NST Business
KUALA LUMPUR: Higher rates are increasing risks for non-bank financial intermediaries (NBFIs) globally, and those with more leverage, less liquidity, and weak risk management will find it harder to navigate the cycle.
According to a Moody's Investor Service report, a higher rate environment impacts NBFIs, creating a more challenging environment to generate strong financial returns and obtain financing.
The report said difficulties are more significant for those NBFIs that adopted leverage-driven investment strategies or took on maturity risks when funding was inexpensive and abundant.
It noted that in some cases, open-ended funds, which now account for a large part of the sector, face liquidity risks from redemption runs or margin calls triggered by falling asset values or weaker portfolio performance.
Moody's Investor Service noted that NBFIs have a larger share of the global financial system than they did a decade ago, but risks are not uniform.
Where their share of financing is high, like in the US (Aaa stable), UK (Aa3 negative), Korea (Aa2 stable) and Brazil (Ba2 stable), risks within the NBFI sector could percolate through the economy, it said.
Further, Moody's Investor Service noted that trouble in the NBFI sector poses risks to other categories of debt issuers.
It said the implications for sovereigns, corporates, banks and structured finance transactions would vary depending on their sector or regional exposure to NBFIs. The greater the number and size of debt issuers exposed to NBFI in stress, the stronger the likelihood that contagion from NBFI weakens overall credit conditions, the report said.
Moody's Investor Service noted that these underlying vulnerabilities were exposed in the "dash for cash" episode in March 2020, when the pandemic spooked investors and several NBFIs were forced to accept steep discounts on some of their illiquid assets to meet a rush of redemptions or margin calls.
"However, fears even spread to less-risky assets like government bonds and were only halted when central banks stepped in as buyers of last resort," it said.
Moody's Investor Service further noted that although NBFIs do not have direct access to any central bank liquidity backstop if they were to see a spike in redemption demands, central banks with a financial stability mandate may have to intervene to support troubled NBFIs or affected entities should spillovers be significant.
It said that resolving insolvent NBFIs or other troubled entities in extreme cases could lead to sizeable direct fiscal costs that governments must absorb.
For banks, it said the banking sector's capitalisation and funding structure are key mitigants to any risks stemming from the financial system, providing buffers to absorb loss from credit defaults.
In addition, Moody's Investor Service said some structured finance deals sponsored by NBFIs could see their performance weaken, as evidenced by rising delinquencies due to tightening.
"As a result of tightening and underlying corporate credit weakening, rising defaults and negative rating activities could have a material negative impact on collateralised loan obligation junior notes, which leverage loans managed by collateral managers back," it said.