The Indian government has sprung into action once more to strengthen the functioning of Non-Banking Financial Companies (NBFCs). The Partial Credit Guarantee Scheme (PCGS) 2.0’s scope has been widened to give greater flexibility to state-owned banks when acquiring bonds and Commercial Papers (CPs).
The Origin and Design of PCGS
The introduction of the PCGS marked a turning point in July 2019. Under this scheme, public sector banks could purchase high-rated pooled assets from financially robust NBFCs and Housing Finance Companies (HFCs). A pool of assets refers to the securitisation of a loan portfolio, which involves converting a loan into a marketable security primarily for raising money by selling them to other investors. These are then sold by the NBFCs/HFCs to banks as an advance payment, resulting in mutual benefits – NBFCs/HFCs receive the much needed funds, while banks land interest-paying assets.
Credit Ratings: An Overview
Credit ratings play a key role in assessing the credit risk linked with a financial instrument or a financial entity. This rating scale ranges from AAA to C and D.
Aatmanirbhar Initiative’s Influence on PCGS
The substantial Aatmanirbhar initiative led to the extension of the scheme in May 2020 (PCGS 2.0). It was expanded to include primary market issuance of bonds/CPs by NBFCs, HFCs and Micro Finance Institutions (MFIs) with inferior credit ratings. To instigate this, the Centre provided a 20% first loss sovereign guarantee to public sector banks for the purchase of bonds/CPs. This consequently resulted in a liquidity infusion of Rs. 45,000 crore into the system, covering papers with ratings of AA and below, including unrated papers.
Latest Extension of PCGS: Its Impact
Further enhancement was made to the scheme by extending it for another three months. This extension, lasting until November 19, 2020, allows public sector banks ample time to build their portfolios of bonds and CPs from NBFCs. Moreover, the government has authorized banks to invest up to 50% of total investments under this scheme in AA and AA- rated bonds, doubling the earlier limit which was almost met.
Criticisms and Controversy Surrounding PCGS
However, the initiative has been met with criticism, primarily because it favors larger NBFCs with superior ratings. The scheme’s initial objective was aimed at offering more significant support to small and medium NBFCs. On the contrary, less than 100 NBFCs have been able to benefit from the scheme since most of these entities resort to term loans instead of raising funds through bonds or CPs.
Understanding Bonds and Commercial Paper
Bonds are financial instruments that borrowers issue to raise funds from investors willing to lend money to them. On the other hand, a commercial paper is a widely utilized, unsecured, short-term debt instrument issued by corporations to meet short-term liabilities.
Defining Primary Market
The primary market pertains to the arena where companies issue new securities that were not previously traded on any stock exchange. These can include stocks, corporate or government bonds, notes, and bills. Conversely, the secondary market enables investors to buy and sell pre-owned securities.
The Way Forward: Expanding PCGS
NBFCs play an indispensable role in sustaining consumption demand and capital formation in the small and medium segment. Hence, ensuring their seamless access to funding is crucial. The extended PCGS aims to fulfill this need in a systematic manner. The government can further augment the scheme’s scope by extending the guarantee cover to term loans offered by banks and financial institutions to NBFCs.