Gains in restoring financial stability may face rough weather due to credit and liquidity stress in non-banking financial companies (NBFCs) in India, according to the Annual Report of the Reserve Bank of India (RBI).
The aggregate demand is slowing in a broad-based manner.
These concerns are, however, being addressed by the RBI, according to the Annual Report for 2018-19, released on Thursday.
India’s macroeconomic stability provided a silver lining. But it is unclear whether this stability mitigated a deeper loss of activity or it reflected the symptoms of the slowdown itself. This dilemma becomes all the more acute when juxtaposed with issues relating to financial stability.
The ongoing repair of banks’ balance sheets and rebuilding of capital buffers have brought about a plateauing of stressed assets and a rekindling of credit flows in anticipation of the reinvigoration of growth impulses, it said.
NBFCs account for around 12 per cent of the assets of the banking and non-banking space. Yet, the emergence of stress following isolated but large credit events and a wider perception of liquidity shortages reveal the degree of interconnectedness in the financial system and the systemic ramifications, the report says.
The ongoing strengthening of the liquidity and regulatory framework for NBFCs will be informed by this experience, especially in efforts to remove regulatory arbitrage, the report concludes.
While the mounting overhang of the impaired assets inhibited lending by the banking system, NBFCs have stepped in to intermediate resources to various sectors of the economy, notes the report.
As the events of FY19 show, there were irrational exuberance and considerable overleveraging, with asset-liability mismatches in NBFCs.
The fall of the IL&FS group and the resultant negativism towards the sector account for the near 20 per cent plunge in the flow of credit to the commercial sector from non-banking lenders in FY19.
Commercial credit flows from NBFCs stood at Rs 9.34 trillion in FY19, down from a high of Rs 11.60 trillion in the previous financial year.
“The decline in flows from non-banking entities was mainly on account of the lower flows from non-deposit taking systemically important NBFCs (net of bank credit to NBFCs) and housing finance companies, particularly in the aftermath of IL&FS fall,” says the report.
The decline continued into the first quarter of FY20 as well, with lending by NBFCs to the commercial sector dipping to Rs 2.44 trillion from Rs 2.83 trillion in the first quarter of FY19.
A series of defaults by cash-strapped IL&FS, starting September last year, led to a liquidity crisis in the system, especially for NBFCs, housing finance companies, and mutual funds. The IL&FS group, under insolvency, owes over Rs 99,000 crore to the system.