NBFCs' challenges could intensify following Yes Bank restructuring: Fitch

India's non-bank financial institutions (NBFI) will likely face renewed pressure on funding and liquidity following the RBI's takeover of Yes Bank this month, Fitch Ratings said on Wednesday.

"The consequences will compound the credit squeeze across the country's financial system, adding to current economic uncertainty," it said.

The move on Yes Bank comes as the impact of the coronavirus is beginning to be felt in India, raising further risks to economic growth and non-banking finance companies' asset quality. "Rising asset quality and funding risks will place pressure on ratings if conditions worsen materially," it said.

The Reserve Bank of India (RBI) last week seized Yes Bank after noticing a surge in withdrawals by depositors.

"The NBFI sector's direct exposures to Yes Bank should be modest as a whole. Yes Bank's issues have been known for some time, and companies have had time to pare back any exposure to the bank over the past year.

"Yes Bank's advances to NBFIs equated to roughly 1-2% of the NBFI sector's total bank funding, and the sector's asset exposures to the bank would be similarly moderate," Fitch said, adding the recent announcement may bring about broader contagion effects for NBFI funding conditions.

The RBI's planned reconstruction scheme broadly protects the deposits and liabilities of the bank, but calls for a writedown of its Basel III AT1 instruments at present. "This may trigger another round of investor risk aversion that tightens market access and raises overall funding costs for borrowers, with wholesale NBFIs likely to remain more vulnerable in this situation," it said.

There may also be knock-on effects for NBFIs if smaller private banks start to face deteriorating depositor confidence.

Banks have been an important source of liquidity for NBFIs amid the funding squeeze in the local debt markets over the past 18 months, and any weakness in bank deposit funding would constrict liquidity available for lending to the NBFI sector.

"An extended credit squeeze will likely exacerbate asset quality risks for the financial sector including NBFIs, which are already facing pressure from a general economic and property-sector slowdown, and an evolving COVID-19 situation," it said. "The asset quality risks that have been largely centred on wholesale property development would, in Fitch's view, start to broaden if the economy becomes more adversely affected."

These events add to the challenging operating environment for Indian NBFIs, with rising uncertainty over funding conditions in the near term.

Fitch said it will be monitoring the rated NBFIs' funding access and liquidity positions closely over the near term, and will assess the broader economic impact of recent developments on potential asset quality trends for any signs of deterioration that may have an impact on the ratings.