Interest Rate Risk Exposure Of The Nbfc Finance Essay
Religare Enterprises Limited (REL) is a global financial services group with a presence across Asia, Africa, Middle East, Europe and the Americas. In India, REL’s largest market, the group offers a wide array of products and services ranging from insurance, asset management, broking and lending solutions to investment banking and wealth management. The group has also pioneered the concept of investments in alternative asset classes such as arts and films. With 10,000 plus employees across multiple geographies, REL serves over a million clients, including corporates and institutions, high net worth families and individuals, and retail investors.
The details of various subsidiaries of REL are given under:
Religare AMC Limited
Asset Management Business
AEGON Religare Life Insurance Co. Ltd.
Life Insurance Company, JV with Aegon(26%),
Religare(44%), and Bennett & Coleman(30%)
Religare Macquarie Wealth Mgmt. Ltd.
JV with Macquarie for Wealth Management Business
Religare Securities Limited
Retail Equity Broking
Online Investment Portal
Religare Commodities Limited
Commodity Broking Business
Religare Capital Markets Limited
PE and M&A Advisory
Religare Finvest Limited
Lending and Distribution business
Religare Insurance Broking Limited
Life Insurance Broking Business
Non-Life Insurance Broking Business
Religare Arts Initiative Limited
Business of Art
Religare Venture Capital Limited
Private Equity and Investment Manager
Vistaar Religare Capital Advisors Ltd.
JV with Vistaar Entertainment Ventures for film fund
India's first ever film fund
Religare - Milestone
JV with Milestone Capital to manage a healthcare and education fund
Religare Finance Ltd.
Capital Market Financing
Fig1: REL Vision and Mission
Fig. 1 shows the vision and mission of Religare Enterprises Limited. Religare has started its journey as a small player with an entry into the area of Institutional Broking, Depository Services, and Retail Broking in 2002. Later, it expanded magnificently into a financial conglomerate with an increased presence in Private Equity, Film Fund, Arts Initiative, Life Insurance, Asset Management, Investment Banking, Insurance Broking, among others, by the end of 2008. The company at present enjoys a market capitalization of INR 5305.98 Crores and is listed on Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). Fig.2 nicely captures the growth story of Religare and shows the addition of new businesses from time to time.
Fig. 2: Time Line showing major Expansion of Religare
The major portion of the summer internship experience was under the NBFC arm of REL that is Religare Finvest Limited.
Religare Finvest Limited
Religare Finvest Limited (RFL) is a wholly owned subsidiary of Religare Enterprises Limited (REL) a NSE/BSE listed entity. REL, through its subsidiary is engaged in providing financial services across all sectors. RFL is registered with the Reserve Bank of India (RBI) as a Non Deposit taking Non-Banking Finance Company (NBFC) and is presently engaged in providing personal credit (such as Loans against Shares (LAS) and Consumer Finance), distribution of Mutual Funds, IPO Financing and Corporate Financial Advisory Services.
Religare Finvest Limited is aggressively making a name in the Financial Services arena in India. In a fast paced, constantly changing dynamic business environment, RFL has developed a change resilient vertically integrated value chain for delivering the most competitive products and services. A brief introduction about them is provided further:
Loan for Commercial Vehicles (CV) & Construction Equipments (CE): RFL started the business in December 2008 and has acquired 709 customers till 31st March 2009 with disbursements of Rs. 582.13 million. The funding is extended to both priority sector small operators and high ended retail and strategic operators both in CV and CE.
Loan against Property: The Company also provides loans against both residential and commercial properties. The said business line was started in December 2008 and total disbursements till 31st March 2009 were Rs. 3,693.35 million. The financial program caters to needs of business entities by providing term loan against security of property.
Small and Median Enterprise (SME) Loans:
SME Lending Business was also started in December 2008. This program caters to the financial needs to companies in the SME space by providing term loans for working capital, purchase of plant & machinery and other business requirements.
The Company has a pan India presence in all major cities with dedicated distribution, operations and risk management teams. RFL ensures highest process and risk equated quality to provide financial facilities to credit worthy customers.
The Company offered unsecured personal loans at fixed rates to specific customer segments, with focus on credit worthy individuals. The average maturity for such loans is 36 months. Since September 2008 it has discontinued Personal Loan business.
The total disbursements under unsecured loans, as on 31st March 2009 were Rs. 3,978.83 million with a total customer base of approximately 9,853.
The total disbursements under Consumer Finance, as on 31st March 2009 were Rs. 8,254.32 million.
Capital Markets Finance
Loan against Shares: RFL provides securities-backed lending facilities to clients. RFL's LAS business involves offering loans secured by shares held by its retail customers, which helps RFL leverage its equity market positions to take increased exposure.
