NBFCs may see profit margins squeezing from RBI draft liquidity norms

India’s shadow banks are likely to see a further squeeze on their profit margins after the Reserve Bank of India signaled it will tighten liquidity requirements to bring them in line with the country’s more closely regulated commercial banks.

Instead of providing a much-expected liquidity window to non-bank finance companies via the regular lenders, the central bank took a tougher stance on Friday by issuing draft guidelines requiring most NBFCs to set aside a liquidity buffer by investing in high-quality liquid assets, primarily sovereign bonds.

“The regulator won’t bail out any particular company but will ensure the NBFCs are more disciplined and strong at the cost of some short-term pain,” said Avinash Singh, research analyst at SBICAP Securities, a subsidiary of State Bank of India. If implemented, the draft guidelines could hit the NBFCs’ margins and business growth, Singh added.

India’s shadow lenders have been under pressure since last year, when a series of defaults by Infrastructure Leasing & Financial Services forced the government to intervene and exposed weaknesses in the sector. Since then, the banks and mutual funds which provided funding to the NBFCs have reduced their exposure, creating a cash crunch which caused the shadow lenders to sell assets and restrict new loans.

Average yields on top-rated five-year bonds issued by NBFCs climbed 16 basis points in April, the biggest monthly gain since June 2018.

The government of Narendra Modi, which received a sweeping new mandate in elections last week, is also signaling a tough line with individual shadow lenders, while not ruling out measures to avert a credit crunch.

“Should there be a need to address the contagion we will do everything that is necessary to keep the credit market functional,” said Sanjeev Sanyal, principal economic adviser at the Finance Ministry. “However we have to be aware of the moral hazard of intervening in every disruption. Otherwise, we will end up perpetuating and encouraging asset-liability mismatch,” Sanyal added.