* Non-banking finance companies face liquidity crunch
* Crunch has caused rift between central bank and government
* RBI allows banks to provide partial credit enhancement (Updates to add cenbank official’s speech)
By Suvashree Choudhury and Abhirup Roy
MUMBAI, Nov 2 (Reuters) - India’s central bank sought on Friday to ease a massive credit crunch affecting non-banking finance companies (NBFCs) by allowing banks to act as partial guarantors for some of their existing debt which should make it easier to refinance.
The Reserve Bank of India (RBI) said banks could now provide partial credit enhancement to refinance bonds issued by NBFCs and housing finance companies (HFCs) with tenors of not less than three years. Until now, banks were not allowed to provide credit enhancement to NBFCs.
Panic over potential debt defaults in the shadow banking sector have caused corporate bond yields of NBFCs to rise by more than 80 basis points since September. The resulting liquidity crunch has added to a rift between the central bank and the government.
“The RBI wants the NBFCs to raise long-term debt and that is why they have laid down the three-year restriction,” said a debt investment banker who has invested in some of the financing companies.
“Mutual funds and insurance companies who have funds but don’t have credit risk appetite will now rely on credit enhancement provided by banks and buy these bonds.”
India’s Finance Ministry reportedly said in a letter to the Ministry of Corporate Affairs that it feared significant default from large financing companies in the next six weeks if no liquidity support was provided to these firms.
According to bankers, 1.04 trillion rupees ($14.41 billion) of debt is set to mature in November and another 623.4 billion rupees in December for papers issued by the NBFC and HFCs.
The RBI said banks can provide a credit enhancement of up to 20 percent of the bonds to be issued and limited such enhancements to one percent of a bank’s capital funds.
The central bank also directed banks to ensure the funds were only used to refinance the existing debt indicating that the bond proceeds from such credit enhancements should not be used for NBFCs’ growth or lending operations.
Meanwhile one top central bank official, in a speech on credit risk and bank capital regulation, defended the RBI’s stringent capital norms for banks given that the probability of companies defaulting, known as cumulare default rates are higher in India than global standards.
“The real strength will come from recognising weaknesses in the balance sheet and making provisions for them rather than pretending to believe that the balance sheet is strong,” RBI Deputy Governor N S Vishwanathan said in a speech on October 29 that was uploaded on the website on Friday.
Vishwanathan’s comments come on the back of the government’s pressure on the RBI to ease lending restrictions on 11 state-run banks. The RBI has barred these banks from lending under the so-called prompt corrective action plan until they improve their capital ratios, reduce bad debt and become profitable.
The lending restrictions have been another key bone of contention between the RBI and the government and this rift widened after another deputy governor Viral Acharya in a speech on Oct 26 had said that undermining central bank independence could be “potentially catastrophic”.
There has been a war of words between the RBI and the government since Acharya’s speech.
$1 = 72.4350 Indian rupees Editing by Euan Rocha and Richard Balmforth