NBFC NPAs: What impact asset classification norms by RBI will have on bad loans in MSME, other segments

RBI has also asked lenders to classify borrower accounts as overdue as part of their day-end process irrespective of the time of running such process. (Image: Pexels.com)

Credit and Finance for MSMEs: The ‘clarification’ on asset classification norms issued by the Reserve Bank of India (RBI) last week, which brings non-banking financial companies (NBFCs) at par with banks in classification norms, could lead to growth in their non-performing assets (NPAs) including among MSME borrowers, according to experts. As per RBI, loan accounts can be upgraded to ‘standard from NPA only if all the arrears of interest and principal are paid by the borrower. This, RBI said is to avoid any ambiguity as “some lending institutions upgrade accounts classified as NPAs to ‘standard’ asset category upon payment of only interest overdues, partial overdues, etc.” This is one of the concerns.

“At an aggregate level, this will definitely result in higher disclosure of NPAs including the MSME accounts and increase the risk of further slippages. The impact will not be uniform across all NBFCs. It depends entirely on whether the NBFC in question was following the spirit of the classification norms. This change makes it difficult for any accommodative stance from the lenders towards the borrowers. NBFCs will definitely be choosier with regard to lending and growth may slow down,” said Kunal Bhakta, Head of Research, First Water Capital Fund told Financial Express Online.

While the changes will be effective from March 31 next year, so far NBFCs have been upgrading accounts from NPA even if the complete dues are not cleared. With the RBI guidelines now, NBFCs, which can’t upgrade accounts to special mention account (SMA) without receiving complete repayment, may record jump in NPAs.

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“The impact would be across all borrower types such as consumers or corporates and not just MSMEs.  But MSME lenders might be more impacted as they would have a higher proportion of loans under NPA and restructuring due to covid. However, the classifications shouldn’t lead to a surge of bad loans, it will lead to fewer bad loans being upgraded back to standard assets. Hence the provisioning and capital requirements could increase for NBFCs and banks,” Aditya Damani, Founder, Credit Fair told Financial Express Online.

Another issue is that RBI has asked lenders to classify borrower accounts as overdue as part of their day-end process irrespective of the time of running such process. Similarly, lenders would also have to classify accounts as SMA as well as NPA as per the day-end process for the relevant date instead of month-end. “In other words, the date of SMA/NPA shall reflect the asset classification status of an account at the day-end of that calendar date,” the RBI notification had read.

What this essentially means is that at NBFCs, if the payment takes more than 30 days from let’s say November 16, then the overdue amount will turn delinquent and NPA after 90 days. This is in contrast to considering month-end to classify the account as delinquent or NPA in case the payment is not received. This might also have an impact on NPAs at NBFCs for a while.

“The rule to classify account standard after complete payment is received will definitely impact overall quantum of NPAs but how high it would be, one can only guess. The quantity cannot be stated. However, classifying accounts as overdue as of day-end will more be a case of software adjustment for lenders. From client’s perspective, it will be an issue,” said Madan Sabnavis, Chief Economist, Care Ratings told Financial Express Online.

Nonetheless, according to FlexiLoans’ Manish Lunia, most large NBFCs already follow the 90-day gross NPA and 180/270 day write off policy in the country and all systemically important NBFCs (with asset size Rs 500 crore and above) which have a bearing on the financial stability of the overall economy also follow the Expected Credit Loss modelling that accrues NPA at the instance of loan based on the models. Hence, “We don’t expect any meaningful surge in MSME NPAs due to these rules. These are mostly prospective notifications and standardization of reporting and customer communication beyond,” Lunia told Financial Express Online.

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Still what NBFCs can do is forewarn borrowers about the new dispensation and work with them to avoid NPA classification. While disbursements might be affected at some point but the demand pipeline has also been reportedly strong for lenders due to post Covid recovery in the economy, pent-up demand for goods in markets, etc. “There is a timeline given to NBFCs to comply with the standardization norms. Some impacted NBFCs will have to accelerate the NPA and credit cost recognition if they are not in sync already. This will have a one-time impact on these entities,” added Lunia.

Referring to the central bank’s proposal to apply scale-based regulation to NBFCs, RBI’s Deputy Governor M Rajeshwar Rao had last month at a CII virtual event said that with the growth in NBFC sector’s size and complexity, there is regulation needs to address the systemic risks arising out of it, Financial Express had reported. Rao had also said that NBFCs must keep the customer at the centre of all innovation and address concerns around governance. “As and when they attain the size and complexity which poses risk for the financial system, the case becomes stronger for greater regulatory oversight,” Rao had said at the event.