Early warning system: Why NBFCs must act now to keep the wells from running dry

EWS: The way to stave off a liquidity crisis?

Is there an impending liquidity crisis that NBFCs must brave? 

Bank credit – which has been the largest source of funds for Non-Banking Financial Companies (NBFCs) – declined to a two-year low of 8.5 per cent in June, down from 36 in October 2022, according to the RBI data. This has had a domino effect on overall credit growth – slowing it down to 15.6 per cent in August 2024. 

This explains why NBFCs are scrambling for access to alternative funding sources – from debentures and bond markets to foreign currency borrowings.  

On one front, NBFCs are battling funding constraints, while on the other, they face the escalating burden of rising credit losses. Signs of increasing slippages and delinquencies are evident, particularly in the consumer credit segment, where NBFC-fintechs hold the largest share of sanctioned and outstanding loans. These delinquency concerns have become so pronounced that they now sit at the forefront of regulatory focus.  

In fact, CRISIL Ratings expects a 1-1.5 percent rise in credit costs for NBFC-MFIs in the coming year due to the buildup of stress from growing delinquencies.  

Then there’s Bajaj Finance – the sector’s trailblazer – whose loan loss provisions surged in the first quarter of this financial year, mainly from ageing delinquencies. During the quarter, the company had to tap into its management overlay (a crisis buffer), allocating ₹105 crore for loan losses and provisions. Despite stable portfolio quality, Bajaj Finance experienced a significant shift in delinquent loans from stage 1 to stage 2, primarily due to subdued collections. 

NBFCs are hard-pressed from both sides 

Adding a third dimension to the squeeze, RBI is all set to release the Expected Credit Loss (ECL) framework for loan loss provisioning. If the RBI raises the buffer requirements even by a fractional delta, it could compound the crunch. 
 
As the saying goes, “When the tide goes out, you see who’s swimming naked”. As market conditions tighten, those without solid liquidity & risk management will be exposed, revealing vulnerabilities that were once hidden during times of plenty. 

Catch the drip before the flood, with advanced Early Warning Systems (EWS) 

The case for developing and implementing an EWS is compelling; effective risk monitoring can significantly reduce both credit losses and capital requirements. In fact, a PWC report suggests that a well-designed EWS could lower loan loss provisions by 10-20% and reduce the required regulatory capital by up to 10%. 

The current landscape presents a two-fold challenge. First, NBFCs struggle with integrating a wider range of data to be able to address emerging risks effectively. Second, they operate within a small window to adapt and respond to new threats and their rules engines are often not equipped to keep pace. 

This is why EWS frameworks must be implemented on a decisioning engine that allows you to test and iterate quickly. This way, it becomes easy to build a solid system of triage that allows you to prioritise and optimise your collection efforts.  

It also serves a widely different use case. Take the case of gold loans, for instance. The segment has been facing the heat of regulatory scrutiny. And one of the major issues has been weaknesses in monitoring of loan-to-value (LTV). With a no-code decisioning engine, business teams can quickly set up and modify rules for monitoring LTV ratios and flagging potential risks associated with price fluctuations. Because in the gold loan business, de-linking gold price volatility to business profitability is of utmost importance. But to do this you need a decisioning engine that integrates easily with external data sources.  

The bottom line 

EWS is not a one-time stopgap measure but rather a unified vision of end-to-end credit monitoring, from loan origination through to collections, enabling lenders to stay ahead of emerging risks. By focusing on proactive, data-driven solutions, institutions can meet regulatory expectations while also transforming their approach to risk management. 

At FinBox, we have been working to help lenders implement EWS frameworks on our Sentinel platform – equipping them to continuously stream data, adjust parameters in real-time, and integrate diverse data sources seamlessly. 

Let me know what you think of EWS systems and how they can be built in a resilient fashion.