How Does RBI Look At Default In NBFC ?

Default and Provisioning.

Asset Classification

Every non-banking financial company shall, after taking into account the degree of well defined credit weaknesses and extent of dependence on collateral security for realization, classify its lease/hire purchase assets, loans and advances and any other forms of credit into the following classes,  namely:

(i) Standard assets;

(ii) Sub-standard assets;

(iii) Doubtful assets; and

(iv) Loss assets.

The class of assets referred to above shall not be upgraded merely as a result of rescheduling, unless it satisfies the conditions required for the upgradation.

“Standard Asset” means the asset in respect of which, no default in repayment of principal or payment of interest is perceived and which does not disclose any problem nor carry more than normal risk attached to the business;

“Sub-Standard Asset” means:

(a) an asset which has been classified as non-performing asset (NPA) for a period not exceeding 18 months;

(b) an asset where the terms of the agreement regarding interest and / or principal have been renegotiated  or rescheduled or restructured after commencement  of operations, until the expiry of one year of satisfactory performance under the renegotiated or rescheduled or restructured terms.

“Doubtful Asset” means a term loan, or  a lease asset, or  a hire purchase asset, or any other asset, which remains a sub-standard asset for a period exceeding   18 months;

“Loss Asset” means:

(a) an asset which has been identified as loss asset by the non-banking financial company or its internal or external auditor or by the Reserve Bank  of India during the inspection of the non-banking financial company, to the extent it is not written off by the non-banking financial company; and

(b) an asset which is adversely affected by a potential threat of non- recoverability due to either  erosion in the value of security or non availability of security or due to any fraudulent act or omission on the part of the borrower;

‘Non-Performing Asset’ (referred to in these Directions as “NPA”) means:

a.        an asset, in respect of which, interest has remained  overdue for a period of six months or more;

b.       a term loan inclusive of unpaid interest, when the installment is overdue for a period of six months or more or on which interest amount remained overdue for a period of six months or more;

c.       a demand or call loan, which remained overdue for a period of six months or more from the date of demand or call or on which interest amount remained overdue for a period of six months or more;

d.       a bill which remains overdue for a period of six months or more;

e.       the interest in respect of a debt or the income on receivables under the head `other current assets’ in the nature of short term loans/advances, which facility remained overdue for a period of six months or more;

f.        any dues on account of sale of assets or services rendered or reimbursement of expenses incurred, which remained overdue for a period of six months or more;

g.      the lease rental and hire purchase installment, which has become overdue for a period of twelve months or more;

h.       in respect of loans, advances and other credit facilities (including bills purchased and discounted), the balance outstanding under the credit facilities (including accrued interest) made available to the same borrower/beneficiary when any of the above credit facilities becomes non-performing asset:

Provided that in the case of lease and hire purchase transactions, a non-banking financial company may classify each such account on the basis of its record of recovery;

Provisioning requirements

Every non-banking financial company shall,  after taking into account the time lag between an account becoming non-performing, its recognition as such, the realization of the security and the erosion over time in the value of security charged,  make provision against sub-standard assets, doubtful assets and loss assets as provided hereunder :-

(i)         Loss Assets: The entire asset shall be written off. If the assets are permitted to remain in the books  for  any  reason, 100% of the outstanding  should be provided for;

(ii)       Doubtful Assets:

(a)    100% provision to the extent  to  which  the advance is  not  covered  by  the  realizable value  of  the  security  to  which  the mortgage guarantee company has a  valid  recourse shall  be made. The realizable  value  is  to be  estimated  on a realistic  basis;

(b)   In regard to the secured portion, provision is to be made on the following basis  to the extent  of  20% to 100% of the secured portion depending upon  the period  for  which  the  asset has  remained doubtful:

     Period for which the asset has remained in doubtful category,

Up to one year,                                    20%

One to three years,                               30%

More than three years,                        100%

( iii)      Sub-standard assets: A general provision of 10% of total outstanding shall  be made

(iv)       Every Non Banking Financial Company shall make provision for standard assets at 0.25 percent of the outstanding, which shall not be reckoned for arriving at net NPAs. The provision towards standard assets need not be netted from gross advances but shall be shown separately as ‘Contingent Provisions against Standard Assets’ in the balance sheet.”

Why Finance Companies Fail In India?

Many retail finance companies have been failing in India with high level of regularity. Very few were saved from 'failings' by converting them into banks.

Many continue to go belly up.
Government through banks and depositors directly, face the brunt.

Many are struggling to stay afloat; they are already talking of converting them into banks, etc. They are in trouble. More  will fail, leaving many banks to hold the hot potatos.

Banking is more closely and strictly regulated in India. NBFCs (Non-Banking Finance Companies) are less regulated. Then, why do finance companies strive to convert them into banks? What attracts? Is it the unlimited money at low cost or the size to cover up?

Why do they fail?

Most companies have 'vested' goals, misplaced priorities, wrong products and wrong leaders in a few cases.

• First, many big finance companies are captive finance companies with a goal to promote, call it "push" - their parent auto /machinery  products. They are expected to take risk in financing dealers, wherever banks have refused financing. They finance 'risky' customers, who have either bad credit history or no credit history, not having a history at all apart. Briefly, it is an unwritten law that they are there for sub-prime lending. They are large in size and it takes some years before the rot is smelled and M & A specialists move in quickly to confuse, sell and/ or cover up.

• Second, these are used as camouflaged financial arms of emerging groups to leverage promoter group's interest, in varying degree, at supersonic speed. They execute their plan preciously and quit the business, as soon as their interest is served. They are deposit focused. They take care not to leave any trace.

• Third, some are promoted as front companies. They cook-up annual results to engineer high speculation in the stock in the market and profiteer. They remain focussed on top line. They choose to close the shop when the environment appears to be unfavorable for long time to come.

• Fourth, a very few companies get aligned intentionally to be a group of a particular religion, caste or sect. Obviously, they build huge nexus and have personal agenda, being highly corrupt apart. One does not need guess where these companies will head for, in the long run.

• Fifth, a few do have stupids heading these companies. They are highly positive sycophants, appearing to be aggressive but perfecting what westerners call apple polishing. They are survivors; they do speak good English. They are generally a class, which may not know the fundamentals of sales, credit or collections and they sure hate losses, delinquency and debt collection. They are generally what are called bean counters; they believe strongly that the profit comes from cost savings only. They churn out each hour a cost saving idea, hardly practical or implementable.  Operation succeeds, patient dies.

• Sixth, wrong policies, processes and/ or people in different combinations become reasons for failure; not having robust credit and collection management, have been the major reasons.

• Seventh, irresponsible lending could lead to huge losses; I know a company where there was a competition between top two managers, heading two different retail finance products, to get the coveted managing director position. Their personal agenda was ahead of business agenda. Obviously, a lot of mistakes were made; losses were huge. Funny thing was that neither of them got the position, but a joker.

A very few finance companies do exist in India, which have less degree of these ailments.

RBI appears looking at NBFCs as a last mile option for credit delivery to the risky and remote prospects. Will they succeed? Are more regulations required? NO. What may be  required is closer oversight, compulsory rating.

Why not have a separate national bank, similar to National Housing Bank, to finance NBFCs and MFIs and more importantly to develop specialised knowledge to oversee closely, for course correction and before it is not tooooooo late.