The contagion of funding stress at non-banking financial companies (NBFCs) is raising asset risks for banks and this will hinder improvements in banks’ asset quality, profitability and capital, said credit rating agency Moody’s Investors Service on Friday.
According to Moody’s, the tight funding for NBFCs—a consequence of the default by Infrastructure Leasing and Financial Services (IL&FS) in September 2018—is raising asset risks for banks in an economy that has grown increasingly dependent on non-bank lenders for credit.
“Funding difficulties are forcing NBFCs to reduce lending, resulting in funding constraints for borrowers relying on non-bank lenders. NBFCs are major providers of loans to the real estate sector, as well as structured or equity-backed loans to controlling shareholders of large companies in various industries," it said.
These borrowers have had relatively easy access to credit in the past few years with finance companies aggressively pushing high-yield loans to them. Among the 19 largest NBFCs by assets, excluding government-owned companies, 10 have such exposures, the report said.
“Borrowers of NBFCs, particularly real estate developers, often do not have sufficient cash flow to fulfil their debt obligations, so they are reliant on funding from NBFCs to roll over their obligations. Tighter availability of credit from NBFCs will create even more stress at corporates relying on finance companies for funding, and this will lead to more defaults on NBFC loans," said Moody’s.
Meanwhile, as financial health of NBFCs deteriorates due to more loan losses, Moody’s said, they will have greater difficulty obtaining funding, which will exacerbate their funding constraints.
“This can result in more non-performing assets (NPAs) from NBFCs for banks. Also, as NBFC customers’ financials weaken, banks will reduce lending to them and, this in turn, will further worsen their funding stress and can ultimately lead to more NPAs from these companies for banks," it said. According to Moody’s, real estate companies are under significant stress, and tighter funding will further increase stress in the sector. Developers are grappling with a large inventory of unsold properties that will take several quarters to clear as high prices continue to deter sales. Moody’s explained that real estate companies have been financing unsold projects with borrowings, primarily from finance companies and, as a result, NBFCs that lend to the real estate sector have grown fast.