Economic Survey 2020, Volume 1 Chapter 8 (Financial Fragility In The NBFC Sector) – Economics

Table of Contents

WHAT IS A NON-BANKING FINANCIAL COMPANY?

NBFCs are financial institutions that offer various banking services but do not have a banking license.
These institutions are not allowed to take traditional demand
In India, NBFC is a company registered under the Companies Act, 2013 engaged in the business of loans and advances, acquisition of shares / stocks / bonds / debentures / securities, leasing, hire-purchase, insurance business, chit business

NBFCs have to be registered with RBI
But there are NBFCs which are regulated by other regulators like- SEBI, IRDAI.
To avoid dual regulation, they are exempted from the requirement of registration with RBI. E.g.- Stock broking

Non-Banking Housing Finance Companies (HFCs),
Retail Non-Banking Financial Companies (Retail-NBFCs) Liquid Debt Mutual Funds (LDMFs)

Therefore, both Debt and Equity investors suffered a massive erosion in wealth due to the defaults.

The NBFC business model itself is
It raises short-term funds which are then lent out as long- term loans.
For example, an NBFC raises money by selling 6-month debt papers and on-lends this as a car loan with a tenure of 5 years.
Now every time the NBFC has to renew the 6-month debt paper or raise fresh loans to repay the old debt paper.
In good times, this happens very smoothly.
But when times are tough, this cycle is broken.
Also there is-
RISKS FROM ASSET LIABILITY MANAGEMENT MISMATCH

An index is developed to estimate the financial fragility of the NBFC sector.
It was found that it can predict the constraints on external financing (or refinancing risk) faced by NBFC firms.
This index is called as the Health Score

Regulators can employ the Health Score methodology presented in this analysis to detect early warning signals.
Downtrends in the Health Score can be used to trigger greater monitoring of an NBFC.