IPO Financing: RFL provides IPO Financing facilities to clients with minimal incremental costs due to its existing infrastructure. Due to adverse market conditions the opportunity for IPO funding was scarce in FY 2008-09.
As clearly evident, RFL is in lending and distribution business and has to meet certain guidelines and reporting requirements as stipulated by the Reserve bank of India. This necessitates an efficient system to be in place that would help in improving internal efficiency and help RFL emulate and even surpass the best practices followed internationally. The company, due to the nature of the business, has to deal with certain risks and incorporate them in the decision making process. Therefore, a proper system is required that could not only meet the requirements of RBI but could also add value to the strategy formulation done by the senior management.
RFL, being a systemically important non-deposit taking NBFC (NBFC-ND-SI) has to meet certain requirements as suggested by RBI. These requirements are given in Annexure I. Therefore, it needs to develop an Asset Maturity Profile as a part of the Asset Liability Management (ALM). All NBFC-ND-SIs were required to fine tune their ALM systems by the FY 2008-09. The disclosure norms are now in effect and the company seeks to improve the existing system into a world class ALM system that would not only meet the regulatory requirements but would also help in dealing with different balance sheet risks. Suggestions are invited by the company regarding the effective implementation of such an ALM system. Among different risk exposures, interest rate risk is one of the areas of concern for the firm. One of the applications of ALM is in the area of managing the Interest Rate Risk (IRR) exposure. An asset liability profile based on maturity is helpful in undertaking the gap analysis whereby an idea of interest rate risk exposure can be obtained. The firm needs to keep a track of its assets and liabilities and more particularly on the gap between the assets and liabilities based on their maturity profile or re-pricing. Funds department, where the project has been granted, often needs the ALM maturity profile to fulfill the requirement of various lending institutions as well.
Moreover, interest rate risk is one of the major balance sheet related risk that the company faces. ALM maturity profile developed as a part of the regulatory requirement of RBI can be further analysed to get an idea of the interest rate risk exposure of RFL. The availability of such an indicator of the Interest Rate Risk will help the company remove the negative mismatch in the assets and liabilities. It also helps in developing a strategy for the future that would minimize the risk exposure. Suggestions were also invited on the incorporation of such analysis into the current ALM system.
Further, RFL has to very frequently meet financing needs as it is in the business of lending and distribution. Bank borrowings are one the primary source of capital for NBFCs in India. The company raises money through Term Loans (TL), Working Capital Demand Loan (WCDL) etc. The raising of a term loan requires the firm to undergo a series of procedures with the bank and further, for the servicing of the loan a separate team has to be put up. As the number of TLs and WCDLs is significant presently and the requirement for more is likely to arise keeping in mind the growth plans of the company, there is a need for timely servicing of loans and fulfillment of various covenants as stipulated by the lender from time to time. Suggestions are invited by the company for an improvement in the internal servicing of loans and streamlining of the related process.
Therefore, the following objectives have been finalized for the summer internship project:
To suggest the improvements that could be incorporated in the ALM system of the firm.
To study the ALM requirements for NBFC-ND-SI, given by RBI.
To examine the interest rate risk exposure of RFL, using the ALM maturity profile.
To understand the process of raising a term loan from a bank.
To suggest improvements in the servicing of loans so as to increase the internal efficiency.
1.2 Literature Review
For the abovementioned purpose a literature survey was done to know the work done in the past and also the current work/research being done in the particular area.
1.2.1 Asset Liability Management (ALM)
Asset Liability Management is the on-going process of formulating, implementing, monitoring, and revising strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerances and constraints.
ALM is used as a system of matching cash flows and thus of liquidity management. Typically two main types of risk viz. interest rate risk and liquidity risk are associated with balance sheet risks. The ALM system rests on three pillars:
ALM Information System (MIS)
ALM Organization (Structure and Responsibilities)
Fig. 3: The Three Pillars of ALM
Interest rate risk is the risk to earnings or capital arising out of interest rate fluctuations. It majorly arises from the differences between the timing of rate changes and the timing of cash flows, from changing rate relationship among yield curves that affect bank activities, from changing rate relationship across the spectrum of maturities, and from interest rate related options embedded in bank products. The value of assets, liabilities and interest rate related, off-balance sheet contracts is affected by a change in rates because the present value of future cash flows and in some cases the cash flows themselves, is changed. For measuring interest rate risk, a variety of methods such as Gap Analysis, the Duration Gap Method, the Basis Point Value Method, and Simulation Methods.
Gap Analysis is a technique of ALM that can be used to access interest rate risk or liquidity risk. It measures at a given date the gap between rate sensitive liabilities and rate sensitive assets by grouping them into time buckets according to residual maturity or next re-pricing period. An asset or liability is treated as risk sensitive if:
Within the time bucket under consideration, there is a cash flow.
The interest rate resets contractually during the time buckets.
