Stresses on the liquidity and asset-quality fronts are set to be exacerbated for non-bank lenders, the firm said in a report.

Non-banking financial companies (NBFCs) in the country are more vulnerable to the risks brought on by the Covid-19 disruption than banks, rating agency Moody's said on Tuesday.

Stresses on the liquidity and asset-quality fronts are set to be exacerbated for non-bank lenders, the firm said in a report.
Asset quality at NBFIs (non-bank financial institutions) will significantly deteriorate as economic disruptions from the coronavirus outbreak deepen an economic slowdown that has been underway in the past few years. Asset quality at NBFIs has weakened in recent years amid worsening economic conditions, and the economic shock from the coronavirus outbreak will exacerbate this trend, Moody's analysts wrote in the report.

Asset quality deterioration at NBFCs on average will be more severe than at banks because the former set focuses more on riskier segments. Funding costs are also higher for NBFCs than for banks because non-bank institutions lack access to low-cost retail deposits. To compensate for this, non-bank lenders need to earn higher asset yields by focusing more on riskier borrowers.

For instance, in both home loans and loans against property, NBFIs have a higher share of loans to borrowers working in the informal sector and self-employed employees than banks. This fundamentally exposes NBFIs to greater asset risks than banks, the report said.

Exposures to corporates and the real estate sector will be most at risk. These borrowers had been facing liquidity constraints before the onset of the coronavirus outbreak, and stress among them will further worsen as heightened risk aversion among lenders and investors makes it more difficult for them to raise funds, Moody's said.

To alleviate stress for borrowers, the Reserve Bank of India (RBI) is allowing financial institutions to provide a three-month moratorium on loan repayments for their customers. These measures will create a significant drain on near-term liquidity at NBFCs. Most of these companies do not have substantial on-balance sheet liquidity because they primarily manage liquidity by matching cash inflows from loan repayments by customers with cash outflows to repay their own liabilities.

Moratoriums on loan repayments will result in substantial declines in cash inflows over the next few months, the report said, adding that the latest government measure to effectively make a direct purchase of NBFC debt, announced on May 14, will provide some near-term relief, but it will not sufficiently address NBFC's structural funding weakness.

The extent of liquidity stress will depend on the number of customers seeking moratoriums and the degree of the economic shock. The longer restrictions on economic activity remain, the longer it will take for loan repayments to return to normal levels even after moratorium periods end. In our base case, we assume that loan repayments will drop 50% during moratorium periods, Moody's said.

Non-bank lender's weakening solvency will raise risks 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. According to data released by RBI, NBFCs owed banks Rs 8.07 lakh crore, as on March 27.

Simultaneously, heightened risk aversion among investors means NBFCs, especially weaker companies, will continue to have difficulty obtaining funding. With limited access to new funding, they will have to manage their liquidity through liquid assets on their balance sheets and customer loan repayments, Moody's said.

Securitisation, which has been a key source of additional funding for NBFCs in the past year, will also become more difficult because collections from securitised loans will fall because of loan moratoriums.