June , 2019
New government needs to nurture NBFCs
15:27 pm

Saptarshi Roy Bardhan

The American statesman, Thomas Jefferson, and investment guru, Warren Buffet, who had between them more than a sesquicentennial era, were almost on the same page as far as a “debt” was concerned. While the former held “never spend money before you have it”, “spend what is left after saving” – quipped the later. In a way, both of them were somewhat conservatively judgmental in their views while assessing a situation that might lead to seeking a debt.Empirically, consumption in an economy is a function of money supply and availability of credit. In India, in addition to the banking system, Non-Banking Finance Companies (NBFCs) and Housing Finance Companies (HFCs) have been the supplier of such credit.NBFCs along with HFCs have grown strongly, more specifically in the last three to four years.  Number shows that the share of NBFCs and HFCs put together in the total credit system has been rising steadily from 15.2% in FY14-15 to 19.6% in FY17-18.This was mainly because of the turmoil going on in the banking space with eleven Public Sector Banks (PSBs) being put under Prompt Corrective Action (PCA) regime of the Reserve Bank of India (RBI). Lending activity became prohibitive to a great extent and good amounts of the credit demand in the economy got channelled to NBFCs and HFCs - leading to the increase in their share in overall credit.On the supply side, the NBFC-HFC combine had to face tough turf in the post-demonetisation period as bank credit was hard to come by. During August – September 2016, secured NCD papers with AAA rating were issued at 8.55 -9.10% and 9~9.30%  coupon rate range on three years and 10 years tenure respectively. During FY 2017-18, in the primary market, the three year coupon rate of similar papers increased by 30-40 bps. However, on the flip side, the entities got access to cheap money, on the shorter end of maturity - from mutual funds, which saw incremental flows during this period. Instruments like Commercial Papers (CP) AND short-term borrowings of up to 90 days issued by NBFCs to mutual funds increased from about Rs. 50,000 crore in March 2016 to Rs. 1.2 lakh crore in September 2018.In September 2018, which happens to be the 10th anniversary month of the fall of Lehman Brothers, the US investment bank, frontline financial conglomerate IL&FS Group defaulted on its repayment obligation which stood at about Rs. 95000 crores. In a knee jerk reaction, the entire NBFC –HFC space went into a tailspin. Several mutual funds who were invested in debt papers (bonds and CP) of different IL&FS companies suffered depletion. The short term money raised from the mutual funds found their way into long term lending by the NBFCs. Because of the trust deficit caused by the IL&FS episode and later by the Deewan Housing downgrade, the short term money could not be rolled back, which caused an asset liability mismatch.After demonetisation, Funding became scarce and to tide over the shortage - Q418 onwards - there has been a galore of NBFC public issue of non-convertible debentures. About 26 issues hit the market garnering more than Rs. 36,000 crore.In addition to confronting the dynamics of the money market, NBFC business has also been changing its complexion over the last three/four years in terms of service offerings and its logistics. In the newer avenue of digital technology, the industry practice improved a lot more in terms of customer acquisition and service delivery. A new breed of lending start-ups have come up who either lend from their own resources through a NBFC or act as aggregators using digital technology based underwriting tools. The credit appraisal process has also gone beyond analysis of income and bank statements of the borrower or referring to his credit score as disseminated by credit information bureaus in the country. The loan appraisal process has become more analytics based.The product basket of NBFCs also filled with innovations where products are customisable according to the finer needs of the borrower. The products are better tailored to give the traditional banking products a run for their money. In a way, therefore, it will not be wrong to say that NBFC sector is now diverse in nature, with a wide variety of models based on products, customer segments, and capital and ownership structures.To foster growth of the NBFC sector, which acts as a complementary to the banking space (and rightfully termed as shadow banking) several sustaining measures need to be taken. If it is making available medium to long term finance at a commercially viable rate, it is also offering certain tax concessions.The second bi-monthly Monetary Policy of RBI, announced on June 6, 2019 also did not yield any positive boost for the NBFC – HFC sector in spite of lowering the policy rate by 25 bps. In the present scenario, the Central Budget of 2019-20, first of the second NDA government to be tabled on July 5, 2019 by the newly appointed Finance Minister Nirmala Sitharaman, is of paramount importance to the NBFC sector.Extension of benefit of Section 43D of the Income Tax Act to the NBFC continues to be on the top of the wish list. Section 43D recognises the principle of taxing income on sticky advances only in the year in which they are received - a benefit already available to banks, financial institutions, co-operative banks, state financial corporations and HFCs. According to FICCI, “NBFCs would be required to recognise income on such NPAs for tax purposes on an accrual basis, resulting in levy of tax on income which may not be realised at all." This would severely impact the liquidity of NBFCs in terms of cash flow pay-outs, their profitability and also impact their cost of operations.As per section 194A, TDS of 10% is required to be deducted on interest payment including processing charges under loan/finance arrangement. However, banking companies, LIC and public finance institutions are exempt from purview of this section. There exist logistical issues for NBFCs to collect the TDS certificates from the borrowers who are large in numbers and widely spread across geographies because of the ‘retail’ nature. This provision puts NBFCs in a disadvantageous position and creates severe cash flow constraints since NBFCs operate on a very thin spread /margin interest. Margins are very low compared to TDS on interest and processing charges. Exclusion of NBFCs from the purview of this section will provide a level playing field to NBFCs similar to banking companies, LIC, UTI and public financial institutions.As per the revenue recognition norm in the newly issued Ind AS, NBFCs may be directed to recognise such revenues upfront and offer to taxation when in the true spirit, the EIS income would be realised in future years. It is suggested that a clarification in respect of taxability of EIS income on receipt basis should be issued by the government in the upcoming Budget pronouncements.Recognition of higher depreciation rates is another area which calls for the FM’s intervention. The NBFCs which are engaged in hire purchase/leasing of vehicles expect the rate to be raised to 30% across the board. On the other hand, depreciation rate on general plant and machinery which is at present 15% in all cases including for the NBFC companies which are engaged in the business of leasing of assets should be allowed at higher rate of 40%.Exclusion from applicability of provisions of section 269T is one area which is largely being debated upon. Repayment of loan through cash for NBFCs is not allowed (other than NBFC- micro finance where the ticket size of the loan is maximum Rs. 60000). However, the banking companies, post office savings bank, co-operative banks have been excluded from the applicability of this section. Restricting this mode of recovery, may have a huge impact on the recoveries and consequentially lead to increase in bad debts. Considering the business model of NBFCs and such huge adverse impacts, NBFCs should be excluded from the applicability of this section. Interest deduction limitation under section 94B interest limitation rules do not apply to an Indian company or PE of foreign company engaged in the business of banking or insurance. Like banking or insurance business, an exclusion of NBFC companies from section 94B of the Act is suggested as they are also in the business of financing and leasing.Waiver of Minimum Alternate Tax (MAT) on statutory reserves and statutory provision like Special Reserve and Debenture Redemption Reserve (DRR) created by NBFCs is another demand. Since these reserves / provisions are all created under the prudential norms of RBI within the ambit of ‘Provision for diminution in the value of Assets’ as per clause (i) of the explanation to section 115JB of the Act and the same should not be added back while computing book profits under section 115JB of the Act.To have a vibrant economy, the NBFC – HFC combine need the proper nurturing so that it continues to complement the banking space. The road covered by Indian NBFCs / HFCs is commendable. A proper direction is now required to have a tab on the overall systemic risk and to deep dive ways and means for funding larger NBFCs and HFCs over time as they become bigger than midsize banks.The author is the Chief Manager (Legal & Risk Management), Peerless Financial Services Limited.

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