Impact of NBFC in Indian economy
Introduction:
NBFCs have been providing the complementary services to the economy, like other
financial institutions, including banks for fulfilling the funds requirements of the society. In the
recent past, the NBFCs have played increasingly important role in resource mobilization and
credit intermediation, thereby helping commercial sector to make up for low bank credit growth.
Credit market share to NBFCs, which had accounted for 12-15 per cent of the total credit
generated in the past two fiscals. With the growing importance assigned to financial inclusion,
NBFCs have emerged as important financial intermediaries particularly for the small-scale and
retail sectors.
There was a huge change in monetary policy over the last year. The benchmark policy
rate was first hiked by 50 bps and later reduced by 75 bps due to weaker-than anticipated
inflation, growth slowdown and softer international monetary conditions. Liquidity conditions,
however, have remained systematically tight since September 2018. The ongoing crisis of
confidence in non-banking financial companies (NBFCs) may prove to be a drag on economic
growth, as balance sheet constraints and higher funding costs may prompt these banks to
slowdown lending.
The start of liquidity crisis in NBFC:
NBFCs had borrowed short term from banks and mutual funds while lending to developers of
long-term projects, which got held up because of various factors. As cash flows dried up, NBFCs
couldn’t repay their lenders. The crisis started in September when IL&FS Financial Services
failed to meet its commercial paper redemption obligations
The flow of fund in the economy:
The NBFCs experienced difficult times in 2018-19 in the aftermath of the ratings
downgrades and default of IL&FS Group, leading to a deep funding squeeze by banks on one
hand and lack of investor appetite for their debt instruments on the other. Bank borrowings,
debentures and commercial paper are the major sources of funding for NBFCs.
Immediately after the IL&FS crisis, NBFCs faced severe liquidity crunch as mutual funds
(MFs) stopped refinancing the loans of NBFCs. The government moved in quickly and took
immediate measures to ring fence the problem and limit contagion. Consequently, the flow of
resources from the banking sector to NBFCs improved for some time. However, the financial
flows to the economy remained constrained because of decline in the amount of equity finance
raised from capital markets and stress in the NBFC sector.
Impact of crisis across the economy:
The Economic Survey for 2018-19, shows that the stress in Non-Banking Financial Companies
(NBFC) sector also contributed to the economic slowdown by adversely impacting consumption
finance. This squeeze in flow of resources to NBFCs has impacted the lending capability of the
sector in recent quarters.
From the demand side, the decline in GDP growth during 2018-19 arose primarily from
deceleration in private final consumption. This could have been due to low farm incomes in rural
areas arising from low food prices and also due to the stress in NBFCs, which affected its
lending. The gap between nominal and real growth rate has decelerated in many segments of the
automobile sector, including passenger vehicles, tractor sales, three and two wheeler sales.
The growth in manufacturing sector picked up in 2018-19, although the momentum slowed down
towards the end of the financial year with a growth of 3.1 per cent in fourth quarter of the year,
as compared to 12.1 per cent, 6.9 per cent and 6.4 per cent in first, second and third quarter
respectively. The growth rate in Q4 of 2018-19 moderated considerably, on account of lower
NBFC lending, which in part led to low sales in the auto sector. The moderation in 2018-19 has
been mainly due to subdued manufacturing activities due to slower credit flow to medium and
small industries, reduced lending by NBFCs owing to liquidity crunch, tapering of domestic
demand for key sectors such as automotive sector, pharmaceuticals, and machinery and
equipment, volatility in international crude oil prices etc
Effects in market:
Equity Markets:
Equity markets continued to trade on the negative side, partly adjusting for the strong
performance over the prior few months. With the NBFCs continuing to face liquidity issues,
there are concerns over credit flow into the economy. Overall GDP growth has been affected
over the last couple of quarters, which in turn affects growth rates of companies.
Debt market:
Large default by corporates like DHFL, Reliance ADAG group finance companies, IF&FS,
Essel, etc continued to plague the bond market. Debt funds with large exposure to such
companies have seen a fall in NAV values
Conclusion:
If the impact of stress in the NBFC sector spills over to this year as well, it may lead to lower
credit off take from NBFCs, which may dampen growth in consumption spending.
NBFCs, particularly those specialised in microfinance, housing, auto finance, rural etc, have
thrived in pockets where traditional banks face limited geographical reach, lower appetite and
ability of mainstream banks to reach such borrowers. On one side, some of the defaulters such
as IL&FS and DHFL, have had a ripple impact on the financial system and on overall credit
flows. On the positive side, promoters of such companies are acting quickly to sell off assets
and repay the loans. This is important to note, as problems are part and parcel of any growing
economy. It is the swift resolution of these problems which makes it a healthy economy.
