“Chasing lower marginal cost of funding in order to retain or acquire market share in lending is a myopic strategy. It is associated with a significant roll-over risk in the medium term and this practice appears to have led to a form of maturity rat race in the financing of the sector,’’ Acharya warned.

He added that a rising asset liability mismatch because of this practice can be an imprudent policy in a time of global and domestic tightening conditions.

“It is best to avoid this in order to safeguard financial firms as well as for overall financial stability,’’ he said.

Deputy governor N.S. Vishwanathan said that in the last two years, NBFCs have expanded massively and relied on diverse sources of funding, including the short-term commercial papers.

Commercial paper is an unsecured money market instrument issued in the form of a promissory note. Corporate houses, primary dealers and financial institutions are eligible to issue these instruments. They can be issued for maturities between a minimum of seven days and a maximum of up to one year from the date of issue.

Vishwanathan said in the case of a few NBFCs, especially the infra focussed ones who lend long term, this has created asset liability management issues as the liabilities need to be rolled over consistently.

I would like to encourage all financial firms to place greater reliance on equity and other modes of long-term finance

Viral Acharya

The Reserve Bank of India (RBI) on Friday had some tough words for the country’s non-banking finance companies (NBFCs) whose reliance on short-term funds had triggered concerns of an asset-liability mismatch. The RBI is now planning to tighten some of the rules in this regard.

RBI deputy governor Viral Acharya asked such firms to focus more on equity and other means of long-term finance, instead of short-term instruments.

NBFCs had been raising such short-term funds as they came at a cheaper rate. However, it led to an asset liability mismatch (as their lending was of a long-term nature) on their books. In a higher interest rate scenario, it had also exposed them to rollover and re-pricing risks.

“I would like to encourage, in fact urge, all financial firms to place greater reliance on equity and other modes of long-term finance for funding of long-term assets, rather than rely excessively on short-term wholesale paper.