Introduction :- 

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.

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.

NBFC :- 

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business. It does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.

Systemically important NBFCs: NBFCs whose asset size is of ? 500 cr or more are considered as systemically important NBFCs. Example. Power Finance Corporation Limited (PFCL), Rural Electrification Corporation Limited (RECL), IL&FS, etc.

Difference between banks & NBFCs:

• NBFCs cannot accept demand deposits (but some can accept Time deposit and such NBFCs are called Deposit taking NBFC).
• Unlike banks, CRR does not apply on any NBFCs while a lower SLR of 15% applies only to Deposit taking NBFC.
• NBFC do not form part of the payment and settlement system and cannot issue cheques drawn on itself.
• NBFCs get license under Companies Act, 1956 and Banks under Banking regulation Act.
• Deposit insurance facility is not available to depositors of NBFCs

Problems with NBFC :- 

• 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.
• 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 unsecure 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 infrastructural 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.

Recent Steps Taken :- 

• For IL&FS crisis: Change in Management: The board of IL&FS was superseded with six new directors after the government moved a petition in the NCLT (National Company Law Tribunal) to remove the previous board of directors.
• Investigation: Government has also ordered Serious Fraud Investigation Office (SFIO) to investigate into the crisis.
• For enhancing Liquidity Relaxation of the Liquidity Coverage Ratio by 2%: It means that banks now have an additional 2% of their deposit base freed up for lending Open Market Operations: The RBI later also enhanced liquidity into the system by purchasing government bonds from the market. Relaxing Asset Securitisation Norms: The RBI has allowed NBFCs to sell or securitise their loan of more than five-year maturity after holding those for six months (Earlier they had to hold these assets for at least one year to do so).

Way Forward for NBFC sector :-

• Better Regulatory Regime: The Financial Sector Legislative Reform Commission (FSLRC) recommendation of creating a body with powers to monitor risk-cutting across sectors should be implemented.
• Timely Project clearances: Ensuring timely clearances, especially to infrastructural projects is a must to minimise cost inflation of these projects. Expanding the “Plug and Play” approach to other sectors can be a possible solution.
• 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