Small firms with poor financials in vulnerable position: RBI report

Bolstering funding sources for liquidity-starved small units important to arrest next NPA wave

RBIA Reserve Bank of India study has said liquidity starved small and medium-sized firms with poor financials are in a “vulnerable situation” and they need funding sources in arresting the next wave of non-performing assets (NPAs).

Small and medium-scale firms in India with sound financial health have indeed shifted to non-bank funding through bonds and CP (commercial paper) market more aggressively in response to the banking stress. Results also indicate that larger firms have the ability to access the market in spite of having poor financial conditions. This leaves the subset of small firms with poor financials in a vulnerable situation,” said the study on ‘Non-bank funding sources and Indian corporates’ published under the aegis of the RBI’s Mint Street Memo.

The results indicate that bolstering the funding sources for efficient but liquidity crunched small and medium-scale enterprises is also likely to be important in arresting the next wave of NPAs,” the study said.

Latest RBI data shows that outstanding bank credit of small and micro units had gone up marginally by 0.8 per cent to Rs 3,57,100 crore by August 2017 as against Rs 354,300 crore in August 2016. According to another RBI study released in August 2016, small companies were finding the going tough with sales and profits taking a big beating in the wake of demonetisation and implementation of Goods and Services Tax (GST). Small companies with a turnover of less than Rs 25 crore reported a 57.6 per cent fall in sales for the quarter ended March 2017. It further said 726 small companies reported a 122.3 per cent plunge in EBIDTA (earnings before interest depreciation, taxation and amortisation) for the March quarter.

The study said current policy is focussed on debt recoveries from larger borrowers. “The results indicate that corporate bond, ECB and CP market have allowed at least a subset of firms to diversify their funding sources. The ability to substitute the sources of financing is important to shield the economy from adverse real effects of a financial crisis,” it said.

It is found that small and medium-scale firms with good financial health are more likely to substitute bank credit with non-bank credit in response to the banking stress. The evidence also suggests that amongst the firms with poor financial condition, relatively smaller firms are effectively rationed out of the credit markets,” it said.

It said large firms can access non-bank funding with relative ease. “At the same time, large firms tend to have stronger banking relationships,” the study said. To test if small and large firms are affected differently due to banking stress, the study included the interaction term between NPA and firm size. “Interestingly, poor financial health can curtail non-bank funding access for smaller firms much more severely than the large firms,” it said.

Indian banking sector is facing the problem of growing non-performing assets (NPAs). “From 2014 to 2017, the average level of NPA to advances ratio across public-sector banks has almost doubled from 5 per cent to 10 per cent. Rising NPA levels have curtailed the supply of bank credit as banks are rebuilding capital or keeping aside larger share of loanable funds against future possible losses,” the study said.

In parallel, Indian financial markets have witnessed a significant development of non-bank sources of credit such as corporate bonds, external commercial borrowings (ECBs) and commercial papers (CP). In 2005, Indian non-financial firms raised roughly 80 per cent of the new debt funding from banking institutions. But the relative importance of bank credit as a source of funding for non-financial firms has reduced dramatically over the last decade.

In 2016, non-bank debt through corporate bonds, CPs and ECBs accounted for more than half of the new debt funding. The share of new non-bank credit to total new debt has risen steadily from around 20 per cent in 2015 to around 53 per cent in 2016. Indian corporates utilized ECBs heavily until 2012. Depreciation of Indian currency against the dollar in 2013 prompted the Indian corporates to substitute ECBs with domestic corporate bonds.

CP issuances now constitute a significant segment and represent roughly 25 per cent of non-bank credit. This implies that in the context of growing financing needs in the economy, the importance of non-bank credit is also rising, the study said.

Source: The Indian Express

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