NBFCs generally source funds by issuing debt ins?t?r?uments like bonds, non-convertible debentures, convertible debentures, commercial papers, mortgages, and leases along wi?th a significant funding fr?om banks. By the very nature of their business, the?re is an element of asset liability mismatch at times, more so for firms those borrow primarily through short-term instruments and finance long-term assets like infrastructure.
Following the default by a major NBFC (IL&FS), domestic insurance companies, banks, provident funds and mutual funds, which were the major lenders or buyer of debt instruments of NBFCs, have become somewhat reluctant to lend. Thus, the cost of borrowing for NBFCs has gone up. For example, interest rate on 3-months AAA commercial paper (which was a major source of funding for NBFCs) has risen by 40 bps to 8.5 per cent within three weeks.
There has been a decline in the commercial paper issuances in September. At 141, CP issuances in September were in fact lowest since June 2010, as per Prime Database. Mutual funds are also facing redemption pressures and an estimated Rs. 2.1 trillion has flown out of liquid and money market funds in September.
Against such a backdrop, there is a small risk of a liquidity squeeze for NBFCs, with around Rs 80,000-100,000 crore of their debt papers coming up for redemption between November and March. While we do not see the prospect of a major crisis, there are some legitimate questions about redemptions and rollovers including the possibility of default. This could in an extreme situation foster contagion across this lender class and disrupt the money and debt markets.
Since 1997 no new licence has been given for a deposit taking NBFC. As of now, only a small proportion of all NBFCs are deposit-taking and thus there seems to be no systemic issue related to depositors. In terms of credit, importance of NBFCs in driving the overall lending to the commercial and households sectors has risen in the recent years. The share of NBFCs in total credit extended in the economy has increased from around 9.4 per cent in March 2009 to more than 17 per cent in March 2018.
In terms of consumer lending, between FY13 and FY17, share of NBFCs in the consumer durables financing has jumped to 32 per cent from 19 per cent. For the industrial sector, a RBI report points out that the share of credit provided by banks to the MSME sector has declined since September 2016. Meanwhile, loans extended by NBFCs to MSMEs have grown at an annual average rate of 35 per cent during the same period and their share in total credit has increased from around 5.5 per cent in December 2015 to 10 per cent by March 2018. Thus, in case of a liquidity shortage, there could be some slowdown in advances by NBFCs and sectors like consumer durables, MSMEs, and housing could be affected to some degree.
However, it is misleading to tar all NBFCs with the same brush. There are entities with robust balance sheets that are likely to have access to bank finance and could find takers for instruments like CPs.
Moreover, it is likely that the banks could re-emerge as a major driver of funding for both MSMEs and consumer durables, and could fill in the interim gap that may arise because of the slowdown in advances made by NBFCs. In that case, the impact on the real economy is likely to be marginal.