Reported gross non-performing assets (GNPAs) for non-banking financial companies (NBFCs)¹ have increased to ~6.8% as on December 31, 2021, a ~150-bps increase over September 30, 2021. This was primarily due to adherence to the clarifications provided by the Reserve Bank of India’s (RBI) circular on NPA recognition issued on November 12, 2021.

But with NBFCs bolstering their collection process, and economic activity improving, NPAs should reduce in the road ahead.

Two provisions of the RBI circular had a significant impact. First is the change in the recognition of NPAs to a daily due-date basis versus month-end basis followed earlier by many NBFCs. Second is the increased stringency in the upgradation of NPAs — now to be linked to the clearing of all overdues by borrowers. Previously, NPA accounts were upgraded if an NBFC paid one or two additional instalments and moved to 60+ or 30+ days’ past due (dpd) buckets. Accounts were largely classified as NPAs only if the overdues exceeded 90 days.

The impact of the circular, however, varies across segments. For the resilient gold loans segment, it was negligible due to the inherent bullet nature of the product. For vehicle finance, the impact was much more — up to 500 bps. Within this, too, loans such as for two- and three-wheelers, commercial passenger vehicles, and first-time user customer segments slipped more due to greater volatility in the cash flows of borrowers in these segments.

Nevertheless, asset quality metrics are expected to improve hereon for three reasons. First is the RBI’s follow-up circular dated February 15, 2022, deferring the implementation of the NPA upgradation norm till September 30, 2022. This provides a reasonable transition time for NBFCs to recalibrate processes, revamp their collection infrastructure and teams, and persuade borrowers to align with the new dispensation. Second is the expected improvement in macro-economic activity, which will act as a tailwind. Third is the limited impact of the omicron wave of Covid-19 so far, with businesses remaining functional with low disruptions.

Says Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, Crisil Ratings Ltd, “We expect GNPAs for NBFCs to reduce 150-200 bps by March 31, 2022. Some of the NBFCs that didn’t see a material impact on their NPAs due to the implementation of the revised recognition norms are not expected to revert to the earlier framework. Some others will do so for respite on reported GNPAs, especially those into vehicle, MSME², and unsecured lending. Going forward, NBFCs are expected to focus on the near-term overdues to reduce delinquencies in the >60 dpd bucket and thus curb incremental slippages into NPAs.”

That said, asset-quality metrics will remain sensitive to the performance of restructured portfolios. Restructuring levels across players and segments have been divergent — more so after the pandemic’s second wave than the first. While most of the restructuring by NBFCs entailed providing a moratorium of six months to one year, regular billing is expected to start from the fourth quarter of this fiscal. The performance of these portfolios remains a monitorable.

Says Rahul Malik, Associate Director, Crisil Ratings Ltd, “While restructuring levels have risen, NBFCs have built strong provisioning buffers, which should provide a crucial offset in the event of fresh slippages in the restructured accounts. The provisioning cover on the total loan book for NBFCs has increased around 200 bps to ~5.5% as of December 31, 2021, from about ~3.5% as on March 31, 2020. Further, most Crisil-rated NBFCs have improved their balance-sheet resilience over the past three fiscals, as reflected in both, improved capital and liquidity buffers. This should help as they navigate asset-quality challenges in the medium term.”

A study by Crisil Ratings shows that on a like to like basis — sans the clarifications on NPA recognition — NBFC delinquencies (90+ dpd) would have declined ~30 bps to ~5.3% as on December 31, 2021 over September 30, 2021.

The improvement can be largely attributed to macroeconomic tailwinds and sharper focus on collections. Future waves of the pandemic, and their consequent impact on NBFC asset quality, will bear watching.

¹ Excluding housing finance companies and government owned NBFCs
² Micro, small and medium enterprises