Informist, Friday, Dec 29, 2023
MUMBAI – The growing interconnectedness between banks and non-banking financial companies through the funding route could potentially increase contagion risk for banks, the Reserve Bank of India said in a report on Thursday.
“Growing bank-NBFC interlinkages could be a source of systemic risk as vulnerabilities in the NBFC sector could amplify financial system stress and spillovers to the banking system,” the RBI said in its latest Financial Stability Report.
During September 2020 to September 2023, bank lending to non-bank lenders increased by 70.7%, sharply higher than the 50.2% growth in aggregate bank credit. Also, bilateral exposures between banks and NBFCs show that most of the NBFCs have a net borrowing position with banks, the RBI report said.
According to data from the RBI’s report, bank borrowings formed 41.1% of NBFCs’ total borrowing, followed by 31.0% through debentures as on Sep 30. Intercorporate borrowings were at 3.3%, while the share of funding from financial institutions was 3.1%, commercial papers at 2.8%, subordinate debt at 2.1% and borrowing from the government at 0.6%. Funding through other sources was at 16%.
In a simulation exercise, scenarios assumed simultaneous default of top three and top five NBFCs, which have the potential to cause maximum solvency losses to the banking system.
According to the results of the exercise done by the RBI, the solvency losses of the banking system under such hypothetical shocks have been on a rising trajectory since September 2021, co-moving with the increasing exposure of banks to the NBFC space.
While the impact of losses on capital was adjusted by assuming a recovery rate of 20%, results showed that, despite the contagion effect, both capital equity tier-1 ratio and capital to risk-weighted asset ratio of banks will remain above the regulatory minimum of 15% owing to ample capital buffers.
However, a weak tail of banks with lesser buffers could witness their capital levels falling below the regulatory minimum, the RBI report said.
Overall, the banking system remains resilient to contagion risk from the NBFC sector, but the presence of a weak tail of banks and growing interlinkages between banks and NBFCs requires both nimble and proactive regulatory and supervisory monitoring, the report said. It also called for actions that prevent the build-up of systemic risk and shore up the capital buffers of weak banks to improve their resilience.
On Thursday, Deputy Governor Swaminathan J said that the growing interconnectedness between banks and non-banking finance companies could pose a contagion risk in the future.
The banking regulator has not seen any alarming indicators yet, but the RBI does not want an extraordinary interconnectedness building up and posing a contagion risk at some point in the future, Swaminathan said at the 10th State Bank of India’s Banking and Economics Conclave.
This has come as the RBI has been repeatedly asking non-banking financiers to reduce their dependence on borrowing from banks and diversify their funding sources. Around 75% of the total borrowings of non-bank lenders are financed primarily through banks and market borrowings, making them the largest net borrowers, according to the RBI Bulletin for September.
This was also reflected in the RBI’s move last month, when it increased the risk weight on exposure to consumer credit, including personal loans, of commercial banks and non-banking finance companies to 125% from 100% earlier, and the risk weight on credit exposure of banks to non-bank lenders by 25% to 125%.
This has come as personal loans and loans to industry drove the aggregate lending by NBFCs, which grew by 20.8% in September from 10.8% a year ago. During the last four years, the compound annual growth rate for personal loans, which was nearly 33% has surpassed the overall credit growth of close to 15% for the NBFC sector.
Going forward, the recent increase in risk weights of select retail loan categories may have implications for NBFC credit growth at the overall, sectoral and sub-sectoral levels, the RBI report said.
Meanwhile, the financial sector has exhibited stability and resilience, with ongoing improvement in asset quality, capital position and profitability in the first half of the current financial year.
While macro stress tests for credit risk suggest that even under a severe stress scenario, all banks would be able to comply with minimum capital requirements, the stress in the NBFC sector has been assessed to be higher under a high-risk stress scenario as compared to the position in March.
Macro stress tests are performed to assess the resilience of scheduled commercial banks’ balance sheets to unforeseen shocks arising from the macroeconomic environment. End
Reported by Subhana Shaikh
Edited by Namrata Rao
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