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Global Nonbank Lenders Continue To Face Stiff Competition, But Less Stringent Oversight Than Banks

Operating and financial performance of non-bank finance institutions (NBFIs or fincos) is closely linked to the economic and industry risk conditions in the countries where they operate. During the past few months, trade tensions--in particular the tariff dispute between the U.S. and China--are casting a shadow on the global economy and financing conditions in all regions. However, central banks stand ready to stimulate growth, and borrowers around the globe continue to enjoy fairly benign credit conditions. Still, S&P Global Ratings believes many countries have their own particularities, which influence the economic performance. In our view, main risks for fincos are the potential consequences of a slowing global economy, increasing protectionist policies, the possibility for a market correction, and liquidity reversal if financing conditions tighten faster than expected.

On the other hand, industry risks and regulatory frameworks for NBFIs vary not only from region to region but also from country to country. In the majority of countries, regulatory bodies have been demanding fincos implement more stringent requirements, and we expect this to continue. Nevertheless, these regulations remain less stringent than those of banks, and we believe this will remain the case at least for the next one to two years.

While we haven't seen a deterioration in the credit quality of the NBFI sector following the weakening global economic conditions, we still believe that market volatility, global trade tensions, declining investment confidence, and unfavorable political conditions in some regions could weigh on their operating performance. U.S.-China friction has broadened from tariffs to technology. Middle East tensions pose a risk to energy markets. These prolonged global tensions have shaken investors' confidence and have the potential to dent long-term growth. In addition, political challenges in Latin America's largest countries have been materializing, and new administrations in the region are facing waning domestic investor confidence as policy uncertainty prevails. On the positive side, The U.S. Federal Reserve lowered the benchmark rate by 25 basis points in July 2019. In this sense, issuers in many regions stand to benefit from declining benchmark borrowing costs, while fincos' funding costs are likely to decrease and their net interest margins to improve gradually.

In our view, during the past 12 months, fincos have been able to refinance their debt obligations and maintain their necessary funding and liquidity needs to continue growing. The latter was successful despite the rising interest rates and market volatility due to geopolitical tensions. Nevertheless, market volatility, coupled with lower credit growth in the majority of regions, remains a concern for all fincos, and could weaken financial performance in 2019 and beyond. Asset quality metrics, profitability, and capital indicators may also suffer. NBFIs with lower asset quality and higher concentrations compared with those of peers could face higher credit risk.

Below, we discuss the risks that NBFIs face and how we reflect these risks in our anchors for fincos. We detail our reasoning behind the NBFI anchors for each country where we rate NBFIs.

Country Anchors: Our View Of The Sector's Economic And Industry Risk

Our country anchors reflect our view of the economic and industry risks that fincos face in that country.

Country Economic risk trend Industry risk trend Bank anchor Adjustment Fincos' anchor
1

Australia

Positive Stable bbb+ (3) bb+
2

Brazil

Stable Stable bb+ (1) bb
3

Canada

Stable Stable a- (3) bbb-
4

Chile

Stable Stable bbb+ (3) bb+
5

China

Stable Stable bb+ (2) bb-
6

Colombia

Stable Positive bb+ (3) b+
7

India

Stable Stable bbb- (2) bb
8

Japan

Stable Stable bbb+ (2) bbb-
10

Korea

Stable Stable bbb+ (2) bbb-
11

Mexico

Negative Stable bbb (2) bb+
12

Mongolia

Stable Stable b+ (2) b-
13

New Zealand

Positive Stable bbb (3) bb
14

Panama

Stable Stable bbb- (2) bb
15

Russia

Stable Stable bb- (2) b
17

Taiwan

Stable Stable bbb (2) bb+
18

The U.K.

Stable Stable bbb+ (3) bb+
19

The U.S.

Stable Stable bbb+ (3) bb+
20 U.S. BDC Stable Stable bbb+ (3) bb+
BDC--Business development companies
NBFI anchors based on BICRA and bank anchors

The foundation of both our bank and NBFI anchors is our Banking Industry Country Risk Assessment (BICRA) of the economic and industry risk of a particular country's financial system. The preliminary anchors for the NBFI sectors aim to reflect the additional risks that fincos face relative to banks. As such, in all countries, we set the preliminary anchor for fincos three notches below the bank anchor. In our view, the additional risks for fincos relative to banks typically include the following:

Fincos typically lack access to the central bank's credit facilities, which increases liquidity and funding risk relative to banks.

NBFIs typically face strong competition from banks because the latter enjoy lower financing costs. Fincos also have higher competitive risk, both among themselves and relative to banks, because of lower barriers to entry as well as more volatile or fragmented business conditions.

Fincos usually lack the prudential regulatory oversight that banks have.

