Health Score for NBFCs & HFCs
The Economic Survey 201920 on Friday unveiled a dynamic health index (Health Score) developed for housing finance companies (HFCs) and retail nonbanking finance companies (NBFCs) to detect early-warning signals of impending liquidity problems facing the companies in the sectors. The survey suggested that policymakers and other stakeholders should use the Health Score as a valuable tool to introduce corrective measures to address unfavourable financial trends in a timely manner.
“A dynamic health index (Health Score) is constructed that captures these risks and can be used as an early warning system to anticipate liquidity crisis in an NBFC. Policy makers can use this tool to monitor, regulate and avert financial fragility in the NBFC sector,” said the survey.
It said the Health Score is based on the rollover risk, which includes asset liability management risk, interconnectedness risk, and financial and operating resilience of an NBFC. The survey's analysis shows the Health Score for the HFC sector exhibited a declining trend after 2014. By the end of 2018-19, the health of the overall sector had worsened considerably. Similarly, the Health Score of the retail NBFC sector was consistently below par for the period between 2014 and 2019.
Following payment defaults by subsidiaries of IL&FS and by DHFL, investors in liquid debt mutual funds (LDMFs) ran collectively to redeem their investments. In fact, the defaults triggered panic across the entire gamut of NBFC-financiers, causing a funding (liquidity) crisis in the NBFC sector.
The problems stemmed from the NBFCs overdependence on short-term wholesale funding from the LDMFs.
“While such reliance works well in good times, it generates significant risk to NBFCs from the inability to roll over the shortterm funding during times of stress. An asset-side shock not only exacerbates the Asset Liability Management problem but also makes investors in LDMFs jittery and thereby leads to a redemption pressure that is akin to a “bank run.” This run on LDMFs then precipitates the refinancing (rollover) risk for NBFCs and further exacerbates the initial problems,” said the survey.