A potential Reserve Bank of India (RBI) rate hike is unlikely to trigger broad-based stress in the asset quality of non-banking financial companies (NBFCs), with risks expected to remain concentrated in select segments unless monetary tightening is prolonged or accompanied by a major macroeconomic shock, Nuvama Institutional Equities said in its October report.According to the report, NBFCs currently have healthy asset quality, while past trends indicate that rate hikes alone have not caused widespread deterioration.“…monetary tightening by itself has not been sufficient to trigger a broad-based deterioration in NBFC asset quality,” Nuvama said. It added that “Stress has typically intensified when rate hikes have coincided with prolonged external shocks or funding/liquidity disruptions.”
Asset quality improved during previous tightening cycle
Nuvama noted that during the FY22-24 monetary tightening cycle, NBFC asset quality improved despite a 250-basis-point increase in the repo rate.The improvement was supported by strong credit growth, higher write-offs, better underwriting and stronger provision buffers, the report said.Citing RBI data, Nuvama said gross non-performing assets (GNPAs) declined from 5.7% in March 2022 to 4.6% in March 2023.On current risks, the report said the impact of the West Asia conflict and global spillovers had so far remained limited to select segments of the NBFC sector.“Importantly, the impact of the West-Asia conflict and global spill-overs has so far remained contained and confined to select low-ticket unsecured PL, BL, micro-LAP, and CV/CE segments,” it said.Nuvama also flagged El Niño-related risks, saying these had remained limited so far but warranted monitoring as their impact could become visible with a lag if winter crops were affected.
Capital buffers , liquidity to support asset quality
The report said healthy capital and provision buffers across most NBFCs, along with abundant systemic liquidity and support for credit growth, were expected to cushion headline asset-quality ratios.As a result, Nuvama said any deterioration was more likely to remain concentrated in specific segments or individual players rather than become broad-based.“Any deterioration is more likely to remain pocketed and segment/player specific rather than broad-based, unless rate hikes become prolonged and are accompanied by a material external or macroeconomic shock,” it said, according to news agency ANI.
Rate cycle impact on NBFC margins
Nuvama also said the impact of the interest-rate cycle on NBFC profitability would vary depending on how quickly assets and liabilities reprice.“The impact of a rate cycle on NBFC margins is unlikely to be uniform with the key differentiator being the mismatch between the repricing of existing assets-liabilities and incremental movement,” it said.