Explained: Why new RBI norms on bad loans are making NBFCs jittery

India’s gargantuan bad loan problem could begin to look even worse following the latest norms notified by the country’s central bank last month. 

A report by credit ratings agency India Ratings has said that non-banking finance companies will likely see their bad loans, or non-performing assets (NPAs), rise by a third once the latest clarification issued by the Reserve Bank of India (RBI) comes into force.

What has the RBI said in its latest clarification?

On November 12, the RBI issued a clarification in which it said that loan accounts classified as NPA may be upgraded to ‘standard’ assets only if the entire arrears of interest and principal are paid by the borrower. The rule will apply to both banks and NBFCs, the central bank had said. 

What has India Ratings said on the impact of the latest RBI circular?

The ratings agency says that the new norms could mean that accounts get categorised as NPAs at a faster rate. 

“Accounts can get into NPA category just for a day’s delay in paying the instalments and once it gets categorised as NPA it will not be able to become standard unless all the arrears are cleared,” India Ratings said.

In other words, accounts would get categorised as NPAs at a faster pace and would remain sticky in that category for a longer period of time, the ratings firm said.

“Both these accounting treatments would result into higher headline number for NBFCs. It may so happen that NBFCs would disclose NPA numbers as per IRAC (Income Recognition and Asset Classification) norms and stage 3 numbers as per Ind-AS separately in their disclosures,” it added.

The ratings firm also said that NBFCs will likely have a modest impact on provisioning because of the clarification as such lenders are using Indian Accounting Standard (Ind-AS), and generally for higher-rated NBFCs, provision policy is more conservative than IRAC requirements. 

However, NBFCs would have to invest in systems and processes to comply with daily stamping requirements, a report in the Financial Express newspaper said, citing the ratings firm.

India Ratings said it understands that NBFCs have presented to the RBI for providing a transition period on this requirement.

But aren’t NBFCs that lend small loans typically better off, as compared to big banks?

Yes, NBFCs are slightly better off, as their borrowers do typically end up paying, albeit with a delay, especially where their repayments are collected in cash. 

Moreover, unlike banks, NBFCs typically indulge in asset-backed lending. This, along with their expertise and ability to manage, monitor and deal with the underlying asset in a focused manner, helps keep their bad loans in check. 

How is NPA identification in India done at present?

At present, NPA identification in India is done on the basis of how many days the dues for a loan asset have remained unpaid. This, says Moneycontrol in an opinion piece, becomes a huge constraint for the borrower. “A default need not always be because of the borrower’s fault,” it said.

Citing an example, Moneycontrol said that a contractor working on a government project often has to take a loan for carrying out the assignment. But if there is a delay on part of the government to make its payments, the contractor may find it difficult to service his loan. “The resultant default instantly becomes public information and all avenues for accessing finance close immediately. The contractor, for no real fault of his own, gets treated like an untouchable within the financial ecosystem,” it said.

The report added that in other countries, too, while the number of days of delay is a consideration, that is not the only criteria while determining whether a loan has gone toxic or not.  

In the European Union, a borrower’s ability to pay is taken into consideration as well. In the US, the value of collateral is given adequate importance. In addition, the ‘past due’ number of days criterion is essentially used for loans of small-ticket size, whereas for large-ticket loans, several qualitative and quantitative factors are also taken into consideration, Moneycontrol said.