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Monetary Transmission via NBFCs strong but impact delays: RBI CAFRAL report

NBFCs tend to mute monetary transmission in the short run but amplify it in the long run

Reserve Bank of India, RBI
Photo: Bloomberg
Aathira Varier Mumbai
3 min read Last Updated : Nov 08 2023 | 3:49 PM IST
The monetary policy transmission through Non-Banking Finance Companies (NBFCs) is strong and in the expected direction, but there is a delay of nearly two years to see its impact on their balance sheet. The transmission to the balance sheet is muted in the short term, said the Reserve Bank of India’s (RBI) Centre for Advanced Financial Research and Learning (CAFRAL).

“Loans and advances fall less than the total shrinkage in the balance sheet. It falls slowly (only in year three following the policy decision) and the impact in the initial two years is, in fact, positive,” said the CAFRAL report.

Also, NBFCs tend to mute monetary transmission in the short run but amplify it in the long run.

The RBI’s Monetary Policy Committee (MPC) has increased the repo rate by 250 basis points (bps) since May 2022, with the domestic rate-setting panel keeping the repo rate unchanged at 6.5 per cent for the fourth consecutive time in October.

Post the Covid-19 pandemic, there has been an increase in the role of NBFCs, which brings focus on their role in monetary transmission as a significant part of their funding comes from financial markets and banks.

A key area of concern has been the NBFCs' ability to raise finances in a contractionary monetary policy environment.

According to the report, the share of loans and advances has become riskier following the contractionary monetary policy.

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"There is a fall in secured borrowings and the NBFCs are forced to compensate by relying on unsecured borrowings," the report observed.

Among the unsecured borrowings, the component that saw the most rise is in debentures, which increased in the two years following the policy announcement, whereas secured debentures fell during these timelines.

As per the report, both secured and unsecured loans from banks to NBFCs decreased during monetary policy tightening. There has also been a significant fall in reserves and surplus, indicating that buffers are growing thinner.

Post the pandemic, there has been an increase in the integration of the NBFCs with the banking sector. Furthermore, the accumulation of risk in the sector is expected to have implications for the financial industry, emphasizing the need for close monitoring and regulatory intervention in the sector against systemic fallouts.

"Considering the five traded NBFCs classified as NBFC-UL by the Reserve Bank, measures reveal a higher sensitivity to market shocks. This trend reflects the gradual increase in systemic risk resulting from greater integration with the financial system," the report added.

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Topics :NBFCsRBImonetary policymonetary policy committee

First Published: Nov 08 2023 | 3:43 PM IST

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