Moratorium to strain NBFC liquidity even further, bad debts to rise

The three-month moratorium for customers will likely cause a lot of hardship for non-banking financial companies (NBFC) as these firms operate with very little short-term liquidity, which can become more strained as customers start defaulting even after the moratorium.

Rating agency Moody’s noted that the moratorium would create a “significant drain on near-term liquidity” at non-banking financial institutions (NBFIs). Most or NBFIs do not have substantial on-balance sheet because they primarily manage by matching cash inflows from loan repayments by customers with cash outflows to repay their liabilities, and “moratoriums on loan repayments will result in substantial declines in cash inflows over the next few months,” Moody’s noted.

The government’s move to directly purchase papers will provide some relief, “but it will not sufficiently address NBFIs’ structural funding weakness,” it said.

India Ratings noted that swift implementation of this package was key to its success, even as the scheme would encourage banks to take exposure to once again.

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“Lower-rated are not active in the bond market and hence investments through non-convertible debentures could create challenges. Lenders would also be looking at operational guidelines to understand reimbursement from the government, i.e. if these can be at the time of it becoming delinquent or it is after completion of recovery proceedings,” India Ratings noted.

NBFCs are staring at substantial asset quality deterioration due to disruptions to economic activity from the Covid-19 outbreak.

“Asset quality at NBFIs has weakened in recent years amid worsening economic conditions, and the economic shock from the outbreak will exacerbate this trend,” Moody’s said.

Asset quality deterioration will hit the NBFCs the most as they focus more on riskier segments as they need to earn a higher spread in the absence of access to deposits.

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At the same time, the asset quality deterioration in the para banking sector has implications for banks as well, as NBFIs’ weakening solvency is an additional risk for banks at a time when risks to systemic stability have increased because of a default by YES Bank, which triggered deposit outflows at some smaller banks. Public sector banks have large direct exposures to NBFCs.


Investors would also want to avoid NBFCs, especially the weaker ones and this would mean the shadow banking sector is staring at a negative funding gap in the coming days.

“With limited access to new funding, they will have to manage their through liquid assets on their balance sheets and customer loan repayments,” according to Moody’s.

Financial consulting firm Avendus noted that investor confidence was shaken in NBFCs after the sector faced four adverse impact in quick succession in the past 18 months.

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“The IL&FS crisis, DHFL liquidity event, YES Bank saga, and now Covid-19 have exposed cracks that have left investors worried,” Avendus said.

According to Avendus, liquidity would be an issue for the smaller players who not only fails to collect loans, but also might not fulfill the criteria to avail funds under the RBI’s targeted long term repo operation (TLTRO) facility.

The repayment capacity of borrowers, especially at the “Bottom of Pyramid” will be impacted by the economic slowdown, and so will be the case with businessmen, even as salaried people would face less pressure.

Mutual funds are major investors of commercial papers (CPs), but faced with redemption pressures they are unlikely to roll over Cps or reinvest in debentures.

“Extended and a possible increase in the moratorium period to unsecured borrowers can weaken the credit culture. Moreover, it will also make it difficult for NBFCs to assess their true loan book status and borrower quality,” Avendus noted.

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