The Health Score Can Serve As a Timely Indicator Of Future Performance Of NBFCs: Economic Survey

The Economic Survey 2019-2020 tabled in Parliament today touches upon non-banking financial companies, which has been ailing the Indian economy for a while. The IL&FS and DHFL default have plunged the entire shadow-banking sector into a crisis that eventually led to a situation of the credit crunch in the Indian economy. But to gauge the robustness and financial health of NBFCs, an index called the health score, which ranges between -100 to +100, has been talked at length in the survey. The higher score will reflect the higher financial stability of that particular non-banking financial company and a health score of 0 is a neutral score, which means neither risky nor safe.

This very indicator constitutes information about Asset Liability Management (ALM) information, excess reliance on short term wholesale funding and balance sheet strength of NBFCs. As per the economic survey, the health score of NBFCs has co insistently been in the negative territory from 2011 to 2019. And in 2018-2019, the health score of NBFCs was -28. The economic survey, taking cognisance of the health score says that 'the score provided significantly early warning signals'.

However, the health score of Housing Finance  Companies (HFCs) has been in negative territory since 2013-2014. As per annual reports of HFCs, in March 2018, the health score of HFCs was at -5.42 and in March 2019 the score stood at -8.60. The economic survey added that this health score is very crucial in understanding the state of NBFCs and HFCs and have the potential of averting any such mishappenings in the future.

The survey also put out metrics affecting the health score of housing financial companies and listed down each and every metric at length and key metrics mentioned are ALM profile, short term volatile capital, assets quality, short term liquidity, provisioning policy, and capital adequacy ratio. And key metrics affecting the health score of retail NBFCs are Liquid Debt Mutual Funds (LDMF) sector exposure to commercial paper (CP) issued by Retail-NBFCs, Liquidity Buffer levels in the LDMF sector, short-term volatile capital, operating expense ratio (Opex Ratio); it is an indicator of the efficiency of Retail-NBFCs, short-term liquidity, provisioning policy, capital adequacy ratio (CAR).

In order to arrest the financial fragility of NBFCs, the survey suggested a series of reforms. It suggested that a regulator could incorporate the heath score methodology to detect early warning signals. Taking stock of the current liquidity crunch situation amongst NBFCs, the survey suggested using the heath score as a premise for directing capital infusion to deserving NBFCs.