Key Details
The paper, Systemwide Stress Test at the IMF: Integrating Nonbank Financial Intermediary Risks, explains why financial stability must be assessed across connected institutions rather than through separate tests of banks, Non-Banking Financial Companies (NBFCs) and investment funds.
India-Related Finding | Why It Matters |
|---|---|
NBFCs depend on wholesale funding and bank loans | They can face liquidity pressure if banks or market investors become unwilling to refinance them |
Infrastructure lending remains concentrated | Delayed repayments from a stressed sector can weaken NBFC cash flows and reduce their ability to service short-term debt |
Bond funds are important NBFC financiers | Investor redemptions can force funds to sell NBFC bonds or stop purchasing new issues |
Banks may avoid lending to stressed NBFCs | Central-bank liquidity support may not reach the institutions experiencing the shortage |
CDMDF provides a market backstop | It can purchase corporate bonds during stress, but the IMF analysis found that its available capacity could not absorb every potential sale |
India’s relatively closed capital account limits external drainage | Liquidity is more likely to move between domestic institutions than leave the country, reducing foreign-exchange pressure but not domestic contagion |
Illiquid corporate-bond trading restricts stress modelling | Sparse market prices make it difficult to estimate how forced sales would affect bond values and balance sheets |
The paper draws lessons from the IMF’s systemwide analysis undertaken for the 2024 India Financial Sector Assessment Program and places them within a wider framework for evaluating non-bank financial risks.
Why Bank-Only Stress Tests Can Miss the Risk
Non-bank financial institutions—including NBFCs, investment funds, insurers and pension funds—hold US$256 trillion of more than US$500 trillion in global financial assets.
Traditional stress tests often examine sectors separately. The IMF paper instead looks at how stress can travel between banks, NBFCs and investment funds, turning a liquidity problem in one part of the system into wider financial stress.
India’s NBFC-Fund-Bank Link Creates a Transmission Chain
NBFCs finance infrastructure, microfinance, consumers and other segments, but many depend on bank loans, commercial paper and bonds rather than household deposits. Liquidity risk arises when longer-term lending is financed through shorter-term borrowing.
Bond funds connect NBFCs with investors. When investors redeem fund units, funds may sell NBFC bonds, allow debt to mature without reinvesting or withdraw bank deposits.
Banks are connected to both. They lend directly to NBFCs and provide deposits and credit facilities to investment funds. During stress, banks may conserve liquidity by reducing exposures, potentially intensifying shortages elsewhere.
The IMF identifies several continuing vulnerabilities:
Concentrated NBFC exposure to infrastructure
Low holdings of readily saleable liquid assets
Dependence on wholesale funding
Periodic bond-fund redemptions linked to tax and bill-payment cycles
Banks’ reluctance to lend to stressed NBFCs
Central-bank collateral policies focused primarily on sovereign securities
The central risk is not necessarily the failure of one sector. It is that defensive action by each institution can make the system collectively less stable.
India’s Capital Account Changes the Nature of the Risk
India’s relatively closed capital account makes large foreign-exchange outflows less likely than in more externally open emerging markets. Money withdrawn from a bond fund may instead move into a domestic bank deposit.
This can protect aggregate foreign-exchange liquidity while redistributing rupee liquidity unevenly. Banks may gain deposits but conserve cash, bond funds may need to sell assets and NBFCs may lose access to refinancing.
India’s capital-account structure therefore reduces one transmission channel without eliminating domestic liquidity risk.
Corporate-Bond Illiquidity Makes Risk Harder to Measure
Forced asset sales can depress bond prices, creating losses for other institutions holding the same securities and prompting further sales—a fire-sale spiral.
The IMF could not reliably model these second-round effects for India because many corporate bonds trade infrequently. Standard methods produced implausible estimates, including larger price effects for more liquid government securities.
This is an important limitation: fire-sale risk is difficult to quantify, not necessarily insignificant.
Existing Backstops May Not Cover a System-Wide Shock
India has introduced liquidity requirements for bond funds and established the Corporate Debt Market Development Fund (CDMDF). The industry-funded mechanism, backed by the Government, can purchase investment-grade corporate debt when normal market liquidity disappears.
The IMF found that CDMDF could support bond-fund liquidations, but its capacity was insufficient to absorb all potential sales in the stress scenarios examined.
The paper does not conclude that the fund should simply be enlarged. Its broader case is for system-wide stress testingthat captures links among banks, NBFCs and funds, identifies data gaps and tests whether safeguards in one sector shift stress elsewhere.
Policy Relevance
Stress tests should connect RBI- and SEBI-regulated entities: Separate assessments of banks, NBFCs and mutual funds can miss the funding channels through which stress moves between them.
NBFC liquidity deserves as much attention as solvency: Asset quality may appear adequate while short-term refinancing becomes unavailable.
Redemption cycles should form part of surveillance: Predictable tax and corporate-payment periods can generate concentrated withdrawals from bond funds and temporary funding pressure for NBFCs.
Backstop capacity should be tested against market-wide scenarios: CDMDF’s resources, eligible securities, activation process and replenishment arrangements need to be assessed against simultaneous selling by multiple funds.
Collateral policy involves systemwide trade-offs: Expanding eligible collateral could improve access to liquidity but may also transfer credit and market risk to the central bank.
Corporate-bond data need improvement: Transaction-level information, investor holdings and reliable estimates of price impact are necessary to model forced sales in an illiquid market.
More buffers do not always make the system safer: Requiring funds to hold additional bank deposits or government securities could strengthen one institution while increasing its connection to banks or sovereign-bond markets.
Follow the Full IMF Paper Here: Systemwide Stress Test at the IMF: Integrating Nonbank Financial Intermediary Risks