Administered rates are changed.
It is contractually pre-payable or withdrawal allowed before contracted maturities.
Thus Gap is equal to the difference between risk sensitive assets and risk sensitive liabilities.
Gap ratio = risk sensitive assets/risk sensitive liabilities
This gap is used as a measure of interest rate sensitivity. The positive or negative gap is multiplied by assumed interest rate changes to derive the earnings at risk. An NBFC benefits from a positive gap, if interest rate rises and if negative gap is there than it is advantageous when the interest rates are falling. The interest rate risk is minimized if the gap is near zero.
Gap analysis was widely adopted by financial institutions when used to manage interest rate risk in tandem with duration analysis. There are many other methods that are quite sophisticated and use simulation software. The decision regarding the method to be chosen for the project is still underway. A detailed picture of all methods and reasons for choosing a particular method shall be discussed in greater detail in the final report.
1.2.2 Term Loans
The primary source of term loans is financial institutions. A term loan is a loan made by a bank/financial institution to a business having an initial maturity of more than one year. The financial institutions provide project finance for new projects as also for expansion/diversification and modernization whereas the bulk of term loans extended by banks is in the form of working capital term loan to finance working capital gap. The maturity period of term loans is typically longer in case of sanctions by financial institutions in the range of 6-10 yrs in comparison to 3-5 yrs of bank advances. The TLs are negotiated loans between the borrowers and the lenders. They are akin to private placement of debentures in contrast to their public offering to investors. All term loans are secured. While the assets financed by term loans serve as primary security, all other present and future assets of the company provide collateral/secondary security for the term loan. Generally, all the present as well as the future immovable properties of the borrower constitute a general mortgage/first equitable mortgage/floating charges for the entire institutional loan including commitment charges, interest, liquidated damages and so on. They are additionally secured by hypothecation of all movable properties subject to prior charge in favor of banks in respect of working capital finance/advance.
To protect their interest the financial institutions reinforce the asset security stipulation with a number of restrictive terms and conditions. These are known as covenants. They are both positive and negative in the sense of what borrower should or should not do in the conduct of its operations and fall broadly into 4 sets as respectively related to assets, liabilities, cash flows and control.
Asset related covenants are intended to ensure the maintenance of a minimum asset base by the borrowers. Included in this set of covenants are:
Maintenance of working capital position in terms of a minimum current ratio
Restriction on creation of further charge on assets
Ban on sale of fixed assets without the lenders approval.
Liability related covenants may, inter alia include:
Restraint on the incurrence of additional debt without the prior approval of the bank.
Reduction in debt-equity ratio by issue of additional capital
Prohibition on disposal of promoter’s shareholding.
Cash flow related covenants which are intended to restrain cash outflows of the borrowers may include:
Restriction on new projects without approval of the lender.
Limitations on dividend payment to a certain amount and prior approval of the lender.
Arrangement to bring additional funds as unsecured loans to meet shortfall
Ceiling on managerial salary and perks.
Control related covenants aim at ensuring competent management for the borrowers. This set of covenants may include:
Finalization of management setup in consultation with the lender.
Effective organizational changes and appointment of suitable professional staff.
Appointment of nominee directors to represent the financial institutions and safeguard their interests.
In addition to the foregoing negative covenants certain positive covenants stating what the borrowing firm should do during the term of a loan are also included in a loan agreement. They provide inter alia, for:
Furnishing of periodical reports and financial statements to the lenders.
Maintenance of a minimal level of working capital.
Creation of sinking fund for redemption of debt.
Maintenance of certain net worth.
III Results and Discussion
Table 1: Break Up of Assets and Liabilities
Interest Rate Shock
Table 2: Effect of Interest Rate Shock on Income Indicators
Table 3: NPV Values of Assets and Liabilities after Interest rate Shock
over 5 yrs
postive shock of 200bps
negative shock of 200bps
impact on asset side
impact on liability side
impact on equity
Table 4: Effect of Interest Rate Shock on Equity
The problem faced by the company also included the timely servicing and requirement to check the covenants of all loans before taking any major business decision. The paper work involved in grant of a TL is huge and a single file for a TL will have essential documents like Sanction Letter, Loan Agreement, Deed of Hypothecation, Power of Attorney, Demand Promissory Note etc. Now every time when the management undertakes a related decision, it becomes necessary for the manager to go through these documents and study each nuance in detail. All this is a time consuming process and seeing the dynamic requirements of business, it was felt that a one stop solution giving all critical information should be created. For this purpose a master file was created giving all critical information of each and every loan of RFL. For this, I read all the loan documents in detail and prepared summary sheets. A sample summary sheet is given hereunder (all the critical data has been disguised to maintain confidentiality)
Religare Finvest ltd.
