New Delhi [India], March 4 : The International Monetary Fund (IMF) has raised concerns about potential financial instability in India due to the concentrated exposure of Non-Banking Financial Companies (NBFCs) to the power and infrastructure sector.
The report highlights that NBFCs are deeply interconnected with banks, corporate bond markets, and mutual funds, which could amplify systemic stress if vulnerabilities emerge.
The IMF report specifically warns about the high exposure of NBFCs to the power sector, which continues to face structural challenges.
Concentrated lending to this sector increases the risk of financial instability, as any distress in power and infrastructure projects could trigger broader stress across banks, bond markets, and mutual funds.
Furthermore, the co-lending model, where banks partner with NBFCs to extend credit to priority sectors, further intertwines financial institutions, increasing systemic risk.
The IMF suggests closer monitoring of NBFCs' lending patterns and improved risk management frameworks to prevent financial disruptions.
The report raises concern that while NBFCs function similarly to banks in many ways, key differences remain. Unlike banks, NBFCs cannot accept demand deposits, and their deposits are not insured.
They also do not have access to the Reserve Bank of India's (RBI) liquidity facilities or payment systems.
The IMF recommends strengthening liquidity regulations for NBFCs, particularly those with significant infrastructure exposure.
Additionally, India's corporate bond market remains underdeveloped, making NBFCs heavily reliant on domestic institutions like banks and mutual funds for financing. This interconnectedness has led to past liquidity crises, with major redemptions in the mutual fund industry linked to corporate bond market distress.
Despite these challenges, India has made significant progress in financial inclusion. The IMF notes that nearly 80 per cent of adults have financial accounts, supported by extensive banking networks and the growth of digital public infrastructure such as the Unified Payments Interface (UPI).
The rapid rise of retail investors in equities has also transformed India into one of the world's largest markets for equity options trading.
India's financial system is diverse and well-developed, with total assets amounting to nearly 190 per cent of GDP. While banks hold around 60 per cent of the financial system's assets, NBFCs have expanded their market share significantly.
Nearly half of the credit to the private sector now comes from non-banking financial institutions, including insurers, pension funds, and investment funds.
The IMF notes that state-owned NBFCs dominate the sector, with the top three government-owned infrastructure financing companies (IFCs) holding one-third of total NBFC assets. Unlike private-sector NBFCs, state-owned entities are currently exempt from large exposure limits, raising regulatory concerns.
The report recommends aligning regulations for both state-owned and private NBFCs to mitigate risks.