IMF Flags Risk: India’s NBFCs' Concentrated Exposure Threatens Financial Stability

The IMF has raised alarms about potential financial instability in India due to Non-Banking Financial Companies' (NBFCs) concentrated exposure to the power and infrastructure sectors. The interconnectedness with banks and mutual funds amplifies risks. Regulatory reforms and improved risk management are recommended to mitigate these systemic threats.

The International Monetary Fund (IMF) has issued a warning concerning potential financial instability in India, stemming from Non-Banking Financial Companies' (NBFCs) concentrated exposure to the power and infrastructure sectors. According to the IMF, the entanglement of NBFCs with banks, corporate bond markets, and mutual funds could exacerbate systemic stress should vulnerabilities arise.

Focusing particularly on the high exposure of NBFCs to the power sector, which has persistent structural issues, the report underscores the financial instability risks associated with concentrated lending. Any distress in power and infrastructure ventures might ripple across banks, bond markets, and mutual funds.

Additionally, the co-lending model, facilitating banks' partnerships with NBFCs to lend to priority sectors, fortifies the financial networks' interconnectedness, heightening systemic risk. The IMF recommends enhanced scrutiny of NBFCs' lending tendencies and the fortification of risk management frameworks to avert financial upheavals.

The report contrasts NBFCs with banks, citing crucial distinctions: unlike banks, NBFCs are barred from accepting demand deposits, their deposits lack insurance, and they do not access liquidity facilities or payment systems of the Reserve Bank of India (RBI). The IMF suggests bolstering liquidity regulations, particularly for NBFCs with significant infrastructure stakes.

India's corporate bond market's underdevelopment forces NBFCs to rely heavily on domestic banking institutions and mutual funds for financing. This interconnectedness has historically led to liquidity crises, often tied to significant withdrawals in the mutual fund industry during corporate bond market disruptions. Nevertheless, India has substantially advanced in financial inclusion, with around 80% adult financial account ownership, aided by robust banking networks and digital public infrastructure growth, such as the Unified Payments Interface (UPI).

Furthermore, the burgeoning of retail investors in equities has positioned India among the largest global markets for equity options trading. With total assets reaching nearly 190% of GDP, India's financial system is diverse and advanced. Banks account for approximately 60% of the financial system's assets, yet NBFCs have significantly expanded their market share.

Non-banking institutions, including insurers, pension funds, and investment funds, now contribute nearly half of private sector credit. The IMF notes the dominance of state-owned NBFCs in the sector, as the top three government-owned infrastructure financing companies (IFCs) control a third of the total NBFC assets. Unlike their private counterparts, state-owned entities are currently exempt from large exposure limits, presenting regulatory challenges.

Aligning regulations for both state-owned and private NBFCs to mitigate risks is strongly recommended by the report. (ANI)

(With inputs from agencies.)