Financial Fragility in Retail-NBFCs

Abstract

This study examines the financial fragility of the Retail Non-Banking Financial Companies (Retail-NBFCs) sector. We show that the liquidity crunch in Retail-NBFCs stemmed from their over-dependence on short-term wholesale funding from Liquid Debt Mutual Funds (LDMFs) and the low level of high-quality liquid investments in the LDMF sector. While such reliance worked well in good times, it generated significant short-term debt rollover problems for Retail-NBFCs during times of stress. The key reason for the inability of Retail-NBFCs to roll over commercial paper was the transmission of systemic risk from Retail-NBFCs to the LDMF sector. Anticipating defaults by Retail-NBFCs, mutual fund investors exited from the LDMF sector. The low levels of high-quality liquid assets in the LDMF sector were insufficient to withstand the concerted redemption pressure by investors and made the LDMF sector reluctant to roll over short-term debt of Retail-NBFCs. We develop a robust tool (Health Score) to estimate financial fragility in a Retail-NBFCs and find that it can predict the constraints on external financing (or rollover risk) faced by these firms.

Keywords: shadow banking, Retail-NBFC, liquid debt mutual funds, rollover risk, redemption risk, short-term wholesale funding, interconnectedness risk, financial and operating resilience, health score, cumulative abnormal returns

JEL Classification: G01, G14, G23, C23