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Big NBFCs need more scrutiny, failure can cause huge losses: RBI report

RBI says the IL&FS defaults and the ensuing stress helped bring market discipline to the non-bank sector (Photo: Abhijit Bhatlekar/Mint)Premium
RBI says the IL&FS defaults and the ensuing stress helped bring market discipline to the non-bank sector (Photo: Abhijit Bhatlekar/Mint)

  • Non-bank lenders have seen their sources of funds dry up after defaults by IL&FS, says RBI's Financial Stability Report
  • The NBFC sector’s gross bad loans as a proportion of total loans increased from 5.8% in 2017-18 to 6.6% in 2018-19

MUMBAI : The Reserve Bank of India called for greater surveillance on large entities in India’s shadow banking sector as their failure could lead to losses that are similar to those of big banks.

“Solvency contagion losses to the banking system due to idiosyncratic HFC/NBFC failure show that the failure of largest of these can cause losses comparable to those caused by the big banks, underscoring the need for greater surveillance over large HFCs/NBFCs," the central bank said in the Financial Stability Report released on Thursday.

Non-bank lenders have seen their source of funds suddenly dry up after a series of defaults by Infrastructure Leasing & Financial Services Ltd (IL&FS) that triggered a liquidity crisis. Banks and mutual funds reduced lending to non-banking financial companies (NBFCs) and housing finance companies (HFCs), creating a cash crunch and forcing the shadow lenders to sell assets and cut back on new loans.

The payment defaults by IL&FS and the ensuing stress helped bring greater market discipline to the NBFC sector “in a way", with the better-performing companies able to raise funds and others finding it difficult to do so, RBI said in the report for June. It is published twice a year—in June and December.

“In a way, the IL&FS stress episode brought the NBFC sector under greater market discipline as the better performing companies continued to raise funds while those with asset quality concerns were subjected to higher borrowing costs," it said.

In the commercial paper (CP) market, the RBI said, absolute issuances by NBFCs have declined sharply from pre-IL&FS default levels. During the stress period, CP spreads of all entities had increased, particularly those of NBFCs, highlighting a reduced risk-appetite for them, it said.

The central bank said that subsequently, CP spreads for NBFCs have reduced and the gap with other issuers has narrowed.

As of 31 March 2019, there were 9,659 NBFCs registered with the RBI, 88 of which were deposit accepting and 263 systemically important non-deposit accepting NBFCs.

The recent developments in the non-bank space have brought the focus on the NBFC sector (including housing finance companies) especially with regard to their exposures, quality of assets and asset-liability mismatches (ALM).

“The liquidity stress in NBFCs reflected in the third quarter of the last financial year (September-December 2018) was due to an increase in funding costs as also difficulties in market access in some cases," it said.

Bank borrowings, debentures and commercial papers are the major sources of funding for NBFCs.

Bank borrowings as a share of total borrowings have increased from 21.2% in March 2017 to 23.6% in March 2018 and further to 29.2% in March 2019. During the same period, dependence on debentures declined from 50.2% in March 2017 to 41.5% in March 2019.

“This indicates that banks are compensating for the reduced market access for NBFCs in the wake of stress in the sector. The top 10 NBFCs accounted for more than 50% of total bank exposure to the sector while the top 30 NBFCs (including government owned NBFCs) accounted for more than 80% of the total exposure," said the report.

Meanwhile, the consolidated balance sheet size of the NBFC sector grew by 20.6% to 28.8 trillion during 2018-19 as against 17.9% to 24.5 trillion during 2017-18. The sector’s gross bad loans as a proportion of total loans increased from 5.8% in 2017-18 to 6.6% in 2018-19. As of March 2019, the capital adequacy ratio of the NBFC sector moderated at 19.3% from 22.8% in March 2018.

The central bank also conducted stress tests on the NBFC sector and on individual lenders in order to gauge their resilience in an event of three stress scenarios—baseline, medium and severe. The tests showed that under the first two scenarios, around 8% of the companies will not be able to comply with the minimum regulatory capital requirements of 15%. “Around 13% of the companies will not be able to comply with the minimum regulatory capital adequacy norms under the third scenario," the report said.

Non-banks have not been able to absorb the shock caused by IL&FS defaults and the consequent shortage in funds available to them.

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