NBFCs may Now Have to Build Extra Reserves to Redeem Debt

Regulators plan to tighten norms for NBFCs to avert delays and defaults in paying off debentures

Finance companies, often perceived by regulators as a weak link in the system, will be asked to build extra reserves to avert delays and defaults in paying off lakhs of investors who buy their debentures. Financial sector regulators plan to tighten norms for NBFCs by making the creation of debenture redemption reserve (DRR) mandatory for all securities. Unlike other companies that have to create such a reserve from their profits every year till the debentures are redeemed, NBFCs are partly exempted from this rule. But with several NBFCs hitting the debt market to raise funds, regulators are of the view that tighter norms are needed to strengthen for the sector. According to Prime Database, banks and financial services firms have raised.7.26 lakh crore through both public debt offers and private placements over the last five years against.82,518 crore raised through equity offerings. Top 10 NBFCs including HDFC, IDFC, Mahindra Finance and Shriram Transport have outstanding nonconvertible debentures of about.89,342 crore as of March 31,2012.There is a thinking that there should be some requirement on NBFCs to create a debenture redemption reserve as this will ensure that NBFCs meet their long-term liability, said a person close to the development. The proposal was recently discussed at an inter-regulatory meeting. While analysts feel that such a move will dampen loan growth and reduce the leverage of non-banking finance companies, rule makers are keen to reduce possible systemic risk by protecting the interest of debenture holders. According to Mahesh Thakkar, director general, Finance Industry Development Council, the industry body for NBFCs, there are more than five lakh investors holding debentures floated by NBFCs. Section 117C of the Companies Act requires every company to create a DRR to which adequate amounts have to be credited every year out of its profits till debentures are redeemed. For manufacturing and infrastructure companies, the DRR has to be 50% of the value of debentures issued through public issue and 25% for privately-placed papers. But NBFCs, as per rules, have to set aside 50% of the outstanding debentures towards a reserve only if there is a public issue. But V Ravi, CFO, Mahindra Finance, feels that a DRR is not necessary for a financial institution as funds raised through debentures are normally deployed in liquid assets like loans to the borrowers of the finance company which are repayable in equated monthly instalments. Hence, there is a steady flow of funds into the company to meet any emergency including partial or full redemption of debentures. Unlike manufacturing companies, debentures raised by financial companies are not deployed in plant and machinery or fixed assets but it is mainly used to on-lend, he says. Ravi is of the view that as long as lending discipline and asset quality are maintained, NBFCs will be able to meet all their liabilities in time. Investment bankers say the move will lead to NBFCs rationalising their fund-raising plans through the debt market and could also impact the ability of NBFCs to pay high dividends.

Economic Times, New Delhi, 23-08-2012