Empower the NBFCs, HFCs

In India where financial inclusion remains a challenge, non-banking finance companies (NBFCs) and housing finance companies (HFCs) have played a crucial role in bridging this gap. 

Access to financial products and services for vulnerable, economically-weaker sections and low-income groups at affordable rates from banks and other institutional players, continues to be a bridge too far for many.

NBFCs and HFCs have both actively provided micro-finance as well as loans for affordable housing, commercial vehicles, agricultural equipment and gold, among others, in isolated areas and unserved or underserved geographies. 

Yet, many of these institutions struggle to procure the necessary capital and debt to expand their business at the required levels. Even when they tap into debt instruments, these are either at a high cost and/or short term and fail to match their long lending cycles. 

This creates uncertainty in terms of the asset-liability match, while leaving wafer-thin margins instead of the adequate risk premium needed for the credit profile of borrowers they serve.

Consequently, the larger objective of access to appropriate financial products by vulnerable groups at an affordable cost in remote regions becomes challenging. The commercial unviability of the brick-and-mortar bank branch network to address financial inclusion means NBFCs have to pitch in a bigger way. 

To make NBFCs more viable, it is important to have a well-developed and evolved alternate financing mechanism to ensure that appropriate and adequate funding is available for deserving, but vulnerable sections at more viable commercial terms to achieve financial inclusion objectives in a fair, transparent manner. 

One such alternative is the creation of a well-developed, robust securitisation market. Securitisation allows NBFCs to provide loans and encash the quantum advanced by way of selling a pool of these loans in the form of a debt instrument that can be listed on stock exchanges so that it can be easily traded and necessary liquidity is available to investors of such loan pools. 

India has the necessary legal framework via the SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002), which regulates such activity. However, the market for listing and trading of these instruments is extremely weak and almost non-existent. Securitisation offers connectivity with the capital market and is a proven mechanism for augmenting funds for lenders.

After the IL&FS fiasco — where the NBFCs defaulted on their debt obligations due to excessive borrowing and cash flow crunch resulting from a massive asset-liability mismatch, funding for such financial companies has dried up completely. Banks, mutual funds and insurance companies subscribing to their bonds and commercial papers have shied away from disbursing further funds to NBFCs. 

Worsening their woes, banks have even stopped providing regular term loans to NBFCs. In the process, sound NBFCs with excellent portfolios and well-managed funds have also been impacted due to this negative sentiment. 

Had there been a well-developed securitisation market, this pain would have been much lower for NBFCs. Diligent institutions would have been adequately rewarded by being able to sell their pool of loans and procuring funds for more onward lending via securitisation.  

Clearly, India’s securitisation market needs to be more viable and vibrant. Typically, it is an investor-driven process and, therefore, the needs and concerns of investors must be adequately addressed to enable them to make well-informed decisions. 

Information for investors will include the nature and type of securitisation structure, underlying loans and pool-related information, details about the SPV (special purpose vehicle – a legal entity created to fulfill narrow, specific or temporary objectives), which exist for ensuring that all investor-related interests are adequately protected, including the credibility and capability statements, the disclosure of risks associated with such transactions and level and nature of credit enhancement, among others. Besides structure-related information, investors’ comfort is enhanced if clear guidelines exist for taxation, accounting and regulatory purposes. There also needs to be uniformity in the approach and intent of various authorities, rather than working at cross-purposes. 

In securitisation transactions, the parameters revolve around important considerations such as ‘true sale’ and ‘bankruptcy remoteness’. The regulatory and accounting treatments would generally flow from these conditions. 

In this context, the constitution of the SPV and its distance/isolation from the originator is important. As the securitisation market expands in volume, the transactions will become increasingly data, research as well as technology-intensive. In due course, the role and capabilities of the SPV to undertake these activities will become an important consideration for investors. 

For such a system to be in place, however, a certain degree of guided development is required. For expanding investors’ participation in securitisation, a suitable policy, as well as operating measures are needed. 

The instrument must also be investor-friendly from the perspective of both the primary and secondary markets. In other words, investors will derive comfort from the nature and quality of the underlying assets as well as from the capital-market friendliness of the tradable papers. 

On the one hand, factors determining the quality of underlying assets (primary market) and the quality and features of the instrument on the other (secondary market) viz. liquidity, trade ability, regulatory aspects, valuation, taxability and infrastructure provisions, are all critical considerations. 

Also, clear guidelines on accounting treatments will spur investors’ preference for securitisation. Therefore, regulatory and supervisory concerns should be addressed vis-à-vis international practices, focusing on the systemic issues premised on ‘zero’ failure probabilities.  

There’s no doubt that a degree of convergence and harmonisation between legal, accounting, taxation and regulatory treatments will drive the securitisation market along with sound and sustainable lines.

The author is Chief Risk Officer, India Mortgage Guarantee Corporation