RBI proposals to restrict land financing by NBFCs: Report

The Reserve Bank`s proposals on restricting specific real estate funding by NBFCs will significantly affect land financing by them, India Ratings and Research (Ind-Ra) said in a report.

In a recent discussion paper, the RBI proposed to restricts real estate funding to only those projects wherein the approvals or permissions are in place

New norms such as board-approved limits for exposure to commercial real estate sector and internal sub-limits for financing land acquisition have also been proposed.

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Besides, the discussion paper stipulates capping the exposure in case of other sensitive sectors such as the capital market.
Accordingly, these proposals are seen as curtailing the risks faced by NBFCs.

"The wholesale NBFCs that have been using structuring to fund land acquisitions have generally been averse to funding land acquisitions over the last couple of years.

"However, the regulation proposed by the discussion paper will impact the business flexibility for real estate-financing NBFCs, which take exposures at several stages of the project."

As per the Ind-Ra report, exposure at the nascent stage of the project carries better margins and enables the NBFC to compensate for the lower margins that it makes on the exposures on advanced-stage projects, which is where it faces competition from banks.

"Having said that, the revised norms put a check on the asset side risks for these NBFCs."

Furthermore, the report cited the proposed restriction on NBFCs to provide loans for the buyback of shares or securities would affect the business model of wholesale NBFCs, which have developed the expertise of offering structured credit to their borrowers in cases wherein banks could not fund them due to regulatory restrictions.

An exposure cap of up to Rs 10 million has also been suggested for initial public offering (IPO) financing.

"In a nutshell, the paper aims at putting stricter regulatory guard rails for wholesale NBFCs, since these are exposed to higher asset side risk and also carry concentration risk in their portfolio."

The paper further talked about base-level NBFCs with an asset size of less than Rs 10 billion.

According to an Ind-Ra estimate, out of the total of about 9,400 NBFCs and about 100 HFCs, only about 200 NBFCs and HFCs would have an asset size that would be higher than this.

"The incremental regulations will be limited for these to the extent of increasing the base level capital to INR 0.2 billion and moving the NPA recognition norm to 90 DPD,"<br /><br />

"Ind-Ra believes that the raising of the capital limit to INR 0.2 billion may prompt many NBFCs that have minuscule level of operations to consider surrendering their NBFC licences."
In addition, the paper proposed new disclosure norms and strengthened corporate governance framework.

These, the report said, will go a long way in reducing the information asymmetry within the NBFC space and instil confidence among various stakeholders.

"A stronger and independent board will infuse the resilience in NBFCs to tide over the challenging operating environment and carry on their operations, maintaining a judicious balance between risk and returns."

The RBI had issued the discussion paper on January 22, 2020, with the objective of curtailing the spill-over risk that an NBFC default could pose to the entire financial ecosystem.
The main suggestions put forth by the draft discussion paper were changes in exposure norms, improving corporate governance framework, increasing capital requirement, improving disclosure standards, strengthening technological backbone and changing provisioning norms.

"While the paper does articulate bank-like regulations for a certain category of NBFCs, it has not specifically discussed the cash reserve ratio (CRR) and statutory lending ratio (SLR) requirements for them."

"Furthermore, while the paper talks about the risk weight arbitrage for NBFCs in the context of standard asset provision, and also articulates a common equity tier-1 (CET-1) of 9 per cent for a certain category of NBFCs, it does not deal with the industry demand on risk weight benefit that is applicable to banks.