A short regulatory note within the monetary policy announcement by the Indian central bank early this week has implicitly pushed up the cost of credit for the country’s huge and bubbling non-banking finance companies or NBFCs. The Reserve Bank of India (RBI) has stated that bank loans to NBFCs excluding those categorised as microfinance institutions (under a recently coined new category NBFC-MFI), will not be reckoned as priority sector loans with effect from April 1, 2011.

Although the RBI has said that detailed guidelines in this regard will be issued separately, it can be a game-changer for NBFCs who depend on bank lending as a source of money to subsequently lend to their consumers with a mark-up. Surely, the impact will not be uniform on all categories of NBFCs and that will be made clear when RBI comes out with the details of the new norms.

But on the face of it, taking out NBFCs from priority sector lending umbrella increases their cost of credit. It also partly shrinks a mode of finance as banks will look to other borrowers to meet their priority sector lending requirements.

The availability of funds can be made up in the short term by generating own funds, either through equity infusion, which has strong limitations, or other means. It is the cost push that is more important as NBFCs now need to either raise the rates they charge from customers or see their profit margins shrink.

This can be especially critical for the business growth of consumer finance companies operating under NBFC licence and who depend on bank loans for onward lending. Till now, these firms have competed with commercial banks by their market presence and quicker disbursement of loans, with risks partly made up by higher interest margins. They will now need to ramp up their action.

The policy direction is in line with recognition for redefining the ‘priority sector.’ This is in line with the recommendations of the Malegam Committee, as also representations from various quarters, to relook at the definition of the priority sector, especially when bank finance was being routed through other agencies. RBI has proposed to appoint a committee to re-examine the existing classification and suggest revised guidelines with regard to priority sector lending classification.

The latest decision on bank lending to NBFCs comes after the central bank had specifically taken out the cushion of cheaper ‘agri loan’ status from gold loan companies earlier this year. This has direct implications for firms such as Manappuram and its larger peer Muthoot that awaits its market debut, having completed its maiden public float with huge investor interest.

In its research report dated February 3, brokerage firm Edelweiss said that the move would impact the borrowing profile and funding cost of Manappuram and might take a toll on growth targets. Edelweiss estimated the rate differential between borrowing costs under ‘agri’ and regular lending to be 100-200 bps and that would be the impact on the gold loan firm.

“For Manappuram, incremental funding cost is likely rise by 100-200 bps due to this notification (which will impact around half of its borrowing). Manappuram has Rs 1,600 crore of rated pool of commercial papers and Rs 4,500 crore of unutilised bank credit lines which will be utilised in the near term to fund incremental growth. The notification will also limit the attractiveness of securitisation due to lower spreads,” the Edelweiss report stated.

Other Regulatory Changes

RBI has also announced certain other regulatory changes that will affect the financial markets. These include:

A mandate to domestic commercial banks to allocate at least 25 per cent or a quarter of the total number of branches to be opened during a year to unbanked rural (Tier 5 and Tier 6) centres to improve banking penetration and financial inclusion rapidly.

Allowing urban co-operating banks to utilise the additional 5 per cent of their total assets, permitted earlier for housing loans up to Rs 15 lakh (from Rs 10 lakh earlier).

Capping bank’s investment in liquid schemes of debt-oriented mutual funds under a prudential ceiling of 10 per cent of their net worth as on March 31 of the previous year (with flexibility to bring it down for existing investments in six months).

Enhancing the provisioning requirements on certain categories of non-performing advances and restructured advances.

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