Funding trouble for NBFCs could result in asset risks for banks: Moody’s

Our Bureau Raising a red flag over the turbulence in the country’s financial sector, a report by Moody’s Investor Services has warned that the continuing liquidity crunch for non banking financial companies could lead to more bad loan risks for banks.

“Tight funding for NBFCs – a consequence of the default by IL&FS, an infrastructure development and finance company, in September 2018 – is raising asset risks for banks in an economy that has grown increasingly dependent on non-bank lenders for the provision of credit,” the report said.

Faced with funding difficulties, many NBFCs are cutting down their lending to borrowers that includes the real estate sector, and structured or equity-backed loans to controlling shareholders of large companies in various industries.

“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,” the report said.

These borrowers have had relatively easy access to credit in the past few years as finance companies have aggressively pushed for high-yield loans to them, it further said, adding that among the 19 largest NBFCs by assets, excluding government-owned companies, 10 have such exposures.

‘Feedback loop’

It also highlighted that banks and NBFCs are in a “feedback loop”, particularly through exposures to the real estate sector. “Real estate companies are under significant stress, and tighter funding will further increase stress in the sector,” the report said.

It further warned that as the financial health of NBFCs deteriorates due to more loan losses, they will have greater difficulty obtaining funding, which will further exacerbate their funding constraints. “This can result in more NPLs from NBFCs for banks,” it said.

The report also said that as the 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 NPLs from these companies for banks.

Loans to retail consumers as well as small and medium enterprises are another important borrower segment for these shadow banks or NBFCs, the report noted.

While this segment has grown rapidly in recent years, it is more now vulnerable to asset quality deterioration in the backdrop of the slowing economy.

“A curtailing of lending by NBFCs will add to risks from retail loans for banks by reducing the availability of credit that individuals can use for refinancing and by contributing to the economic slowdown,”the report further warned.