The first edition of the India Finance Report published by the Centre for Advanced Financial Research and Learning (CAFRAL), an independent body set up by the Reserve Bank of India, has taken stock of India’s non-bank financial companies sector — commonly called the shadow banking sector — and pointed out both the ongoing improvements and emerging risks. On the positive side, the CAFRAL report finds that after the liquidity crisis of 2018 and the Covid pandemic, the NBFC sector has improved, along all dimensions — capital position, asset quality, and profitability. For instance, as against the stipulated norm of 15 per cent of the capital to risk-weighted assets ratio (CRAR), in 2022-23, NBFCs witnessed a notable improvement with the CRAR rising to 27.6 per cent from 22.9 per cent in 2019-2020. Similarly, gross and net non-performing asset (NPA) ratios continue trending downwards.
However, the study also points to some new risks. It notes that in the past few years, bank financing for NBFCs has begun to rise again. “This raises concerns about systemic contagion and underscores the need for tighter preventive measures to mitigate potential systemic fallout”. Explaining the notion of systemic risks when several key parameters look benign, the CAFRAL report states: “Although current ratios post-2017 show lower liquidity risk, they are not a good gauge for systemic risk — the risk which arises due to externalities that individual firms do not take into account in their decision-making process, and an unravelling of which can have deleterious effects on the real economy.” It underlines that systemic risks build up in periods of tranquil financial conditions due to increased risk-taking, and tend to aggravate the effect of a shock through negative spillovers such as fire sales across firms during a crisis.
There are two reasons both the RBI and the government should take this report’s findings seriously. One, the global, as well as the Indian, economy has just witnessed two periods of stark contrast in terms of monetary policy. First, there was an extremely loose monetary policy, aimed at protecting economic growth and businesses during the pandemic. This was immediately followed by an equally sharp contraction in monetary stance following the sudden and sharp rise in inflation. The back-to-back monetary shocks are catching businesses off-guard. Two, the events of the past 15 years have shown that the health of India’s NBFC sector is crucial to sustaining India’s economic growth, especially through millions of MSMEs. In the decade after the Global Financial Crisis of 2008, the NBFCs acted like shock absorbers to the Indian economy — providing credit when formal banks were struggling with NPAs. Regulators must ensure that past mistakes are not repeated.
