A new liquidity requirement for India’s non-bank finance companies (NBFCs) proposed by the country’s central bank has received a thumbs-up from Moody’s Investor Service.
The credit ratings agency (CRA) said that the Reserve Bank of India’s (RBI) proposed change in regulation for the liquidity coverage ratio (LCR) applicable to NBFCs is credit positive, as it will reduce the risk of liquidity shortfall that could disrupt their ability to collect repayments on loans backing asset-backed securities (ABS) or ABS deals.
The Moody’s report notes that NBFCs ate the main originators of ABS transactions in India. Beginning 1 April 2020, the RBI requires NBFCs to maintain a minimum LCR of 60%. This will then increase in phases over four years to reach 100% by 1 April 2024. Increasing their stocks of liquid assets and improving their liquidity management should better equip non-banks to cope with short-term cash outflows.
“The LCR will ensure NBFCs maintain minimum liquidity buffers in the form of high-quality, highly liquid assets such as government bonds to meet short-term outflows, instead of relying on cash inflows to do so as they have done in the past,” the Moody’s note added.
The agency notes that in India, repayments for loans backing ABS deals are mostly collected or paid in person and in cash, rather than made through electronic payment systems.
Were NBFCs to be hit by a liquidity shortfall, this could disrupt their ability to actively collect loan repayments from borrowers and therefore disrupt the loan amounts flowing through to ABS deals. The new LCR rules should reduce the risk of such disruption.
The LCR requirement is the latest in a series of measures introduced to improve funding and liquidity for NBFIs following last September’s default of India’s Infrastructure Lending & Financial Services (IL&FS). The demise of the infrastructure financing giant triggered a credit squeeze on India's short-term capital markets and highlighted structural funding and liquidity weaknesses for NBFIs.
Over the subsequent nine months, many NBFIs have been making structural changes to the way they manage funding and liquidity, including by reducing exposure to short-term funding sources such as commercial paper, while lengthening the durations of their liabilities. NBFIs have also increased their funding through securitisation, the agency noted.
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