RBI may also open special window for mutual funds to get refinance against collateral.
A coordinated and consultative approach at this point of time to address the various problems of the sector is critical to national economic health and stability.
Keywords: Provide partial credit enhancement (PCE), NBFCs, RBI, UPSC IAS
