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The International Monetary Fund (IMF), in its report titled India Financial System Stability Assessment, has flagged significant vulnerabilities in India’s financial architecture, particularly arising from the Non-Banking Financial Companies (NBFCs) sector. Despite overall resilience post-pandemic, the increasing interconnectedness and exposure of NBFCs pose emerging systemic risks.

A major concern highlighted is the concentration of NBFC lending to the power sector. In FY 2024, 63% of power sector loans were provided by just three large Infrastructure Financing NBFCs—an increase from 55% in FY 2020. This overexposure, particularly by state-owned NBFCs such as IREDA, raises red flags given the inherent risks in infrastructure financing, including delays, cost overruns, and revenue shortfalls. The report notes that 56% of NBFC lending was financed by market instruments like corporate bonds and mutual funds, heightening the risk of contagion in case of financial distress.

NBFCs differ structurally from banks. They cannot accept demand deposits, lack deposit insurance coverage, and have no direct access to Reserve Bank of India (RBI) liquidity windows. Consequently, any shock in their repayment capacity can lead to asset-liability mismatches, potentially spilling over into banks, mutual funds, and bond markets, amplifying systemic risks.

The IMF also examined stress scenarios such as stagflation—a situation characterized by slow economic growth and high inflation. In such cases, public sector banks (PSBs) are particularly vulnerable. The Capital Adequacy Ratio (CAR) of PSBs could fall to the regulatory minimum of 9% under stress, threatening their ability to absorb losses. This is concerning, as the RBI mandates a minimum CAR of 12% for PSBs. The IMF recommends that PSBs retain earnings instead of paying dividends to strengthen their capital buffers and support credit flow during downturns.

While banks and NBFCs have shown broad resilience, ‘weak tails’ exist—non-systemic NBFCs and urban cooperative banks with below-minimum or even negative capital. This underscores the need for strengthened regulatory oversight, especially over state-owned NBFCs, which currently enjoy relaxed prudential norms. The IMF calls for uniform regulation across public and private NBFCs to ensure a level playing field and greater financial stability.

The report also emphasizes the need for improved data sharing and systemic risk monitoring, especially related to NBFC exposures, household credit, and climate-linked financial risks. Physical and transition risks remain moderate but are notable in monsoon-dependent agriculture and carbon-intensive industries like thermal power.

Recommendations include:

• Extending the cybersecurity risk framework to major NBFCs.
• Implementing IFRS-9 based credit risk assessments and countercyclical capital buffers.
• Improving insolvency and bankruptcy resolution mechanisms to reduce recovery time and enhance credit discipline.

India’s financial system is becoming more diverse and inclusive, with rising digital financial access and market participation. However, to sustain growth and resilience, proactive reforms in NBFC regulation, capital adequacy, and systemic risk management are essential.