Rising trend of bank financing for non-banking financial companies (NBFCs)

Rising trend of bank financing for non-banking financial companies (NBFCs)

Subject :Economy

Section: Monetary Policy

The rising trend of bank financing for non-banking financial companies (NBFCs) has raised concerns about the potential for systemic contagion, prompting the need for tighter preventive measures, as emphasized by the Centre for Advanced Financial Research and Learning (CAFRAL). This independent body, established by the Reserve Bank of India (RBI), has urged caution and the implementation of checks and balances to mitigate the possible systemic fallout.

The India Finance Report 2023, unveiled by RBI Governor Shaktikanta Das, underscored the dangers of inter-linkages within the financial sector. Notably, larger NBFCs have been borrowing from banks and subsequently lending to smaller NBFCs, leveraging regulatory arbitrage. This close integration has necessitated enhanced monitoring to avert potential systemic repercussions.

The report further cautioned that the growing reliance of NBFCs on scheduled commercial banks for funding, along with banks’ increased cross-lending within the sector, has heightened systemic risks. Additionally, it highlighted the consequences of a contractionary monetary policy, leading to increased risk in NBFCs’ portfolios, especially in terms of unsecured loans.

Observations revealed that bank borrowing constituted a significant portion of NBFCs’ total borrowings, with public sector banks emerging as the primary lenders, followed by private sector and foreign banks. The study emphasized the buildup of systemic risk during tranquil financial periods, emphasizing the potential negative spillovers during crises.

The researchers at CAFRAL stressed the positive correlation between the NBFC index and the bank NIFTY index, emphasizing the crucial role of banks as a vital funding source for NBFCs. They also warned that the increasing interconnectedness within the sector, coupled with reliance on regulatory arbitrage, may have significant systemic implications. Regulatory authorities were urged to exercise caution and establish effective checks and balances to mitigate potential risks in the medium term.

Monetary Policy

Monetary policies are tools used by central banks to manage and control the money supply in an economy, which in turn influences interest rates and inflation. They can be broadly categorized into two main types: contractionary and expansionary.

1. Contractionary Monetary Policy:
   • Aim: Aims to reduce the money supply, curb inflation, and slow down economic growth.
   • Methods: Central banks implement this policy by increasing interest rates, selling government securities, and raising reserve requirements for banks.
   • Impact: This policy can lead to reduced borrowing and spending, higher cost of borrowing, decreased business investments, and a slowdown in the overall economic activity.
2. Expansionary Monetary Policy:
   • Aim: Aims to stimulate economic growth and increase the money supply in the economy.
   • Methods: Central banks implement this policy by decreasing interest rates, buying government securities, and lowering reserve requirements for banks.
   • Impact: This policy encourages borrowing and spending, reduces the cost of borrowing, promotes business investments, and stimulates overall economic activity.

The choice between a contractionary or expansionary policy depends on the current state of the economy, the central bank’s goals, and the prevailing economic conditions, including the level of inflation, employment, and overall economic growth.

About CAFRAL –

CAFRAL stands for the Centre for Advanced Financial Research and Learning.

It is an independent body established by the Reserve Bank of India (RBI) to conduct research, training, and knowledge dissemination in the fields of banking and finance.

CAFRAL’s primary goal is to support the development and stability of the Indian financial sector through comprehensive research, policy analysis, and training programs for professionals in the industry. It operates as a think tank and a hub for generating insights and promoting understanding of various aspects of the financial system, contributing to informed policy decisions and effective regulation.

NBFC and Bank NIFTY Index

The NBFC index and the bank NIFTY index are two separate financial indicators that provide insights into different aspects of the financial sector, specifically related to non-banking financial companies (NBFCs) and banking institutions.

1. NBFC Index:
   • The NBFC index is a financial indicator that tracks the performance and trends of the non-banking financial companies in the market.
   • It provides a snapshot of the overall performance of the NBFC sector, including factors such as growth, profitability, and risk exposure.
   • The index helps investors and analysts assess the health and stability of the non-banking financial sector, enabling them to make informed investment decisions.
2. Bank NIFTY Index:
   • The Bank NIFTY index is a market index that represents the performance of the banking sector in India.
   • It comprises the most liquid and large Indian banking stocks listed on the National Stock Exchange (NSE).
   • The index is an important benchmark for investors, providing insights into the overall performance and trends of the banking industry, including both public and private sector banks.