Country-specific adjustments to the preliminary anchor

In some cases, we make country-specific adjustments that result in a finco anchor that's higher or lower than the preliminary anchor. We narrow the differential when we consider fincos' incremental risks relative to banks in the same country to be lower than those assumed in the preliminary anchor. In these situations, factors may include government oversight, regulation, or access to the central bank's funding. For example, Mexican fincos benefit from access to government-owned development banks, which represent a stable funding source for this sector even during market turmoil, as was the case during the 2008-2009 global financial crisis. Therefore, for Mexican NBFI anchors, we only deduct two notches from the banking anchor instead of three. We may also narrow the differential when the bank anchor is low ('bb+' or below) and already reflects some of the incremental risks we typically see in the finco sector. Conversely, we may widen the differential if NBFIs face additional funding, economic, or competitive risks; or operate under a weaker institutional framework than assumed in the preliminary anchor.

Australia

Our 'bb+' anchor for fincos in Australia is the standard three notches below the bank anchor, which we derive from our BICRA. Our three-notch standard deduction reflects our view of the incremental industry risk of NBFIs relative to banks. We consider that fincos operate under weaker regulatory oversight and institutional framework, with higher competitive risk, and typically less-stable revenue through economic cycles. Funding risk for fincos is also higher than for banks, in our view, because they typically lack access to central bank's funding.

Domestic fincos benefit from Australia's wealthy, open, and resilient economy, a low-risk institutional and competitive framework, and conservative regulatory standards. Despite ongoing orderly unwinding of imbalances in the housing market, Australian banks and fincos remain exposed to risk emanating from a rapid growth in house prices and private-sector debt for several years, in combination with Australia's external weaknesses--in particular its persistent current account deficits and high level of external debt. We consider these imbalances expose the banks and fincos in Australia to a scenario of a sharp correction in property prices and its severe consequences. Nevertheless, we consider that the probability of such a scenario remains relatively remote and that loan losses in the next two years are likely to remain very low by historical and international standards.

Brazil

The NBFI anchor for Brazil is set at 'bb', which is one notch below the anchor for domestic banks. We usually assess the fincos' anchor three notches below the banks' anchor. However, we modify this notching based on industry dynamic for fincos operating in Brazil.

Unlike their peers in other jurisdictions, fincos in Brazil are also subject to the central bank's oversight and regulations, including regulatory capital adequacy ratios. Moreover, these entities have access to the central bank's funding; however, with lesser ability than banks to use it because NBFIs can only access intraday and overnight operations, while banks have access to operations with longer term. At the same time, fincos in Brazil are authorized to issue Deposit Guaranteed by the Brazilian Credit Guarantee Fund (FGC), which provides a stable long-term funding alternative for those companies by attracting investors due to FGC's larger guarantee coverage. FGC is a private institution, owned by large banks, responsible for the protection of savings account holders and investors in case of regulatory intervention in a financial institution, liquidation, or bankruptcy. However, we still believe fincos face stronger competition from banks and other finance companies, have less stable and diversified sources of revenues than banks, underscoring the one-notch deferential between the NBFIs' and banks' anchor.

The Brazilian NBFI anchor should move in tandem with the banks' anchor, maintaining the one-notch differentiate notch. Still, the trend in the BICRA's industry and economic risks in Brazil is currently stable.

Canada

Our anchor for our ratings on fincos in Canada is currently 'bbb-'. NBFIs in Canada have moderately higher funding risk than banks due to the lack of access to the central bank's funding and relatively higher use of wholesale funding. NBFIs also face greater competitive risks than domestic banks, given the absence of substantial barriers to entry. While there are some federal regulations as well as provincial laws, Canadian NBFIs face lower prudential regulations than domestic banks, resulting in moderately increased risk relative banks. Like the anchor for Canadian banks, the one for fincos reflects the country's competitive economy, which is tempered by a substantially indebted household sector and outsized real growth of house prices since 2000.

Chile

The anchor for Chile-based NBFI fincos is 'bb+', reflecting the standard three notches below the bank anchor. This reflects the lack of access to the central bank's credit lines, lower regulatory oversight than for banks, and higher competitive risk than for banks due to relatively low barriers to market entry.

China

We believe that fincos operating in China face higher risks than domestic banks. These risks include the lack of access to the central bank's credit lines, heavy reliance on wholesale funding, and less-comprehensive prudential supervision and regulation for many. Fincos are not subject to pricing controls and face lesser distortion than banks stemming from state ownership. However, these companies are more susceptible to business cycles, leading to more volatile revenues. Compared with banks, fincos generally have higher financing costs. For all these reasons, the anchor for fincos operating in China is 'bb-', two notches below that for banks.

Colombia

We establish a 'b+' anchor for Colombian NBFIs, which is three notches below the anchor for banks operating in Colombia. The above reflects NBFIs' typical lack of access to the central bank's credit lines, higher competitive risks than among banks, and lower regulatory oversight. Colombian fincos rely on wholesale funding sources, including commercial credit facilities and market debt issuances. Moreover, these entities usually face strong competition from banks, so their margins are more susceptible to come under pressure and their revenues are more volatile than the average of the banking system. On the other hand, Colombian NBFIs are not subject to the significant prudential regulatory oversight, as opposed to banks. For example, fincos are not required to hold minimum capitalization levels as banks do.

