RBI rate cuts unlikely to push credit demand as NBFC crisis deepens

Credit growth is unlikely to pick up despite the three successive rate cuts by the central bank due to the capital constraints at banks and the deepening crisis in the non-banking lenders sector, warns a report.

The Reserve Bank had cut its key policy rate on Thursday by 25 bps, its third such move in successive policy reviews in 2019, to a nine-year low to help spur sagging growth.

"We expect credit growth to remain slow, despite the latest interest rate cut, as most banks are capital-constrained and non-banking financial institutions are facing tighter funding conditions," global rating agency Fitch said Friday in a note.

It said NBFCs currently account for a fifth of the overall credit as against 15 per cent five years ago.

Meanwhile, on the troubled Dewan Housing Finance, the report termed the recent events as a "demise", highlighting the funding risks for the broader NBFC sector. Issues with NBFCs were already known to the market but Dewan became a focus point after the failure of IL&FS last September contributed to a sector-wide liquidity squeeze as investors turned risk averse, it noted.

"Liquidity of NBFCs is sensitive to market sentiment as their business models rely on short-term wholesale funding, which can dry up fast if market sentiment turns negative," the report said and explained that because of these pressures, top NBFCs have begun to explore other sources of funding and are working onto start tapping the overseas bond markets.

Accordingly, the agency expects NBFCs to become more regular issuers in the offshore bond markets, which can be "credit positive" if managed prudently.

The funding squeeze has led to increased cost for the shadow banking sector and a slowdown in loan growth them, the report said, noting that these players are an important channel for extending credit to the wider economy with wide distribution networks.

Non-performing assets-related issues at banks only led to NBFCs' importance growing much higher, it said, adding NBFCs' fast loan growth in an environment of relatively benign interest rates was increasingly funded by short-term funding, in particular, commercial papers issued to mutual funds.

It can be noted that in the past as well, analysts have pointed out to asset liability mismatches as the real problem that led to the problems for the NBFCs since the latter half of 2018.

Traditionally, the banking system has been an important source of funding for NBFCs due to a push to "priority lending", while the mutual funds segment has also deployed investments.

"Both of these funding sources for NBFCs have become more risk-averse, which means that the sector is likely to face higher funding costs and a period of deleveraging, although the better-positioned NBFCs should still be able to achieve loan growth," the agency said.