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Home Business Insights Risk and Regulation

Higher interest rates raise risks for non-bank financial institutions

FutureCFO Editors by FutureCFO Editors
July 19, 2023
Photo by TimArbaev on iStock

Photo by TimArbaev on iStock

Higher interest rates raise risks for non-bank financial institutions globally, said Moody’s recently.

Given higher interest rates and lower growth, distress in the largely unrated non-bank financial institution (NBFI) sector globally could have spillover credit impacts on many other sectors, the credit rating agency noted.

The Financial Stability Board groups entities in these less transparent and regulated parts of the financial system as other financial institutions (OFIs), which include investment funds, securities dealers, broker dealers, finance and leasing companies.

Some economies could be highly exposed to any pullback in lending if NBFIs provide a significant proportion of credit to the economy, such as in the US and the UK, said Michael Taylor, a Moody's Managing Director.

“That said, some specific sectors within emerging markets like China's property sector are also reliant on non-bank funding,” Taylor pointed out. 

Moreover, NBFI stress can rapidly spread to other financial institutions, weighing on funding conditions and potentially leading to mark-to-market losses at other financial institutions, according to Moody’s. 

In pockets where regulatory oversight and transparency are low, it can be difficult for policymakers to anticipate and quickly stem NBFI financial stress that damages market confidence and tightens liquidity, the firm added. 

Meanwhile, the implications for sovereigns, corporates, banks and structured finance transactions will vary depending on their sector or regional exposure to NBFIs, Moody’s observed.

NBFIs with high leverage, less liquidity and weak risk management are most vulnerable to stress from higher rates, Moody’s said. 

Those that have adopted leverage-driven investment strategies, as well as those that invested heavily in less liquid assets when funding was inexpensive and abundant, will face difficulties generating returns amid higher rates, the firm warned. 

Open-ended funds account for a large part of them, according to Moody’s, adding that financial stress can escalate quickly for some open-ended funds when declining asset values or weaker portfolio performance lead to redemption runs or margin calls.

Related:  Moody’s: Asian Liquidity Stress Indicator drops for the first time in eight months
Tags: interest rateMoody's
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