NBFC

What to Do if Your NBFC Faces a Liquidity Crunch? Practical Solutions

NBFCs or Non-Banking Financial Companies play a vital role in the Indian economy. They provide easy access to finance, especially to the small and medium enterprises (MSMEs) sector, and help in increasing financial inclusion. NBFCs can provide quick and flexible loans compared to banks, which is very helpful, especially for new and small businesses. 

However, the NBFC sector has come under pressure in recent times. The financial instability and loan defaults of Infrastructure Leasing and Financial Services (IL&FS) have affected the entire NBFC sector. These have created a general perception of a credit crunch and funding shortage in the market. 

So, the main question is how NBFCs, after proper NBFC registration, can protect themselves from a funding crunch and continue to operate stably in the long term. In this article, we will analyze those effective solutions. 

Understanding NBFCs and Their Activities 

An NBFC is a company that mainly carries out financial activities. These include lending, investment, leasing, and asset financing. Like banks, NBFCs play an important role in financing and lending, but there are some differences in regulatory rules. 

There are different types of NBFCs. For example: NBFC-ICC (Investment & Credit Company), IFC (Infrastructure Finance Company), IDF-NBFC (Infrastructure Debt Fund), NBFC-MFI (Micro Finance Institution), NBFC-Factors, Mortgage Guarantee Company, etc. Each type of NBFC provides different types of loans and financial services. 

The key to the stability of NBFCs is Asset-Liability Management (ALM). The proper alignment of cash flow from the company’s assets and the maturity of loans or liabilities. If ALM is not done properly, financing failures and funding shortages can occur. Therefore, ALM is an essential part of the business plan for every NBFC. 

Reasons for NBFC Liquidity Crunch 

The biggest example of a liquidity crisis in the NBFC sector is the defaults of IL&FS. The credit problems of a single company create pressure on the entire NBFC sector, which leads to a shortage of credit and funding. The market is starting to perceive all NBFCs as risky, even though many companies are actually stable. 

One important reason is the Asset-Liability Mismatch (ALM). When short-term funds are invested in long-term assets, problems in repaying the loan may arise in unexpected situations. For example, in the case of vehicle loans, SME loans, or microfinance, the type of ALM is different. In the case of short-term loans, funds are returned quickly, and money management is easy. On the contrary, if long-term investments are not matched with short-term loans, the crisis increases. 

Real estate and builder funding also increased the risk. Such loans are risky due to the slow market and project delays. On the other hand, LAP (Loan Against Property) and microloans are relatively safe. 

The impact of market perception is also important. After events like IL&FS, investors perceive all NBFCs as equally risky. So, even strong NBFCs may face a funding crunch. Therefore, a transparent analysis of the ALM and financial stability of the companies is essential. 

Effective Solutions to Deal with Liquidity Crunch 

A liquidity crunch is not just a financial problem, but it also affects the reputation of the institution, lender’s confidence, and its ability to survive in the market. Therefore, a planned and realistic strategy is needed to deal with such a situation. Some important solutions are discussed below- 

A. Strengthening Asset-Liability Management (ALM) 

The key to NBFC financial stability is to maintain proper ALM. One should try to maintain as much positive ALM mismatch as possible, i.e., meeting short-term liabilities with short-term assets. It is better to review the ALM report regularly and not invest in long-term projects with short-term funds. This keeps cash flow balanced and reduces the risk of a sudden liquidity crisis. 

B. Diversifying funding sources 

NBFCs should use different funding sources instead of relying on one source. For example, Commercial Papers (CPs), bank loans, mutual fund subscriptions, and securitization. However, caution is necessary in using rollover of short-term funds, as over-reliance can create crises in the future. 

C. Emphasis on providing safe loans 

NBFCs should avoid risky sectors and focus on providing MSME, small business, and short-term loans. These loans have a fixed recovery period, and the risk is relatively low. It is wise to limit high-risk investments like real estate or builder funding. 

D. Establishing strong risk management and good governance 

Regular MIS reporting should be maintained by forming a Risk Management Committee and the ALM Committee within NBFCs. Presenting realistic information to the board and following strict credit policies helps in maintaining financial discipline. 

E. Use of refinancing and rollover strategies 

Refinancing or rollover methods can be used in a planned manner to meet the short-term funding deficit. However, this should be done transparently and to a limited extent. Maintaining a trustworthy relationship with lenders can help maintain financial stability even in times of crisis. 

Role of RBI Regulation and Compliance 

The Reserve Bank of India (RBI) has issued strict rules to strengthen the liquidity management of the NBFC sector. Every NBFC is required to prepare and submit Asset-Liability Management (ALM) reports at regular intervals. This process helps institutions maintain a balance between their sources of funds and liabilities. 

Simultaneously, the RBI has issued corporate governance guidelines, where credit policies, risk management policies, and board reporting are mandatory. Compliance with these rules increases market confidence in NBFCs and strengthens investor confidence. Regular NBFC compliance can help institutions avoid future funding challenges. Overall, proper adherence to RBI guidelines is the cornerstone of NBFCs’ financial stability and market credibility. 

Future Outlook and Best Practices 

The long-term stability of NBFCs depends on planning and careful risk management. Institutions should diversify their funding sources, such as bank loans, debentures, or securitization. Investments in high-risk sectors should be pursued with a prudent lending policy. In addition, stress testing and ALM reviews should be conducted regularly so that institutions are prepared for sudden changes in the market. 

The NBFC sector can play a bigger role in financial inclusion and MSME development in the future, but this requires proactive planning and a risk-preventive approach. It is not possible to deal with future liquidity crises without proactive management. 

Conclusion 

To overcome the liquidity crisis in the NBFC sector, pragmatic steps are needed. A strong ALM system, diversified funding sources, risk control mechanisms, and full compliance with RBI guidelines. Proactive risk management and strong governance policies help NBFCs grow sustainably. 

If institutions maintain proper financial planning and regular stress testing, the impact of a liquidity crunch can be minimized. 

Enterslice provides a complete solution for your NBFC, expert guidance on liquidity management, regulatory compliance, and risk mitigation. Our experienced team will help you build a stable, compliant, and sustainable NBFC. Join Enterslice today and secure your organization’s future. 

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