The unfavorable market condition has resulted in declining share of long-term market debt in the liability profile of shadow banks, and the gap has been filled by bank funding.
The declining market funding for non-banking financial companies (NBFCs) is a cause for concern as it has the potential to heighten the liquidity risks the sector is already facing after the IL&FS debacle, the Financial Stability Report (FSR) of the Reserve Bank of India (RBI) said.
While market funding for the sector as a whole has reduced, the sufferers because of this have been smaller NBFCs. Smaller, mid-sized NBFCs, which are AA or below rated, as well as unrated entities have been shunned by the banks and markets, accentuating the liquidity tension faced by NBFCs, which was also reflected in the lacklusture response to targeted long-term repo operations (TLTRO 2.0). Only half of the money on offer by the RBI was taken by banks in the auction that was supposed to provide liquidity to NBFCs at cheaper rates.
Long-term market funding in terms of non-convertible debenture (NCDs) in NBFCs liability portfolio have reduced to 40.8 per cent by December 2019 from 49 per cent in March 2017, and the gap has been mostly filled by the banks as bank funding to NBFCs went up to almost 30 per cent from 23 per cent in the same period.
The shadow banking sector has been grappling with funding issues since the IL&FS debacle. Even the banks became risk-averse to lend to smaller NBFCs, but the larger ones with good ratings and parentage have been able to raise funds from the market at rates that are lower than the rates prevailing in pre-IL&FS era. As a result of the funding issues, NBFCs started maintaining liquidity buffer of two-three months, despite higher costs. With the Covid situation unfolding, the RBI foresees risks to the sector and consequently, systemic risks may intensify.
The RBI feels that IndAS accounting could impinge on the balance sheet risks, especially asset quality and provisioning; finances of NBFC-MFIs and contagion from mutual funds due to redemption pressures and customer confidence.
The Covid situation and the subsequent moratorium announced by the RBI have resulted in a huge liquidity and ALM issue for the sector as collections dropped. According to RBI’s estimate, 39-65 per cent of assets of NBFCs were under moratorium and the impact of this on the sector can be substantial. Assets under moratorium of the sector are dominated by wholesale customers and real estate developers, although retail portfolios in the micro loans and auto loan segments have been affected.
The central bank feels the partial credit guarantee scheme of the government is extremely crucial for the NBFC sector because Covid and the moratorium have created a cash flow problem in the sector. And with significant short-term maturities coming up, the government scheme may provide the much-needed liquidity required to the sector. In July, the sector is seeing maturities of CPs and NCDs to the tune of Rs 38,117 crore, Rs 34,171 crore in August, and Rs 18,750 crore in September.
The government has tried to provide liquidity support to NBFCs via the special liquidity scheme and the partial credit guarantee scheme.
Stress test conducted by the RBI has revealed that the capital adequacy ratio of the shadow banks may deteriorate and similar stress tests on individual NBFCs have revealed that 11-20 per cent of the entities may be found wanting on their regulatory capital requirements.
While the sector was facing liability issues, the asset side was not as bad as it was for the banks. But, with gross non-performing assets declining for successive quarters till December 2019, it surged in March 2020 and GNPA reached 6.4 per cent from 5.9 per cent in December 2019.
The net NPA ratio was marginally lower in March 2020 quarter than the previous year. The capital adequacy of the sector stood at 19.6 per cent in March 2020, which was lower than its level a year ago.