Banks that lend to NBFCs may face increase in their bad loans: Moody's

Banks may see a spike in bad loans because of stress in the non-banking financial company (NBFC) sector, rating agency Moody’s said on Friday, warning that the trend of improvement in key bank metrics is likely to reverse or slow.

Large exposures to NBFCs and the sectors they lend to — such as real estate — leave banks vulnerable, it said. And, the weakening of NBFCs’ capacity to lend to retail borrowers and small and medium-sized enterprise (SMEs) may add to pressures on asset quality of banks.

“The funding challenges at NBFCs are raising asset risk for banks. This is happening in an economy that has grown increasingly dependent on non-bank lenders. It is credit negative for banks,” it said.

“NBFCs and banks are stuck in a negative feedback loop. They have been forced to reduce lending, raising refinancing pressure among borrowers, and translating back into loan defaults and further stress for NBFCs.”

Srikanth Vadlamani, vice-president and senior credit officer, said: “This rising stress among NBFCs, in turn, means that nonperforming loans at the Indian banks that lend to them are very likely to rise.”

Stress is particularly evident in the real estate sector, where developers often lack the cash flow to fulfill their debt obligations, and are reliant on NBFC funding to roll over obligations.

With real estate companies already facing significant stress, tighter funding will only add pressure and weaken loan performance. Pockets of stress also exist in the retail and SME sectors, both of which have grown rapidly in recent years and are heavily reliant on NBFC funding, it added.