Why NBFCs may be more vulnerable to Coronavirus than banks?

The recent statement released by Moody’s Investors Service reveals that the COVID-19 pandemic is likely to disrupt non-banking finance companies (or NBFCs) more than banks.

Jun 11, 2020 10:06 IST India Infoline News Service

Among other industry domains like tourism and the hospitality sector, the global financial sector has also been severely impacted by the COVID-19 crisis. The BFSI or banking sector in India is facing its own set of financial challenges with the future outlook looking bleak at the moment.

The recent statement released by Moody’s Investors Service reveals that the COVID-19 pandemic is likely to disrupt non-banking finance companies (or NBFCs) more than banks. Going by this April 2020 report by Economic Times, NBFCs are currently sitting on 40-60 thousand crores worth of debt repayments and non-convertible debentures (or NCDs) worth around 87,000 crores – that are due for repayment in June 2020.

So, how has the NBFC industry been impacted by the current outbreak? Let’s look at some key pointers in the following sections.


COVID-19 Lockdown – How it impacts India’s NBFCs?

1. Payment defaults
As of March 27,  2020, Indian banks have lent over 8 trillion (in Indian rupees) to NBFCs, according to the latest data released by the Reserve Bank of India. This is an increase of 26% from the previous year. After borrowing money from banks, NBFCs lend it out to borrowers at higher margins. As a majority of borrowing customers for NBFCs are small business owners, the probability of defaulting on their due payments has increased – due to lack or restricted business activity.

























Image source: Times of India

Given their focus on business sectors with higher risks, NBFCs are now more vulnerable than banks when it comes to making timely loan repayments. Despite the three-month moratorium package offered by RBI, the NBFC industry faces an overall debt of 1.75 lakh crores maturing by June 2020.

2. Delayed EMI repayment

It’s not just the NBFCs that could default on their payments. NBFC customers can also default on their EMI repayments – thus adding to the overall cash crunch and an increase in NPAs.

While large banks can still afford to lend to high-earning executives in top-level companies, NBFCs or smaller banks will find it harder to lend to reliable borrowers even in the post-COVID era.

With a further extension of the current economic lockdown, delays in EMI repayments could slow down loan disbursements that could finally affect the GDP figures. As NBFCs are a safe source of funding for many businesses, a drop in loan disbursement can reduce the liquidity and increase the cash crunch.

3. Loss of credit

The impact of delayed payments is likely to reduce the liquidity within NBFCs. Additionally, this can have a subsequent impact on the credit quality of loans and other portfolios.

To alleviate the industry concerns, the RBI has announced a Rs30,000cremergency package for NBFCs that could allow some short-term relief. However, this government package is not sufficient for solving the funding-related problems within NBFCs. The core problem that separates NBFCs from commercial banks is that they are more exposed to riskier industry segments - like real estate, which were declining even before the virus outbreak.

As reported by Economic Times, Financial experts even project that the weakening quality of assets could further worsen the liquidity crunch in leading NBFCs.

4. Depleting capital

It’s not just the loss in credit that NBFCs have to face up to – there is also a major loss of capital. With the significant size of NBFC loan and investment portfolio, mark to market (or MTM) losses could wipe out NBFCs capital reserves. This could result in a violation of the industry’s capital adequacy norms. The RBI requires both banks and NBFCs to maintain their Capital to Risk Assets Ratio (or CRAR). While the minimum CRAR for banks is set at 9%, NBFCs have it much tougher with a minimum CRAR of 15% - that is distributed as 10% for Tier-1 and 5% for Tier-2 capital.

To counter this problem, NBFCs are now seeking relief from RBI, particularly in the norms for Tier-2 capital that has been hit the worst. How do all these factors ultimately impact the projected earnings among leading NBFCs? That brings us to the final impact.

5. Overall earnings

Thanks to the increasing cash crunch and depleting capital, NBFCs are staring at a potential fall of 30-70% in their earnings for the financial year 2021. While adequate liquidity can take care of loan repayments or even asset quality, lower earnings are going to adversely impact the net profit and balance sheet in this industry.
























Image source: Business Standard

According to UBS analysts, the earnings for the NBFC sector in India is likely to be reduced in the range of 11-65% for the financial year 2021-22. Even as large private sector banks are projected to post good earnings in the third quarter of 2020, NBFCs will continue to see weak earnings for all remaining quarters.

Conclusion

Thanks to its investment exposure in riskier domains, the NBFC industry is facing serious challenges as it tries to combat the economic impact of the COVID-19 outbreak. Even as the Indian economy is likely to reopen towards the later part of the year, NBFCs will continue to face challenges in improving their asset quality and cash crunch.

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