‘NBFCs need scrutiny, failure can cause losses’: RBI

The Reserve Bank of India (RBI) 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 (housing finance companies/non-banking financial companies) 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 (FSR) 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 that triggered a liquidity crisis. Banks and mutual funds reduced lending to NBFCs and 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, the 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 March 31, 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 HFCs) 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 CPs 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 lakh crore during 2018-19 as against 17.9% to ₹24.5 lakh crore 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.