Possible risks hanging over NBFC space

Possible risks hanging over NBFC space

The NBFCs borrowings through debentures and commercial papers (CPs) have been on the rise in the last 5 years.

There are suddenly concerns of liquidity crunch and the possible asset liability mismatches in the non-banking finance company (NBFC) space. The size of the NBFC sector in India is about Rs 22  lakh crore in terms of assets. In fact, NBFC sector has been growing robustly in the last few years, while the banking sector saw some contraction, especially due to slowdown in corporate lending.  Here are some possible risks that are now hanging over the heads of NBFCs:

Growing leverage

The NBFCs borrowings through debentures and commercial papers (CPs) have been on the rise in the last 5 years. As per the latest RBI data, the borrowing through commercial paper, which was about Rs 46,200 crore in March 2014 rose to Rs 1,26,700 crore  in March 2017. The rise for the year ending March 2017 was about 48 per cent.  The share of debentures and CP together accounts for over 40 per cent in the resource mix of the NBFCs.

Reversal of interest rate cycle   

There is a reversal of interest rate cycle as interest rates are now inching up both domestically and also in the international market. The yields are already hardening in the domestic market due to inflation fears and a weak currency. Given the buoyant US economy and dollar strengthening, the RBI may be forced to use interest rate tool (by hiking rates) to protect the rupee from further depreciation. There are expectations that many NBFCs will have to replace their existing CPs with higher interest rates.  There could be some liquidity crunch as many mutual funds may not be keen to increase their exposure in the NBFC space.  This may result in higher cost of funds for NBFCs as they rely heavily on market borrowing through debentures and commercial paper.  

The rise in micro and small loans

In the last few years, the NBFCs  have also grown their portfolio of small and micro loans in a big way. For instance, the small and micro loans at Rs 50,800 crore  in March 2017 shows a rise of 55 per cent from the previous year.  Post the success of Bandhan Bank, the NBFCs have gone to this segment in a big way where there are risks of lack of credit history, scale and historically high NPAs.

Rise of small ticket size consumer durable loans

The retail loans, especially consumer durable financing, credit cards and affordable housing segments have also grown big time in the last few years.  There are few strong players with the backing of parent or holding companies, but many are also first timers, especially in segment like affordable housing finance. The unsecure loan segment is also on the rise in the NBFC segment. Many are forecasting asset quality issues if there is a deterioration in the India's macro economic situation.

Too much reliance on Mutual Fund money

In terms of interconnectedness, the mutual fund and the NBFC sector is strongly related as the mutual fund is the biggest fund provider to NBFC space by way of commercial paper and debentures. Experts say all the investment by mutual fund in the NBFC sector is not in high investment grade or triple A.  If there is a problem with few NBFCs, there can be a chain reaction of selling the exposure, which could create more trouble for the NBFC sector.