The banking sector has increased its exposure to non-banking financial companies (NBFCs) by nearly four times since the beginning of 2018, while mutual funds have reduced their exposure by almost a third, according to a report by The Indian Express.
Banks lend more to NBFCs amid liquidity crunch
The report, based on data from the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), showed that banks’ exposure to NBFCs rose from Rs 1.9 lakh crore in January 2018 to Rs 7.3 lakh crore in September 2023, a jump of 3.8 times. This increase was mainly driven by public sector banks, which accounted for 71% of the total exposure in September 2023, up from 59% in January 2018.
The report attributed this trend to the liquidity crunch faced by NBFCs after the collapse of Infrastructure Leasing & Financial Services (IL&FS) in September 2018, which triggered a crisis of confidence in the sector. The RBI intervened to ease the liquidity situation by allowing banks to lend more to NBFCs and providing them with targeted long-term repo operations (TLTROs). The RBI also relaxed the norms for banks to classify loans to NBFCs as priority sector lending (PSL), which incentivised banks to lend more to NBFCs.
Mutual funds reduce exposure to NBFCs amid risk aversion
On the other hand, the report showed that mutual funds’ exposure to NBFCs declined from Rs 2.2 lakh crore in January 2018 to Rs 1.5 lakh crore in September 2023, a drop of 31.4%. This decrease was mainly due to the reduction in exposure to commercial papers (CPs) and non-convertible debentures (NCDs) issued by NBFCs, which fell by 55% and 24%, respectively, during the same period.
The report explained that mutual funds became more risk-averse after the IL&FS crisis and the subsequent defaults by Dewan Housing Finance Corporation Ltd (DHFL) and Reliance Capital Ltd (RCL), which led to rating downgrades and erosion of net asset values (NAVs) of several debt schemes. The SEBI also tightened the regulations for mutual funds’ investment in debt instruments, such as imposing limits on sectoral exposure, duration, and credit quality.
Implications of the divergent trends
The report highlighted the implications of the divergent trends in banks’ and mutual funds’ exposure to NBFCs for the financial stability and growth of the economy. It noted that while banks’ increased lending to NBFCs helped to mitigate the liquidity stress and support the credit flow to the real sector, it also increased the interconnectedness and contagion risk between the two sectors. It suggested that banks should monitor the asset quality and performance of NBFCs closely and maintain adequate provisioning and capital buffers.
The report also observed that mutual funds’ reduced exposure to NBFCs reflected the shift in investor preference from credit risk funds to low duration and liquid funds, which offered lower returns but higher safety and liquidity. It argued that this could hamper the development of the corporate bond market and the diversification of funding sources for NBFCs. It recommended that mutual funds should enhance their risk management and governance practices and improve the transparency and disclosure of their portfolio holdings.
