Money & Banking

NBFCs: ‘Health Score’ can sound an alert

K.R.Srivats New Delhi | Updated on January 31, 2020 Published on January 31, 2020

This diagnostic tool can be used as an early warning system to anticipate liquidity crisis

The funding crunch in the economy caused by the crisis in the non-banking finance company (NBFC) sector (IL&FS, DHFL etc) over the last two years has prompted the government to take a holistic view of financial fragility.

It has, through the Economic Survey, mooted the concept of ‘Health Score’ as a measure of health of an NBFC. This diagnostic tool can be used as an early warning system to anticipate liquidity crisis, according to the Survey.

The Survey has through analysis established that firms in the NBFC sector are susceptible to “rollover risk” when they rely too much on the short-term wholesale funding market for financing their investments in the real sector.

POLICY INITIATIVES

The Survey has suggested a slew of policy initiatives that can be employed to arrest financial fragility in the shadow banking system. It has suggested that regulators can employ the Health Score methodology to detect early warning signals of impending roll-over risk problems in individual NBFCs. Downtrends in the Health Score can be used to trigger greater monitoring of an NBFC.

When faced with a dire liquidity crunch situation, as experienced recently, regulators can use the Health Score as a basis for optimally directing capital infusions to deserving NBFCs to ensure efficient allocation of scarce capital, the Survey has suggested.

Health Score can also be used to set prudential thresholds on the extent of wholesale funding that can be permitted for firms in the shadow banking system. This norm would be consistent with macro-prudential regulations that are required to internalise the systemic risk concerns arising due to an individual NBFC’s financing strategy. These norms could be counter-cyclically adjusted because the seeds of a liquidity crunch are sown during the good times, the Survey has suggested.

PUBLIC SECTOR BANKS

In the case of public sector banks, the Survey has suggested the use of fin-tech. Bank employees can be provided with employee stock option plans (ESOPs) to enable them to become owners in the banks. ESOPs will incentivise them to embrace risk-taking and adopt innovation continually, according to the Survey.

EXPERT TAKE

Finance Industry Development Council (FIDC) Co-Chairman, Raman Aggarwal, said the idea of a health score is a good one. The suggestion that the Government should fund deserving NBFCs based on the Health Score is broadly in line with what the FIDC has been saying.

However, the concept and methodology of calculating the score needs wider discussion. “This needs discussion because the basic premise that NBFCs are over dependent on liquid debt mutual funds is something that we don’t agree with”, Aggarwal said.

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Published on January 31, 2020
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