Analysis: India's shadow banking sector likely to face shake-up after default

Capri Global Capital

28/09/2018 06:47

* Small shadow banks with low capital likely to be ousted
    * Banks, bigger shadow banks likely to buy out small players
    * Shadow banks need to tackle asset-liability mismatch-
expert

    By Krishna N. Das and Neha Dasgupta
    NEW DELHI, Sept 28 (Reuters) - India's burgeoning shadow
finance sector is likely to face a shake-up after defaults at
one major lender battered the nation's financial markets in the
past week and reinforced worries about credit risk.
    Industry officials and experts say they expect Indian
regulators to cancel the licences of as many as 1,500 smaller
non-banking finance companies because they don't have adequate
capital, and to also make it more difficult for new applicants
to get approval.
    The Reserve Bank of India (RBI), which has been tightening
rules for non-banking financial companies (NBFCs), did not
respond to requests for comment.
    Better capitalised and more conservatively run finance firms
are likely to swallow up an increasing number of smaller rivals,
the experts said. That could make it difficult for many small
borrowers to get loans, especially in the countryside where
two-thirds of India's 1.3 billion people live, and put the
brakes on a surge in private consumption with a knock-on effect
on growth. urn:newsml:reuters.com:*:nL4N1WB1YC
    Infrastructure Financing and Leasing Services Ltd (IL&FS)
 ILFS.UL , a major infrastructure financing and construction
company, sent shockwaves through the NBFC sector when it
defaulted on some of its debt obligations in recent weeks.
 urn:newsml:reuters.com:*:nL3N1W804S
    Then last Friday, a large fund manager sold short-term bonds
issued by home loan provider Dewan Housing Finance  DWNH.NS  at
a sharp discount, raising fears of wider liquidity problems.
 urn:newsml:reuters.com:*:nL4N1WA21K
    "The way things are unfolding, there is certainly cause for
concern and the sector could see consolidation," said Harun
Rashid Khan, a former deputy governor at the RBI and now a
non-executive chairman at Bandhan Bank Ltd  BANH.NS , formerly a
microfinance company specialising in small-value loans.
    "The whole issue is they have to take care of their
asset-liability mismatch," Khan said in reference to concerns
that some of the firms have borrowed short-term when their
revenue streams are longer-term.
    The spotlight has now been turned on thousands of
"high-risk" small players dominating lending in villages and
towns.
    The shadow banking sector now comprises more than 11,400
firms with a combined balance-sheet worth 22.1 trillion rupees
($304 billion), and is less strictly regulated than banks. It
has been attracting new investors, particularly as the nation's
banks have had to slow their lending as they seek to work
through $150 billion of stressed assets.
    The NBFC loan books have grown at nearly twice the pace of
banks, and the cream of them, including IL&FS, had received top
credit ratings.
    Those credit ratings are now being called into question -
IL&FS has suffered a series of downgrades in recent months - and
there are growing concerns that many of these firms took on
excessive credit risk by lending to people with little means of
paying them back. There are also growing questions about whether
lax regulation has allowed some of these firms to be used for
money laundering. 
    
    WINNOWING OUT
    Rising borrowing costs, exacerbated by the turmoil in
markets in recent days, will lead to a credit crunch in the
sector and make it difficult for firms that aren't well
capitalised to survive, according to top investors in the
sector.
    "Smaller NBFCs will face the problem of cost, their quantum
of liquidity may not be the same as they are getting now. But
medium and large-sized NBFCs should be able to achieve their
volume as well as access to funds," said Rajesh Sharma, owner of
Capri Global Capital  CAPG.NS , an NBFC that had a loan book of
12.5 billion rupees ($172 million) in the last fiscal year.
    He added that in the absence of any financial incentive for
NBFCs from the government, those who "can't manage their
portfolio performance will perish".
    The RBI has already been cancelling licences of those who do
not have a minimum capital base of 20 million rupees ($275,330).
    "RBI has issued show-cause notices, given them time and is
now in the process of cancelling their registration. Ultimately
up to 1,500 should go out," said Raman Aggarwal, chairman of
Finance Industry Development Council, an industry body.
    At the same time, Aggarwal said the central bank is
"flooded" with hundreds of new applications to set up NBFCs. 
    He denied there was any wider asset-liability mismatch in
the sector. But bankers and former central bank officials said
the scrutiny will be higher for newer players now that
"asset-liability mismatches have magnified among existing
NBFCs".
    Nearly 11,000 of India's NBFCs are small and medium-sized
businesses with an asset base of less than 5 billion rupees. But
the top 400, many of which are backed by banks and finance
companies, control about 90 percent of the assets under
management, Aggarwal said.
    
    "NOT RIGID"
    NBFCs have been differentiating themselves from banks by
forming personal relations with customers despite charging up to
2 percentage points higher interest, said Aggarwal.
    "They know the local market dynamics, they understand the
local economics, so you can take a credit call based on the
first few minutes of discussion with the borrower,"  he said. 
    Unlike banks, NBFCs are "not rigid" and lend to even those
borrowers who may never had a bank account, credit history or
tangible assets, Aggarwal said. That could include someone
buying a motorised rickshaw or setting up a small restaurant.
    Analysts say the current uncertainty in the market will mean
NBFCs with financially strong backers such as LIC Housing
Finance Ltd  LICH.NS , Power Finance Corp  PWFC.NS , Rural
Electrification Corp  RURL.NS , Bajaj Finance  BJFN.NS  and
Cholamandalam Investment and Finance  CHLA.NS  will stand out.
    And there is set to be an acceleration in deals, they said.
    Over the past two years, IDFC Bank  IDFB.NS  has bought
Grama Vidiyal Micro Finance, Kotak Mahindra Bank  KTKM.NS 
bought BSS Microfinance, RBL Bank  RATB.NS  took over Swadhaar
Finance while IndusInd Bank  INBK.NS  has announced the
acquisition of Bharath Financial Inclusion.
    "There should be some consolidation in the market and
regulation," said S.S. Mundra, a former RBI deputy governor who
is now on the board of Indiabulls Housing Finance Ltd  INBF.NS ,
a home loan provider.
    "That would be good for the system in the long run."
    ($1 = 72.6400 Indian rupees)

 (Reporting by Krishna N. Das and Neha Dasgupta; Additional
reporting by Euan Rocha; Editing by Martin Howell and Raju
Gopalakrishnan)
 ((Krishna.Das@tr.com; +91-98711-18314,  +91 11 4954 8026;
Reuters Messaging: Krishna.Das.thomsonreuters.com@reuters.net,
Twitter: https://twitter.com/krishnadas56))