ABC BANK- TERM LOAN OF RS. 100 CR (30 MAR 20XX)
Sanction Letter Date
Type of Facility
Working Capital Requirement for onward lending
INR 100 Crores
PLR i.e. 16.50% - 5.15% (i.e an effective rate of 11.35% p.a)
1. First pari passu charge on all present and future standard Non Capital Market Receivables of the borrower with a cover of 1.XX times
2. Non disposal undertaking from REL
INR 50,000+ taxes
36 equal monthly instalments from the date of first disbursement
Religare Finvest Ltd.
ABC BANK- TERM LOAN OF RS. 100 CR (30 MAR 20XX)
Covenants to be met on frequent basis
Statement of stocks and book debts, on a monthly basis, to be submitted latest by 25th of subsequent month
Unaudited half yearly income statement within 60 days of the close of each semi-annual period, to be submitted.
Originally signed or certified true copy of audited financials to be submitted within 180 days after the close of each FY
Not to create assume or incur any further indebtedness of a long term nature whether for borrowed money or otherwise, except with prior written consent of the bank
Not to enter any scheme of merger, amalgamation, compromise or reconstruction without prior written consent in case the rating of RFL would fall below P1/F1/A1 subsequent to such a scheme
Prior written consent required for transfer or creating any charge, pledge, hypothecate lien, mortgage, encumbrance or security over assets specifically charged to the bank.
The borrower shall, with the previous consent of the lender, be at liberty from time to time to sell or dispose off in any manner otherwise than in the ordinary course of business, the hypothecated assets or any part thereof provided the value of such hypothecated assets realised, is utilised to repay the facility.
Event of Default
If any of the events has occurred, then, the bank will be entitled to terminate or suspend the facilities with immediate effect. The event of default include:
Any of borrower's or any security party/issuer's indebtedness towards any creditor exceeding an aggregate amount of INR 10,000,000 or its equivalent as determined by us is not paid when due pursuant to court order, decree or judgement to which there lies no appeal, will be considered as an event of default.
An event of default occurs if it is certified by an accountant of a firm of accountants appointed by the bank that the liabilities of the borrower exceed the assets or the borrower is carrying business at loss.
If a receiver is appointed in respect of the whole or any part of the property/asset of the borrower, it'll count as an event of default
An event of default occurs upon happening of any substantial change in the constitution or management of borrower without previous written consent of the bank or upon the management ceasing to enjoy the confidence of the bank.
Change in material ownership structure of the borrower constitutes an event of default
The rates of interest and periodicity of payment stated above are valid until further notice and are subject to our internal reviews and or changes in externally prevailing directives of regulatory authorities.
In case disbursement/drawls/utilisation of loan or any part thereof are made pending creation & perfection of full and final security in favour of YES Bank (unless a specific time frame granted by YES BANK), borrower shall pay additional interest @ 2% p.a. over& above applicable interest/commission from 1st draw down date till the date of final security is fully & finally created and perfected to the satisfaction of YES BANK.
Additional interest & default interest @2%P.a. or such other rate as the Lender deems fit will be levied over & above applicable ROI.
Increased cost shall be paid by the borrower as a result of: (1) the introduction of, or any change in, or any change in the interpretation, administration or application of, any law or regulation (2) compliance with any law or regulation made effective after the date of this facility letter.
Increased cost shall mean: (1) introduction of new taxes or any increase in the taxes such as interest tax etc by the Govt of India will be fully borne by the borrower (2) increase in risk weightage of the loan: 25 bps increase in risk weightage by the regulatory authorities would result in increase of 25 bps in the interest rate for the loan (3) increase in provisioning for the loan: 100 bps increase in provisioning, by the regulatory authorities would result in increase of 25 bps in the interest rate for the loan.
Holding of REL not to fall below 51% of the RFL share capital.
Not to transfer or assign any of the rights, obligations, interest, or benefits under the agreement to any other person.
If credit worthiness deteriorates, in lender's sole opinion, and /or when the rating has been downgraded by the credit rating agency in its report then the bank shall be entitled to unconditionally cancel the facility without any notice and upon such cancellation, the outstanding facility shall immediately become due and payable irrespective of any agreed maturity and the bank shall be entitled to enforce security.
If at any time the value of the said securities falls so as to create a deficiency in the margin requirement specified by the bank from time to time or if there is an excess over the loan amount, the borrower shall within seven days of notice from the bank, deposit with the bank additional security in the form of cash or such other securities which may be acceptable to the bank, falling which the bank may at its discretion sell, dispose off or realise any or all of the said securities without being liable for any loss or damage or diminution in value sustained thereby.
The division of various covenants under different heads is done on the basis of functional needs rather than any academic classification given in the literature review section. Above information is only for a term loan, when all such information is combined for all the facility, then it becomes much easier for a manager to take a quick and well informed decision.
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