Many NBFCs are structured in a manner that leaves room for inherent asset-liability mismatch. If we take the example of infrastructure HFCs, usually the assets are long-term, while the funding is short term. The onus lies on the system to ensure that the cash flow generated out of the assets is both viable and timely. The same wisdom held true in the IL&FS crisis of 2018. The sheer nature of the business of IL&FS demanded effective management of assets and liquidity in the short- and long-terms.
Interestingly, in the case of IL&FS, even though there were startling discrepancies in the balance sheet, auditors and rating agencies noted them and moved on – or arguably, did not take notice at all.
Any stringent regulatory guidelines aimed at improving the liquidity situation of NBFCs were in the transition phase.
In this context, the role of a robust monitoring mechanism becomes most important for safeguarding the health of the system. In retrospect, in the IL&FS scenario, adhering to a four-tier governance framework – involving both internal and external lines of defence – could have perhaps accelerated intervention and remediation by authorities.
More power to RBI through the ratification of new regulations
Perhaps the silver lining – a direct consequence of the NBFC liquidity crisis – was the much-needed shakedown of the shadow banking system jointly by RBI and SEBI. Steps towards remediation included: grouping HFCs under the RBI ambit (pulling them away the National Housing Bank); stripping several non-compliant NBFCs off their licenses1; granting the RBI power over NBFC boards (Union budget FY20)2; new norms to improve the liquidity situation, and so on.
Come 2020, the extension of a gradually scalable LCR and NSFR from banks to NBFCs will also be a strong step by the RBI in this direction.
Liquidity powered by an advanced technology suite like rt360
The liquidity risk management framework of a bank or an NBFC is a decisive factor in how effectively the liquidity position of a financial institution is measured and maintained. The best outcomes are when stakeholders from different levels of the NBFC (organizational-level, business-level and user-level) are involved in the process as independent, yet accountable members. As the final frontier, external regulators, auditors, and credit rating agencies, need to play proactive roles in identifying risk factors, flagging and following through to closure.
The potential risk of liquidity crisis can be mitigated through these best practices:
- Creating a robust framework incorporating three ALM pillars viz., ALM information system, ALM organisation (Asset-Liability Management Committee or ALCO) and ALM processes
- Monitoring structural and short-term dynamic liquidity at both the gap-analysis level and stock approach
- Maintaining a good balance of high-quality liquid assets and stable funding
- Leveraging advancements in technology to empower and drive the liquidity governance framework across levels 1, 2, 3 and 4 (external)
- Early identification, continuous monitoring and remediation of liquidity issues in the short-term and long-term
- Scheduled stress testing for pitfalls, accounting for both institutional and market risks
- Planning for contingencies and de-escalation strategies
Across the NBFC sector, asset-liability management (ALM) is at the nascent stage, and needs to be structured at par with scheduled commercial banks. The RBI’s latest guidelines, involving the ALCO, and its rules enforcing new monitoring mechanisms, have fuelled an urgency among NBFCs to adopt technology for liquidity risk management.
In today’s volatile marketplace, the interest rate risk by itself must be closely linked to funds transfer pricing, intraday liquidity and overall capital management. There is a need for a holistic approach using a robust Asset-Liability Management (ALM) framework to protect earnings and capital while reducing complexity and ensuring compliance.
A standardized system with an independent and targeted governance framework (adhering to RBI regulations and supported by specialist firms) can make an ocean of difference in the financial health of an NBFC. Such a specialist application can help banks and NBFCs meet their immediate liquidity requirements. Beyond this, it can also leapfrog them to the next level of compliance.
NBFCs can use such high-powered systems to:
- Maintain a proper mix of assets and liabilities to mitigate liquidity risks
- Build an appropriate mix of rate sensitive assets and liabilities to enable sustainability against Interest rate fluctuations, thereby improving the Net Interest Margin (NIM) and increase of shareholder’s value
- Maintain high levels of asset quality and liquidity through regular stress testing using Basel III recommended LCR, accounting for potential threats from select business streams
- Measure concentration risk like Top 20 depositor’s ratio, funding sources, counterparties etc.. that enables FIs in diversification of their funding profile
- Robustly monitor intraday liquidity position, stress testing and sensitivity analysis for the FIs to prepare for potential risk events
- Implement and enable a liquidity workflow system across the governance framework, involving various stakeholders
- Track and record transactional activities for audit and action
- Identify, measure and remediate shortfalls on real-time and periodical basis, converting data into analytical insights
- Stay future-ready and flexible to accommodate the changing demands of users, evolving business models in FinTech, and the fluctuating regulatory landscape, using highly-scalable micro-services based architecture
As a FinTech specialist and pioneer in financial risk management solutions, BCT Digital, a division of Bahwan CyberTek (BCT) helps banks and financial institutions mitigate risk and safeguard operations through its flagship product suite rt360. Made in India – and built by bankers for bankers – rt360 is a game-changing solution suite that provides NBFCs the ability to drive sustained growth. The competencies it brings to the picture place NBFCs in a competitive position to take advantage of dynamic market changes while mitigating the associated liquidity risks.
- Time buckets for measuring liquidity risk
- Residual maturity pattern for measuring liquidity gaps
- Intraday liquidity management through BIS metrics and monitoring tools
- Liquidity risk management through stock ratios including LCR, NSFR, balance sheet ratios, funding concentration
- Interest rate risk in the Banking Book (IRRBB) measurement
- Duration computation
- Stress testing/scenario analysis on liquidity and interest rate risk
- Mapping of general ledger heads
- Business rules-based scenario/what-if-analysis
- Granular insights with interactive dashboards
- Behavioural studies for non-maturing items
- Impact analysis
- Cash flow accounting
- Data aggregation and multiple risk reporting formats, leveraging BCBS 239 principles
- Open architecture for seamless integration with multiple touch points
- Increased scalability and high degree of customization
Adopting a comprehensive, automated approach towards ALM through rt360 offers several measurable benefits:
- Liquidity risk mitigation thereby enabling NIM and equity in both the short-term and long-term respectively
- Improved ability to strategically hedge interest rate risk by measuring the impact of interest rate fluctuation on NBFCs’ P&L (NII) and equity (EVE)
- Early identification of intraday liquidity gaps to meet potential stress situations
- Improved regulatory compliance by adhering to Basel guidelines, and automated regulatory reporting on liquidity and interest rate risk
- Accelerated decision-making, due to end-to-end automation of data aggregation, reporting, and superior visualization through dashboards
- Automated stress testing for short- and long-term, institution-specific and market-wide scenarios, enabling NBFCs to maintain adequate liquidity and capital under stress conditions
Ms. Jaya Vaidhyanathan
President — BFSI & Strategic Initiatives and CEO, BCT DigitalMs. Jaya Vaidhyanathan is an independent Director on several Boards and is focused on bringing in the best global corporate governance principles to India. Her work has found coverage in top news websites like The Hindu and The Times of India. Recently, she pioneered award-winning Early Warning Systems for Indian banks, which have found acclaim in the industry and among counterparts.