The COVID-19 related disruptions would worsen the asset quality of non-banking financial companies (NBFCs) and further aggravate their liquidity stress, according to a report.
The weakening of NBFCs' solvency will increase risks for banks that have large direct exposures to the sector, global rating agency Moody's said in a report.
The sector has been facing liquidity challenges as investors became risk averse after a series of defaults by IL&FS Group in September 2018.
"Asset quality at non-banking financial institutions (NBFIs) will significantly deteriorate as economic disruptions from the coronavirus outbreak deepen an economic slowdown that has been underway in the past few years," Moody's said in a report.
Asset quality deterioration at NBFCs on average will be more severe than at banks because the former focuses more on riskier segments, according to the report.
The Reserve Bank of India's (RBI) three-month moratorium on repayments of loans would create a significant drain on near-term liquidity at NBFCs, the report said.
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Most NBFCs do not have substantial on-balance sheet liquidity because they primarily manage liquidity by matching cash inflows from loan repayments by customers with cash outflows to repay their own liabilities, it said.
"Moratoriums on loan repayments will result in substantial declines in cash inflows over the next few months, the rating agency said.
The extent of liquidity stress will depend on the number of customers seeking moratoriums and the degree of the economic shock, the report said.
The longer the restrictions on economic activity remain, the longer it will take for loan repayments to return to normal levels even after moratorium periods end, it said