A Big Non-Banking Lender Failure Can Cause Huge Losses (Download PDF)

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The Non-Banking Financial Companies gross bad loans increased from 5.8 % in 2017 - 18 to 6.6 % in 2018 - 19. RBI expressed a concern of greater surveillance on large entities in India’s shadow banking sector as their failure could lead to losses that are similar to those of big banks.

The government took over the operations of Infrastructure Leasing and Financial services because of the series of defaults.

This Image of Reserve Bank of India

This Image of Reserve Bank of India

This Image of Reserve Bank of India

Overview

  • The RBI in its latest Financial Stability Report expressed that the potential losses in the event of the failure of a large housing finance company or non-banking financial company underscore “the need for a greater surveillance upon these firms”.

  • After Infrastructure Leasing and Financial services (IL&FS), Other weaker lenders such as Dewan Housing Finance Corp. and Anil Ambani’s Reliance Capital Ltd. are struggling, putting the loans they received from a handful of the regulated banks at risk.

RBI’S Concern & Steps

  • Indian banks have extended about 7 % of their loans to NBFCs. Additional risks stem from their investments in the companies’ bonds.

  • NBFCs and HFCs have funded themselves by borrowing from banks, mutual funds, insurers, and pension funds, exposing other financial firms in the event of a default.

  • The failure of HFC with the maximum capacity to cause solvency losses will lead to a loss of 5.8 % of the tier-1 capital across the banking system, and the failure of one bank, according to the RBI stress tests.

  • The failure of the equivalent NBFC would result in the loss of 2.7 % of total tier-1 capital and also lead to a bank failure, the RBI added.

  • In May 2019, the RBI plans to tighten liquidity requirements for the non-bank firms, issuing guidelines that would force most of them to set aside a buffer by investing in high-quality assets.

  • The RBI’s stress tests showed that the banks’ bad-loan ratio could fall further to 9 % in March 2020, after dropping the most in 15 years to 9.3 % as of March 31.

  • The central bank conducted stress tests on the NBFC sector and on individual lenders in order to gauge their resilience in an event of three stress scenarios baseline, medium and severe.

  • The tests showed that under the first two scenarios, around 8 % of the companies will not be able to comply with the minimum regulatory capital requirements of 15%. “Around 13 % of the companies will not be able to comply with the minimum regulatory capital adequacy norms under the third scenario.

  • The recent developments in the non-bank space have brought the focus upon the NBFC sector (including housing finance companies) especially with regard to their exposures, quality of assets and asset-liability mismatches (ALM).

  • The liquidity stress in NBFCs reflected in the third quarter of the last financial year (September-December 2018) was due to an increase in funding costs as also difficulties in market access in some cases.

- Published/Last Modified on: August 13, 2019

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