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Impact of Demonetisation on NBFCs

By Monica V.

Demonetization is expected to negatively impact NBFCs in the short run, however, no significant long-term impact is expected, as the liquidity crunch is cyclical and not structural.

Factors that will influence the Impact:

Loan against Portfolio (LAP)- CRISIL in its sector analysis recently said that LAP as an asset class would witness pressure. A fall in resale prices of property and elongation of time to liquidate a property would exacerbate delinquencies in this segment. LAP business faces asset quality risk because NBFCs have aggressive lending practices as they consider unaccounted income while deciding on income eligibility and loan amount for a borrower.

Exposure to Small and Medium-sized Enterprises (SMEs)- A significant portion of SMEs thrive on the success of the parallel economies, hence, greater the exposure to SMEs greater will be the negative impact on the earnings. Public sector banks are likely to have a greater negative impact than private sector banks, as they have more exposure to SMEs.

A Proportion of Unsecured Loans- Greater the number of unsecured loans, such as consumer durable loans or personal loans, greater will be the as against secured lending such as mortgage lending.

Exposure to Real Estate Loans- Majority of Real Estate transactions happen with black money, hence demonetization is likely to reduce the demand. This will bring in the much needed correction in the real estate prices in India, and provide an opportunity to the middle class population to make real estate investments which is a positive in the long run. Also, demonetisation may prove beneficial for lenders and housing finance companies (HFCs) as the average size of home loan is likely to increase, as people have less cash in hand and thus would need to borrow more. Furthermore, since majority of real estate transactions happen using black money, demonetisation poses a greater concern about the growth of NBFCs rather than on asset quality.

Businesses running on daily credit basis- Customers, such as small farmers and unskilled labourers, of NBFC-micro financial institutions (NBFC-MFIs), whose livelihood is based on cash payments, do not have bank accounts and/or sufficient means to either exchange existing Specified Bank Notes (SBNs) in their possession into notes of acceptable denomination, or make a transition to cashless means of finance. This is impacting their daily businesses, and thus negatively affecting the timely repayment of loans taken by them from NBFC-MFIs.

Limit on withdrawal by NBFC-MFIs- NBFC-MFIs generally lend to smaller customers by borrowing from banks. Thus, a restriction on their borrowing will negatively impact onward lending to their customers. Thus, it is being argued that:

  • Similar to banks, NBFCs should be allowed to exchange SBNs as they have greater penetration in rural India than banks,
  • Should be allowed to receive payment of loans in SBNs, upto a certain period, as this will reduce cases of unintentional defaults in loans and also ensure that the overall asset quality of the NBFC-MFI sector does not get eroded
  • The withdrawal limits for companies involved in the micro-financing sector should be relaxed in order to promote growth

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