DHFL demise highlights funding risk at Indian non-bank lenders: Fitch

Mumbai (Maharashtra) [India], June 7 (ANI): Dewan Housing Finance Corporation Limited's (DHFL) liquidity problems and its failure this week to pay coupons highlight the funding challenges faced by India's non-bank finance sector, according to Fitch Ratings.
The liquidity pressures are in stark contrast to the banking sector which has not faced significant liquidity pressure or deposit withdrawals, despite asset-quality and capital weaknesses.
Non-bank financial institutions' (NBFI) issues were already known to the market but DHFL became the focus point after the failure of Infrastructure Leasing & Financial Services (IL&FS) in September 2018 contributed to a sector-wide liquidity squeeze as investors become more risk-averse.
The NBFIs' liquidity 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.
Funding models of housing finance companies and NBFI loan companies which have become increasingly reliant on short-term funding to fund longer-term assets have been particularly affected by the liquidity squeeze.
The sector pressures have led top NBFIs to explore other sources of funding and to start positioning themselves to tap the US dollar bond market.
"We expect Indian NBFIs to become more regular issuers in the offshore bond market as they seek to diversify their funding sources. If prudently managed, this should be credit positive as funding profiles are strengthened," Fitch said.
The funding squeeze has contributed to higher funding costs and a slowdown in loan growth for NBFI sector. NBFIs are an important channel for extending credit to the wider economy, given their wide distribution networks, which are often more extensive across rural India than those of banks.
The sector's role as a credit provider became outsized as the Indian banking system was forced to deal with its weak asset quality. Banks, particularly public-sector banks, were undercapitalised and had limited capacity to lend more. NBFIs now account for nearly 20 per cent of credit to the economy compared with about 15 per cent five years ago.
NBFIs' fast loan growth in an environment of relatively benign interest rates was increasingly funded by short-term funding, in particular, commercial paper issued to the mutual fund sector. The banking system also is an important source of funding for NBFIs, driven in part by the regulatory push for banks to provide 'priority lending,' with NBFIs an important conduit for this.
Both of these funding sources for NBFIs 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 NBFIs should still be able to achieve loan growth.
The sector's reliance on short-term funding has reduced since late 2018 and some stronger NBFIs have shifted towards longer-term funding, such as term loans or negotiable certificates of deposit.
"We expect credit growth in India to remain slow, despite this week's interest-rate cut, as most banks are capital-constrained and NBFIs face tighter funding conditions," said Fitch in a statement. (ANI)