Fixed Income: Risks in investing with NBFCs

The whole business of NBFCs raising debt seems very opaque and worrying. Today, financial conglomerates have a slew of subsidiaries and associates, all formed with strategies to meet regulatory compliances that vary from one business to another. There are terms & conditions that retail investors find difficult to comprehend and are, therefore, not equipped to take a call with a suitable degree of comfort.

More disturbing is RBI’s belief that NBFCs are immortal. They have permitted NBFCs to issue ‘perpetual bonds’ to investors, with a 10-year option that enables NBFCs to repay but prevents the investors from demanding repayment. It is akin to writing off your wealth for a fixed rate of interest. RBI works in favour of NBFCs by just letting them increase the interest rate by a mere one percent at the end of the 10th year. So, if at the end of 10 years India faces high inflation and interest rates, there is no recourse for the investor. If interest rates decline dramatically in 10 years, then the NBFC is likely to repay the investor and raise new money, if it is still around. After the first 10 years, if the NBFC does not repay, it cannot repay ever. Clearly, RBI seems to have worked overtime to give free money to NBFCs. The only safeguard provided is that a single investment has to be at least five lakh rupees which keeps the small investor away from such dangerous instruments.

‘Subordinated debt’ being allowed to be raised by NBFCs from retail investors, with a minimum ticket size of just Rs5,000, seems to be another issue. These debenture-holders—who hold the subordinate debt—will be paid only after senior creditors are repaid in full. This is a very high-risk instrument that should not have been allowed to enter the retail domain. It is funny and ironic that bankers give loans on ‘secured’ terms and the RBI expects the public to lend money with no conditions for repayment! Clearly, RBI seems to think that the retail public can assess credit far better than bankers!

NBFCs are clearly witnessing a period of turmoil. The world over, excessive and unregulated credit has created problems that cannot be ever resolved by anyone, let alone central bankers. They have been wanton in their creation of problems that have no solutions—only everlasting misery. The other worry is their unholy nexus with capital markets in the form of lending money against shares. They provide parking bays for promoters who manipulate share prices of their companies. Most of the loans go to operators and promoter proxies who use the leverage from NBFCs to manipulate share prices. Whilst it is agreeable that NBFCs play an important role in credit delivery, the excesses will bring the whole industry to its knees. 

In addition to all of the above, there are a slew of issues that come from financial conglomerates that hide more than they tell. For instance, a trusted brand of a group is used to sell issues of associates and subsidiaries. There is no bond or assurance about whether the parent entity would be in existence at the time of maturity. SEBI actively aids and abets the charade by letting companies open issues with two to three days’ notice, giving no time to read anything about the issuer. With so many swift changes in the industry, should the regulator allow them to raise non-repayable debt? Our regulators appear more like the cops in Hindi movies who turn up after the deed is done.

Imagine how it would feel not get your money back; the long-term risks do not seem to be adequately compensated by the marginally higher interest rates.
 

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Changes in Our Business Model
 
 
Greetings from Moneylife Advisory Services
 
Between financial years 2019-21, SEBI has come up with extensive changes to investor advisor regulations. On Sep 23, 2020, SEBI had issued new additional guidelines. This comes just two months after extensive changes announced in July 2020. Earlier, in December 2019 there was an ad hoc circular
 
As a result of these changes, IAs, cannot accept fees through credit cards, will have to sign a 26-clause investor agreement, have to maintain physical record written & signed by client, telephone recording, emails, SMS messages and any other legally verifiable record for five years. IAs were already asked to record the suitability and rationale for every piece of advice given, sign them and store them for five years.
 
While these extensive and frequent changes, designed to strengthen the conduct of IAs are well-meaning, these have sharply increased compliance efforts and cost. We, being online advisors, find many of changes harder to implement, compared to advisors working in the physical space. We will have to have an army of advisors, administrative and tech staff to be compliant. If we do this, we will have to divert money to these areas and the cost of our service will double. We want to remain the least-cost service in the market to benefit more and more people. In the circumstances, we are forced to change our business model from “advisory” to “research”. This will mean the following:
 
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Debashis Basu
Founder