NBFIs resort to pawning as business contracts
Licensed Finance Companies (LFCs) encountered a challenging year marked by significant shifts in their traditional business models.
The year witnessed a remarkable contraction in the LFCs’ loans and advances portfolio, registering a 5.6% year-over-year decline to stand at Rs. 1.1 trillion at the end of Q3. This downturn starkly contrasts the 14.5% growth observed in the corresponding period of 2022. A mix of stringent vehicle import restrictions and adverse macroeconomic conditions pressured the core business of leasing and hire purchase, leading to a gradual shift towards pawning advances. Pawning advances now account for 17.3% of the total lending outstanding in the sector.
Macroprudential Surveillance Department Director W. A. Dilrukshini said, “The successful implementation of the master plan for consolidation of non-bank financial institutions introduced by the Central Bank in the latter part of 2022 helped to build up confidence of the sector and caused an increase in capital an improvement in deposit growth and decline in borrowings in the sector however declining interest rates with monetary policy easing will cause this trend to reverse.”
Dilrukshini was speaking on December 29 at the launch of the Financial Stability Review of 2023 at the Central Bank of Sri Lanka.
Gross and Net Stage 3 loan ratios escalated to 20 % and 14 % respectively, by the end of Q3 of 2023, a notable increase from 16.8 % and 11.7 %, respectively, reported by the end of Q3 of 2022, showing deterioration in the asset quality thereby increasing the vulnerability of the sector to credit risk. a reflection of the industry’s pivot towards more diversified and arguably riskier loan portfolios. Pawning advances, primarily gold-backed loans, emerged as a significant component of LFCs’ strategies to withstand the economic headwinds. The sudden surge in pawning was driven by consumers’ need to cope with elevated inflation and diminishing household incomes, leveraging gold as a haven amidst the turbulence.
This strategic shift comes with significant perils. The inherent volatility of gold prices introduces a new set of risks to LFCs, historically accustomed to more stable asset classes like vehicles. Additionally, the overall asset quality within the sector deteriorated, with Gross and Net Stage 3 loan ratios escalating notably from the previous year. This deterioration suggests an increasing vulnerability to credit risk, exacerbated by regulatory changes in loan classifications.
These challenges will continue as the sector’s liquidity position remains robust due to being buoyed by increased investments in Government securities which are no longer giving interest rates over the cost of deposits. Companies will also be forced to further consolidate within the sector as there are considerable legacy issues that have yet to be addressed. With the recapitalization of the banking sector, it is likely that NBFIs will be further crowded out of the lending sectors.
LFCs continued to be unable to garner investor confidence. The report notes ‘Tier-1 eligible capital continued to dominate the total capital of the LFCs sector accounting for 94.5 per cent of total capital. Irrespective of strengthening the capital position of the sector, few companies need to comply with minimum capital requirements. Therefore, continuation of the consolidation of LFCs is required to maintain the resilience of the sector.’ (TP)
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