RBI Financial Stability Report: Pandemic May Intensify Systemic Risks For NBFCs

India’s NBFCs have been facing considerable stress since the IL&FS Crisis in September 2018.

Pedestrians walk past the Reserve Bank of India (RBI) in Mumbai, India, on March 3, 2020. (Photographer: Kanishka Sonthali/Bloomberg)
Pedestrians walk past the Reserve Bank of India (RBI) in Mumbai, India, on March 3, 2020. (Photographer: Kanishka Sonthali/Bloomberg)

Business interruptions linked to the coronavirus pandemic may intensify systemic risks for India’s non-banking financial companies as they face pressure on assets and liabilities.

NBFCs have been facing stress since September 2018 when subsidiaries of the IL&FS group defaulted on loan repayments. While most non-bank lenders have reduced their asset-liability management issues and are relying more on bank funding, the coronavirus outbreak can intensify systemic risks, or vulnerabilities due to market-related or economic events, the Reserve Bank of India said in its bi-annual Financial Stability Report.

“Stress on NBFCs and cooperative banks, that had mounted in the wake of credit events in 2019, has been exacerbated by risk aversion and flight to safety among banks, leading to funding constraints and differentiation in market access,” the report stated. “The outlook remains clouded with considerable uncertainty as the pandemic takes its toll.”

Small and mid-sized NBFCs rated AA or below may face accentuated liquidity risks as banks and debt markets stay away from lending to these firms, according to the report.

Given uncertainty over cash flows because Covid-19, the report said that market borrowings of private NBFCs and housing financiers maturing in the short term become relevant. Such lenders have Rs 75,164 crore worth of commercial papers and bonds maturing between July and September. Of these, more than Rs 52,000 crore belong to AAA-rated companies, it said.

Around 50% of non-bank loan assets, on aggregate, are under loan moratorium as of April 2020, it said.

The gross non-performing ratio of the NBFC sector rose in March, although it had been declining till December 2019. The capital adequacy ratio of the sector fell to 19.6% in March from 20.1% a year ago.

Stress Tests And Contagion Losses

The NBFC sector’s capital-to-risk weighted assets ratio may decline to 17.2% from 19.4%, if the gross bad loans were to deteriorate under a baseline scenario, according to stress tests conducted by the RBI.

The sector’s capital to risk assets ratio will decline to 15.2% if the gross NPAs were to rise significantly under the very stressed scenario.

The report said 11.2% of non-bank lenders wouldn’t be able to comply with the regulatory minimum CRAR ratio of 15% under the baseline scenario, and 19.5% companies would fail to comply under a very stressed scenario.

“NBFCs and housing finance companies are the largest borrowers of funds from the financial system. A substantial part of this funding comes from banks,” the report said. “Therefore, failure of any NBFC or housing finance company will act as a solvency shock to their lenders which can spread by contagion.”

The contagion risks of a failure of an NBFC or housing financier, according to the RBI report, has increased as of March compared to December. But thanks to a better capitalised public sector banking system and a shrinking inter-bank market, banks are more immune to contagion risks.

A failure of any of the top three state-owned NBFCs could knock off between 4.3% and 5% of the banking system’s tier-1 capital, while the failure of private NBFCs could lead to an erosion of 2.7%, the report said. The failure of a mortgage lender would knock off 6.77% of banks' tier-1 capital.

The RBI, however, reiterated that a failure of an NBFC or a housing finance company would not lead to a failure of any bank.

Also Read: Bank NPAs Could Rise To Highest In 20 Years In FY21: RBI FSR July 2020

Impact of T-LTROs

The RBI, in February, began pumping in liquidity into the financial system through long-term-repo operations to enable better transmission of its monetary policy.

Between February and March, it had provided LTRO funds worth Rs 1.25 lakh crore. It later infused targeted LTRO funds worth Rs 1 lakh crore as part of its response to the Covid-19 outbreak.

These measures brought down yields on treasury bills and longer-dated government papers and on money market instruments like commercial papers and certificate of deposits.

“Borrowing costs in financial markets have dropped to their lowest in a decade on the back of abundant liquidity ... Abundant liquidity conditions along with three-year LTROs have anchored the short-term government security yields closer to the policy repo rate,” the report said.

As a result of lower borrowing costs, there were record fresh corporate bond issuances worth Rs 2.09 lakh crore in the first quarter of 2020-21.

Also Read: RBI FSR July 2020: Shaktikanta Das Focuses On Stability Post-Pandemic