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Ratings Downgrades: What does it mean for banks and NBFCs?

Updated : May 01, 2019 11:01 AM IST

Over the weekend, rating agency CARE downgraded the long-term debt of Reliance Home Finance and Reliance Commercial Finance to default status or ’D’ rating. Rating agency ICRA also downed the rating on commercial paper of Reliance Capital to sub-investment grade. This led to a sharp fall in shares of many banks and NBFCs on Tuesday. Shares of Reliance Capital, Indiabulls, DHFL, L&T Fin, Edelweiss fell by 5-10 percent, while IndusInd, Bank of India, Bank of Baroda, etc. fell by over 5 percent.

The downgrading is expected to hurt inflows into debt mutual funds. This, in turn, can hurt funding available to NBFCs. Credit Suisse lists a number of banks, mutual funds and NBFCs which have exposure to the four stressed groups - Il&FS, DHFL, ADAG and Essel.

According to the experts, this issue may not result in a major accident but could lead to cut in NAVs for some debt fund and therefore impact the flow of funds. For banks, it may mean a little more NPAs than they were prepared for and for NBFCs it may mean expensive money and therefore a growth slowdown.

Mirae Asset Global Investments’ Mahendra Jajoo said this issue will have an impact over a period of time in terms of a slower pace of flows into debt schemes. He said it is not an industry-wide phenomenon but there are few problem schemes which are affected.

According to him, investors are concerned with two things. “One is they are not sure as to how much more is going to come because for the last 3 or 4 months we are seeing continuously one development after another. Second is that because the valuation or the markdown process of some of these securities is something which has not been well understood, people are not sure as to which day or when or by how much the markdown will happen. So, people may hold back fresh investment and may look at bank fixed deposits or something,” said Jajoo.

Vice President of Financial Institutions Group at Moody's Investors Service Srikanth Vadlamani said he was looking at how it would impact the NBFC funding because of their reliance on the debt capital markets.

“The way to look at it is that when the IL&FS issue came up, that was the major shock because that was not expected and that led to almost a freezing of the markets. More importantly, the NBFCs were not prepared for that. So if you look at just prior to the onset of the IL&FS episode, they were running pretty high as far as their dependence on CP’s was concerned," he said.

“I think what we have seen across NBFCs over the last six months, the IL&FS was a huge wakeup call and there have been corrective measures both in terms of the asset side, they have been large asset sell down for some of the NBFCs and on the funding side, almost most of them have reduced the reliance on CPs in favour of bank clients,” he added.

“I think there is going to be a generalised trend of increase in the credit cost for the system as a whole. I do not think it is just going to be limited to the NBFCs and given the trend of banking system moving aware from more risky project financing kind of funding to safer working capital kind of financing,” said Money market expert Neeraj Gambhir. "So, in general, the corporate sector and the NBFCs both will face higher credit cost or higher credit premium from the lending community," he added.
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