Indian non-banking financial companies' NPLs to soar by up to 100bps

But asset quality will stabilize over the next 12 months.

Moody's Investors Service expects that non-banking financial companies (NBFCs) in India will see their asset quality stabilize over the next 12 months, although the reported nonperforming loans (NPLs) ratio may increase due to changing recognition norms.

"The ongoing tightening of NPL recognition norms mean that the minimum standards for NBFCs will match those of banks, a credit positive," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

Moody's analysis is contained in its just-published report "Indian Non-Bank Finance Companies: Asset Quality to Stabilize" by Vadlamani and Dipanshu Rustagi, a Moody's analyst.

Retail asset quality over the next 12 months will benefit from the Reserve Bank of India's accommodative monetary policy and stronger economic outlook, says Moody's.

This means that delinquencies that were on an upward trend due to slower economic growth, and weaker debt servicing by borrowers, will stabilize. 

However, the new NPL recognition norms, which bring the definition of nonperforming loans in-line with the definition used by banks, will likely push up reported NPLs by 80-100 basis points over the next 12 months.

However, this change in norms will mean declining profitability for many NFBCs. The additional credit provisions needed to meet the tighter NPL norms will dent their return on assets by 20-30 basis points, says Moody's.

Funding will remain a credit weakness, as regulatory restrictions on retail deposit mobilization mean that NBFCs must rely on wholesale sources of funding. Liquidity management is particularly problematic for housing finance companies which exhibit average asset durations of about seven years—because there is limited lender appetite for long-dated paper with tenures in excess of five years.

In addition, because housing finance companies' assets are mainly floating-rate, any mismatches will be exacerbated if interest rates continue to fall, notes Moody's.