Economic Survey 2020: Keep health score for NBFCs, get early warning

The Economic Survey has suggested the use of a ‘health score’ index for non-banking finance companies (NBFCs), which can be used to decide on the optimum capital infusion to deserving NBFCs that will ensure efficient allocation of scarce capital during the times of crisis.

The index ranges between -100 and +100 with higher scores indicating higher financial stability of a company and employs information like asset liability management (ALM) problems, excess reliance on short-term wholesale funding and balance sheet strength of the NBFCs.

“The health score provides a good diagnostic for the problems in the NBFC sector. For instance, health score of a stressed NBFC was consistently low throughout the period 2011-19 with a sharp decrease in 2017-18. Hence, the health score of the stressed NBFC over the entire eight-year period provided significant early warning signals,” it said.

The survey shows that except for 2011 and 2017, the ALM mismatch in the shorter tenures was negative for all the years coinciding with the years when the health score of the NBFC was low. Also, post 2015, the average reliance on short-term wholesale funding increased over 200%.

“Given the long-term duration of assets of the stressed NBFCs, this overdependence on commercial paper funding created exposure to refinancing risk,” the survey said.

The health score for HFCs also exhibited a declining trend post 2013-14. From a peak of 53.44 points in March 2014, the score for housing finance companies fell to 5.70 points in March 2017 and moved to the negative territory at 5.42 in March 2018 and further to 8.60 points in March 2019.

“The trend of the health score showed early warning signs, well before the HFC sector eventually faced constraints on external financing from 2017-18. Again, this confirms that the health score is a leading indicator of stress in the HFC sector,” the survey said.

The index can serve help in predicting refinancing-related stress faced by the financial firms in advance. “It can serve as an important monitoring mechanism to prevent such problems in future. Furthermore, disaggregating the components and examining their trends can shed light on how to regulate NBFCs. Other than its utility as a leading indicator of stress in the NBFC sector, the health score can also be used by policy makers to allocate scarce capital to stressed NBFCs in an optimal way to alleviate a liquidity crisis,” the survey said.


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