Bad loans getting bigger: how NBFC lending can add to banks’ bad debt woes

Moody’s report also said real estate companies are under significant stress, and tighter funding will further increase stress in the sector.

The continuing liquidity crunch facing non-banking financial companies will likely increase bad loans risks for banks, arising from both — the NBFCs themselves, as well as from companies borrowing from them, warns a report. The spillover of stress among NBFCs to borrowers, and ultimately to banks, will hinder improvements in banks’ asset quality, profitability and capital, which is credit negative, says a report by Moody’s on Friday.

NBFCs have has been facing liquidity crisis following the bankruptcy of IL&FS in September 2018.”Tight funding for NBFCs, a consequence of the default by IL&FS in September 2018, is raising asset risks for banks in an economy that has grown increasingly dependent on non-banking lenders for the provision of credit,” Moody’s said in
the report.

Owing to liquidity crisis, NBFCs are forced to reduce lending, leading to funding constraints for borrowers relying on non-bank lenders. This increases the risk of loan losses for NBFCs, and as a result, they will continue to have difficulty in obtaining funding, the report said. “As financial health of NBFCs deteriorates due to loan losses, they will have greater difficulty obtaining funding, which will exacerbate their funding constraints. It can result in more bad loans from NBFCs for banks, the report said.

Also, as NBFC customers’ financials weaken, banks will reduce lending to them, which in turn will further worsen their funding stress and can lead to more bad loans from these companies for banks, it warned. A type of NBFC credit to controlling shareholders, or promoters, of large listed companies across various industries is also emerging as a source of asset risk for banks. Corporate promoters use their company shares as collateral to borrow, mostly from NBFCs or mutual funds, typically for the purpose of making investments, including in external businesses.

“The risk for banks is that promoters with weak governance can use company resources to repay their debt, causing financial damage to their businesses, which as a consequence, can default on their own loans from banks, the report said. Refinancing can be difficult for promoters of companies as investments they make using loans are often illiquid, a problem made worse by tighter availability of credit from NBFCs.

The report further said the non-bank lenders collectively have a large market share in retail and SME loans, a segment that has grown rapidly in recent years and now is susceptible to asset quality deterioration as the economy slows. “A curtailing of lending by NBFCs will add to risks from retail loans for banks by reducing the availability of credit that individuals can use for refinancing and by contributing to the slowdown,” the agency said.

The report also said real estate companies are under significant stress, and tighter funding will further increase stress in the sector. It could lead to more NPLs for banks because they have large exposures to NBFCs active in real
estate lending.

Banks also have direct exposures to real estate companies, and the growing stress in the NBFC sector will result in more impairments of bank loans to these borrowers.”However, increases in banks’ real estate NPLs will be marginal as their direct exposures to real estate companies remain small, growing more slowly than NBFC loans to the sector,” it said.