Rising risks hit Indian banks as regulators call to save NBFIs

The defaults of Infrastructure Leasing & Financial Services and Dewan Housing has investors spooked.

Banks are expected to shoulder the additional risk involved the central bank set priority lending status for credit to NBFIs for on-lending to finance agriculture, small businesses and home-buyers, according to Fitch Ratings. 

Also read: Indian banks grapple with $10m liquidity crunch

In a move that bucks global trend trying to break linkages between banks and NBFIs, the country's central bank raised the single-exposure limit to 20% of Tier 1 capital (from 15%); and reduced in the risk weight for consumer loans (except credit cards) to 100% (from 125%). This comes on the heels of several other initiatives to boost lending to the struggling sector, including harmonising risk weights on NBFI exposure, allowing banks to raise additional liquidity by selling excess government securities, and a partial credit guarantee from the government on banks' asset purchases from NBFIs.

Historically an important provider of consumer loans in India, the NBFI sector is under significant funding pressure as investors shy away following the default of Infrastructure Leasing & Financial Services in 2018 and Dewan Housing this year.

"Most banks will be reluctant to lend to weaker NBFIs as they are focused on conserving their limited capital while grappling with legacy bad loans and a new wave of deteriorating asset quality," Saswata Guha, analyst at Fitch Ratings said in a report. 

Only a portion of the funding pressure on NBFis will be lifted following the directive by the central bank as only the strongest NBFIs benefit. 

Guha said that the reduction in the risk weight for consumer loans will give a small boost to banks' regulatory capital ratios, enabling banks to lend slightly more for each unit of capital. This bodes well for loan growth but negative for their overall credit profile.