Non-bank financial institutions (NBFIs) are playing an increasingly significant role in financial intermediation in a number of Asia-Pacific (APAC) markets, with rapid growth over the last five years spurred by tighter regulation of banks, the low interest environment and technological development. Fitch Ratings expects these factors to continue to support strong growth over the next couple of years, although interest rate normalisation and greater regulatory scrutiny of NBFIs in some APAC markets could create headwinds in the medium term.
NBFIs can provide an alternative source of credit to borrowers who might be underserved by banks, which often avoid labour-intensive small-ticket lending. NBFIs tend, for example, to be more active in their outreach to SMEs. This is particularly important in APAC’s emerging economies, where only 13% of SMEs have access to credit, according to the World Bank. Policymakers in some APAC markets have encouraged NBFI development as a way to address this problem and promote financial inclusion. NBFIs can also diffuse credit risk across the financial system.
However, NBFIs can also add to risks in the financial system if they are overly reliant on short-term wholesale funding, lack transparency or grow at an excessive rate. Moreover, the non-bank sector is subject to weak regulatory oversight in some markets. Notably, rapid growth in APAC has occurred amid benign asset quality. Vulnerabilities created by expanded risk appetite and unproven underwriting standards could be exposed by a market downturn.
The financial assets of other financial intermediaries (OFIs) in APAC grew by a compounded rate of 16.9% in US dollar terms in 2011-2015, almost double the global rate of 8.6%, according to data from the Financial Stability Board. OFIs include all financial institutions except banks, insurance companies, pension funds, public financial institutions, and central banks, so is broader than our own definition of NBFIs, but it should provide a reasonable proxy. OFIs’ share of financial assets in APAC rose to 15.5% in 2015 from 10.2% in 2011.
Tighter bank regulations and the undercapitalisation of some banking systems have pushed some activities out of banks into NBFIs. Low interest rates and investors’ search for higher returns has also supported NBFI growth by improving access to funding. Meanwhile, technological advances have helped to challenge the advantages that banks have traditionally held as a result of their larger scale, branch presence and client information.
OFI assets have grown faster than GDP in most APAC economies, but growth has been exceptionally rapid in China (see chart), where OFI assets rose to 68% of GDP in 2015 from just 21% in 2011. China’s non-bank sector lacks transparency and involves increasingly complex relationships with banks, which further adds to financial stability risks. The Chinese authorities have recently signalled stronger enforcement of risk-management regulations, but they also continue to rely on rapid credit growth to meet GDP growth targets, which limits their scope to rein in the non-bank sector.
However, in most APAC markets the non-bank sector is still too small to pose significant systemic risks. India provides one contrasting example to China in terms of the balance between benefits and risks. Its NBFI growth has been more measured than China’s, but the sector has helped to soften the economic impact of a sharp fall in lending growth by the capital-constrained banking sector. There are still shortcomings in the regulatory oversight of Indian NBFIs, but this has tightened over the last couple of years. Moreover, large Indian NBFIs have substantially higher capitalisation levels than banks, as is the case in most markets.