Increase in Systemic Risks For NBFCs

Non-banking financial companies (NBFCs) in India have been in the news for a while now. The Covid-19 pandemic and the lockdowns that have followed have impacted several sectors but it has particularly affected the NBFC sector. However, the crisis first began in 2018, following the collapse of Infrastructure Leasing & Financial Services (IL&FS).

In 2018, once IL&FS defaulted on repayment of a loan it had borrowed from Small Industries Development Bank of India (SIDBI), it got into a debt cycle. Soon, there was news of other NBFCs in a similar situation as investors started losing faith, with NBFC market capitalisation getting depleted. According to news reports (*) NBFC funding provided by mutual funds also started dipping. According to a SEBI report, debt mutual fund exposure to the NBFC sector fell by 20 per cent y-o-y in August 2019. (**) For the NBFCs, liquidity became a huge issue and there was a lack of confidence among investors about the sector.

Interventions to strengthen NBFCs

On top of the 2018 NBFC events came the Covid-19 crisis and the lockdown in late March. The RBI offered a three-month moratorium for repayment of loans and allowed banks to decide if they wished to offer a moratorium for repayment of loans to NBFCs. The moratorium was eventually extended and stays in place till August end. Further, the finance ministry announced a special liquidity scheme in early July to provide financing for stressed NBFCs and housing finance corporations (HFCs). As many as 15 proposals to the tune of nearly Rs 6,400 crore were cleared as of August 7, according to the Finance Ministry.

In spite of these announcements, the warning bells of an increase in systemic risks for NBFCs have been rung. Towards the end of July, the RBI released its Fiscal Stability Report(***), which points out that there are further risks to the NBFC sector, which would eventually pose a systemic risk to the financial sector on the whole. The report notes that NBFCs were the biggest fund borrowers from the system, and as of March end this year, they had to make gross payments to the tune of over Rs 8 lakh crore. The second biggest borrowers were HFCs.

Most of the funding that NBFCs needed were availed from scheduled commercial banks, while the remaining was made up for by borrowings from asset management companies-mutual funds and insurance firms. The RBI’s report mentions that a failure on the part of any of the NBFCs or HFCs will pose a shock to the lenders (majority of whom are banks) and this shock may be contagious. The report also notes that NBFCs’ excessive dependence on funding from banks turns them “uncompetitive”.

Further, in spite of banking support, liquidity risks for NBFCs come from decreasing borrowings from the market. The RBI report notes that anywhere between 11.2 and 19.5 per cent of NBFCs would not be in a position to meet the minimum capital adequacy ratio or CRAR of 15 per cent under stress tests. This percentage is the ratio of the NBFC’s capital to its risk.

NBFC health matters

Non-banking financial companies play a key role in fulfilling credit requirements alongside banks. The RBI’s July 2020 report notes that there were a little over 9500 NBFCs registered with the central bank as of September 30 last year. The total assets of NBFCs and HFCs (as of March 2019) ran into Rs 44.4 lakh crore, with the NBFC share at 70 per cent. It is important that NBFC health is taken care of, so the financial system is able to recuperate post pandemic.

A recent World Bank report, titled India Development Update, stresses the need for reforms in the NBFC sector. The report suggests that in order to empower the sector, the recent liquidity scheme could be made institutional. The report notes this and other reforms such as boosting fintech, public sector bank consolidation among others would help boost financial reforms. It adds that these reforms may be the way ahead to ensure that the economy is back on its track.

In conclusion

The NBFC sector has been under a lot of strain ever since the IL&FS crisis in 2018. It has been saddled with liquidity and funding issues. The pandemic has further posed a strain on the sector. The government, along with the RBI, has launched schemes to boost the sector. It needs to be seen if the systemic risk to NBFCs is taken note of and reforms put into place to ensure a sound financial system.

What about the common investor? The health of NBFCs notwithstanding, investors should continue to make prudent choices and pick options that suit their personal goals. If you have not invested before, it’s time you open a demat and trading account now, and pick your options such as e-gold, FDs or the best mutual funds. A good assessment of one’s risk tolerance, goals and investment horizons will help the investor make appropriate choices.