Health index can signal early signs of liquidity risks in NBFC sector

Usage of the Health Score index by regulators can detect early signs of impending liquidity risks in the shadow banking sector. Downtrends in the index can be used to trigger greater monitoring of non-banking financial companies (NBFCs). The health score of the housing finance sector after 2014 exhibited a declining trend and it had worsened by 2019. Similarly, the retail-NBFC index was consistently below par from 2014 to 2019.

The Survey found that NBFCs raise capital from the commercial paper (CP) market at lower cost and face risk of rolling over the CP debt at short frequencies. Since liquid debt mutual funds (LDMF) are the main funding source for NBFCs for short-term debt, any asset side shock to the NBFC, which puts its asset liability management at risk, ends up posing a systemic risk to the LDMF sector. There is also an increased likelihood of concerted redemption by investors across the entire LDMF sector leading to fire sales of LDMF assets. These redemptions increase roll-over risk in a vicious cycle for the stressed NBFCs.

There is a shift in funding sources for NBFCs at present. Bank borrowings has increased 27 per cent over a one-year period. Credit deployment by mutual funds has been contracting since October 2018. The share of CPs decreased 31.2 per cent, while the share of NCDs increased 7.7 per cent.