As NPLs build up, finance companies call for regulatory forbearance

• Sector asset quality deteriorates to 11.37% by end-March 
• Return on equity halves to 6.62% by end-March from 11.96% a year ago
• Request regulator to relax statutory and liquidity reserve ratios 

Non-bank finance company sector asset quality hit a fresh low even before the full effects coming from the pandemic had a bearing on the repayment capacity of borrowers as non-performing loans (NPL) in the sector rose to a new high in the three months to March. 

The gross non-performing loan ratio—a key metric calculated using gross loans and advances in default against the total outstanding loans and advances by the sector—hit 11.37 percent by end-March, up from 10.59 percent in December 2019 and 7.71 percent a year ago. 

The banking sector non-performing loans, which remained far below that of the finance company sector, also climbed to 5.1 percent in March from 4.7 percent recorded in December 2019, but the provisional data up to May showed a further increase up to 5.6 percent.

Finance companies typically have a higher NPL ratio as the sector mostly lends to the high risk borrowers or the borrowers who are typically rejected by banks. 

The asset quality of licensed finance company sector saw significant improvement when the sector NPL ratio fell to 4.89 percent in March 2017. But since then it has been on a steady upward path. 

However, the specialised leasing company sector, a sub-sector of the licensed finance companies, which engages only in leasing, saw its non-performing loan ratio rising only to 5.42 percent from 4.92 percent. Typically this sector has maintained a low NPL level given the nature of its business. 

Bulk of the NPLs carried by the licensed finance company sector is lending to micro borrowers, SMEs, pawning, mortgage loans on movable and immovable properties etc.
This segment had a NPL ratio of 11.56 percent by end-March 2020, up from 10.78 percent in December 2019.  

The sector with assets of Rs.1.3 trillion was already under pressure even before the pandemic struck them as earnings, growth and asset quality were on a weaker footing due to consistent slowing of the economy due to a mix of anti-growth economic policies, extreme weather and Easter Sunday attacks last year.  

The return on equity of the sector, a proxy for earnings, was 6.62 percent by end-March, slightly up from 5.56 percent in December 2019, nearly halved from 11.96 percent a year ago.
The pandemic brought in fresh set of risks to the sector with finance companies losing income from a large swath of borrowers due to loan moratoria and losing out new business to banks which can offer loans at 4 percent under the Central Bank-introduced re-finance scheme. 

While the sector is seeking to become partners of the refinance scheme, finance companies this week requested the regulator to relax their statutory and liquidity reserve ratios to have access to more liquidity to fund loans at low rates. 

While the loan guarantee scheme recently introduced by the Central Bank also may be diverting some of the finance company clients to banks, the banks may also be willing to lend to these high risk borrowers as the Central Bank underwrites the default risk up to 80 percent of the loan. 

While some of the larger finance companies secure medium term funding for lending purposes, a large section of the finance companies depend on deposits and bank borrowings, which results in higher cost of funds for them, making it harder for them to sell loans at competitive rates.