TLTRO 1.0 did little to reduce the concerns of the NBFC segment which has been reeling under huge ALM stress. More than 80% of the one lakh crore capital raised by banks under the scheme went to either quasi government entities or to large AAA private corporates. Remaining was absorbed by large manufacturing corporates or large AA rating category NBFCs. Virtually nothing trickled down to smaller financial institutions who have been hit hard by the Covid-19 crisis.
TLTRO 2.0 announced by RBI with the stated intent to channel liquidity to small and mid-sized corporates, including non-banking financial companies (NBFCs) and micro finance institutions (MFIs), will again fail to hit the “target” due to various reasons. The same are detailed below –
Banks have over the past five years been gradually increasing their exposure to the NBFC sector. The share of NBFC credit as percentage of overall credit exposure has inched up from 5% in March 2015 to more than 8% as on January 2020. Many banks are already hitting their internal sectoral limits and are constrained from taking incremental exposure to the sector considering heightened risks and high existing exposures.
Secondly, though public sector banks have adequate eligible securities to avail TLTRO funds, they are however constrained on equity capital to take lower rated exposures (which is a requirement considering segment wise targets under TLTRO 2.0). Private sector banks (including small finance banks) on the other hand don’t normally carry excess eligible securities on their balance sheet and may not be incentivised enough to purchase incremental securities to avail TLTRO funds. This is more relevant for banks with higher cost of capital. For example, let’s say a bank has 7.25% cost of funding. The bank will need to raise capital at 7.25% and deploy in government securities yielding 6.5% to raise TLTRO funds. This introduces a negative carry for banks. Considering that duration of the exposures can be upto three years, banks will also be exposed to substantial “interest rate risks” arising from Gsec movement and floating repo rate movement. These factors reduce economic incentives for banks to do the transaction.
Lastly, any deployment done by the banks in MFI sector will not provide them Priority sector benefits. This is because the underlying instruments can be bonds and commercial papers and the same are not eligible for PSL benefits. Thus, banks willing to lend to MFIs would rather prefer to do the same via loans and not block MFI limits by availing TLTRO funds.
Above factors significantly reduce the value proposition of the scheme. Instead the RBI should have pushed banks to extend moratorium to NBFCs for existing liabilities. Also, the need for incremental liquidity for MFIs and NBFCs with rating category “A” or lower is limited. This is because the fresh disbursements have virtually come to a halt due to lockdown. Also, for this segment the cumulative capital market repayments are less than 1000 Cr till 31st May 2020. Most of their repayments are due for term loans taken from banks and other large NBFCs. This implies that if these NBFCs get moratorium on their existing term loans the requirement for incremental funding is not significant.
Update : RBI in the FAQs on TLTRO ,edited on 21st April 2020, has clarified that “In order to incentivise banks’ investment in the specified securities of these entities, it has been decided that a bank can exclude the face value of such securities kept in the HTM category from computation of adjusted non-food bank credit (ANBC) for the purpose of determining priority sector targets/sub-targets. This exemption is only applicable to the funds availed under TLTRO 2.0.”
This is a welcome step however it still does not completely address the arbitrage with respect to PSL considering that term loans extended by banks to MFIs get PSL benefit while any exposure under TLTRO 2.0 will be only reduced from Adjusted Net Bank Credit(ANBC) of banks i.e. banks will not need to seek incremental PSL credit for exposures taken under TLTRO 2.0. For example, lets say a bank has existing ANBC of INR 100 Cr with existing PSL exposure of 40 Cr and takes INR 10 Cr incremental exposure via term loan to a NBFC-MFI. Its PSL exposure becomes approximately 45% ( 55Cr/ 110 Cr) while if the same exposure is taken via TLTRO 2.0 as bonds the PSL exposure remains at 40%.