The sector has been driven into a comatose state by a RBI diktat in January 1998 which made it compulsory for finance companies to get credit ratings if they wanted to raise public deposits. The central bank linked the amount of deposits to ratings obtained. Any amount above the ceiling had to be repaid.

There was a furore for a month or so, following which the RBI relaxed its guidelines to allow repayments spread over a few years.

Thousands of NBFCs were forced to repay large amounts to depositors, something which they found difficult because of the liquidity crunch caused by the sluggish economy and a slowdown in repayments byborrowers.

Most finance companies have barely been able to keep their heads above the water and a rash of bankruptcies and closures has been predicted. The sector sent an SOS to the finance minister several times and it now appears that Sinha has realised the dangers to the economy of a large number of NBFCs going belly up.

The full details of what exactly the Reserve Bank is going to do to pull the sector out of the mire are not known, but a few indications are available.

At one end of the spectrum is the hope that the RBI will totally delink rating from the amount of deposits and go back to the system in force several years ago. But this appears unlikely, especially since the RBI may not be enamoured of a total rollback.

A realistic expectation would be that rating will be mandatory for bigger NBFCs. But the rules fixing the amount of deposits that can be raised will be relaxed considerably.

There is a strong school of thought that the minimum credit rating for larger companies to raise depositswill be fixed at A minus. Such companies may be allowed to retain deposits equal to five times their net owned funds. Companies with higher ratings will be allowed to raise larger multiples of their net-owned funds.

It is expected that, for small and medium NBFCs, the level of deposits will be delinked from credit ratings. But some ceilings on deposits linked to net-owned funds are likely to be imposed. RBI will also introduce its own system of rating these NBFCs.

No changes are contemplated in the prudential norms and capital-adequacy ratios now in force, as both the industry and the regulators feel that these are necessary for maintaining the health of companies. Under the schedule imposed by the RBI, the capital-adequacy ratio will go up to 12 per cent and the statutory liquidity ratio to 15 per cent from April 1999.

Sinha is stated to have been convinced that something needs to be done to loosen the noose around NBFCs after industry representatives made a strong presentation to him when he was inChennai some months ago.

The representative bodies also formed a task force to interact with the RBI and the finance ministry and come up with recommendations that will satisfy the regulators and pull the industry out of the crisis. The task force seems to have finally convinced the regulators that the existing framework is killing the industry

The credit-rating agencies have also been telling the RBI and the finance ministry that rating cannot be a determinant of the amount of deposits that an NBFC can be allowed to accept.

A credit rating, they said, merely gives an indication of the probability of a company paying interest and repaying matured deposits on time. It does not in any way indicate whether a company will continue to prosper or will go belly up. From the investors' point of view, ratings cover only the risk of default and not of loss of money.

Therefore, the rating agencies told the regulators, some other system has to be devised to monitor whether an NBFC is making the best use of publicdeposits or heading towards closure.

INSIGHT

A retrograde step

By planning to delink deposit mobilisation from credit rating, the RBI to a certain extent will be meeting a long-standing demand of various NBFC associations, particularly the AL&FS. These associations had actually been demanding that credit rating be done away entirely for smaller NBFCs, that is, firms with a capital base below Rs 5 crore. In addition, they also sought delinking of deposit mobilisation with credit rating for medium and larger NBFCs. The RBI was not receptive to the idea, and rightly so.

But at the same time relaxation of these norms for smaller companies could be a very dangerous trend and the RBI should continue with strict deposit-mobilisation limits linked to net-owned funds. Small NBFCs are the ones likely to default and under no circumstances must the need for rating for small NBFCs be withdrawn.