We could revise Colombia's BICRA industry risk score to a stronger category because the banking regulatory framework is improving. Nonetheless, if the later materializex, the bank anchor would remain unchanged as well as our notching for the Colombian NBFIs.    

India

In our opinion, India's low-income economy and the government's limited fiscal flexibility constrain the country's economic resilience. However, the medium-term outlook for India's growth remains healthy due to the country's solid demographics, public and foreign direct investment, private consumption, and reforms such as the removal of barriers to domestic trade tied to the imposition of goods and services tax.

We believe Indian fincos face greater industry risk than banks because fincos generally have no access to the central bank's funding and are subject to less onerous regulations, despite some requirements on capital adequacy, liquidity, and asset quality management. However, several fincos in India have created strong niches, domain expertise, and economies of scale to support revenue stability and mitigate competitive pressures.

Japan

We assess the anchor for fincos operating in Japan as 'bbb-'. Its trend is stable, reflecting our view that the current anchor level incorporates competitive dynamics in the Japan's financial sector as high risk. We narrow the gap in anchors for fincos and banks in Japan by one notch to reflect the favorable characteristics of the NBFI sector. One of them is the funding stability. A typical finco in Japan is backed by a member of a large corporate or financial group, and so has a sound funding base. In addition, historical revenue stability among Japan's fincos is not substantially weaker than that of the banking sector, except for consumer finance companies that charge the borrowers at high interest rates.

Korea

Our 'bbb-' anchor for fincos in Korea is two notches below the bank anchor. We believe domestic NBFIs face incremental industry risk relative to banks because fincos are more dependent on market-sensitive funding, given the lack of access to the central bank's funding, generate volatile revenue, and face competition from banks. The prudent regulatory supervision and oversight for fincos tempers these weaknesses.

Mexico

We establish a 'bb+' anchor for Mexican NBFIs, which is two notches lower than the bank anchor. We have reduced the differential between the bank and NBFI anchors to two notches from our standard three notches. This is because NBFIs in Mexico benefit from the existence of government-owned development banks, which represent a stable funding source to this sector even in stressful situations. Additionally, the government has a track record of support through guarantees and liquidity during periods of market turmoil. The ongoing decline in domestic oil production and a softening in the services sector are the main factors behind the economic growth slowdown in Mexico, with an expected GDP growth of 1.3% for 2019. Therefore, our concerns about the economic risk in the country translate into a negative trend in the banking and NBFI anchors. If the Mexico's economic risks materialize, we could adjust both anchors downward by one notch.

Mongolia

The 'b-' anchor for fincos operating in Mongolia is two notches lower than the bank anchor. We believe domestic NBFIs face incremental industry risk relative to banks. That's because fincos are more dependent on market-sensitive funding owing to the lack of access to the central bank's funding. They also face more competition than banks due to lower market-entry barriers. We believe regulatory oversight in Mongolia is looser than international standards.

New Zealand

Our 'bb' anchor for finance companies in New Zealand is the standard three notches below the bank anchor, which we derive from our BICRA. The three notches reflect our view of fincos' incremental industry risk relative to banks because of weaker regulatory oversight and institutional framework, higher competitive risk, and typically less-stable revenue through economic cycles. Funding risk for finance companies is higher than banks, in our view, because they typically lack central bank access.

Fincos benefit from New Zealand's open, resilient, and well-developed economy, augmented by high-income levels and a creditor-friendly legal framework. Offsetting these strengths is New Zealand's substantial reliance on external borrowings, persistent current account deficit, and the elevated risk of a sharp correction in property prices, despite the recent growth slowdown in residential house prices and in private-sector credit extension as the credit cycle matures.

Panama

Given that Panama's BICRA already incorporates the lack of access to central bank's credit lines, because of the absence of lender of last resort in the country, the anchor for fincos operating solely in Panama reflects only a two-notch adjustment compared with our standard three-notch gap with the bank's anchor. Consequently, we're only applying lower regulatory oversight, and higher competitive risk relative to banks.

It is our belief that fincos face stronger competition and have lesser revenue stability due to concentration in business lines compared with banks. Fincos are not regulated by the Superintendencia de Bancos de Panamá; therefore, they're not required to hold any minimum capital and liquidity ratios as we expect for banks. As a result, our starting point is 'bb' for all fincos with 100% exposure in Panama.

Russia

Our anchor for fincos, in particular leasing companies, operating in Russia is 'b', two notches below the anchor for Russian banks. We don't apply standard three-notch difference because as the anchor for Russian banks is already low (at 'bb-') and, in our view, the one for fincos reflects some of the incremental risks we typically see in the NBFI sector. We note that leasing companies don't have direct access to the central bank's funding, but funding profiles of some larger players are supported by the ownership structures (regulated parent finance companies or government). We also note that leasing companies are not currently regulated by the central bank. Even though we understand the law on leasing is under review and it includes only minimum capital requirements (in absolute terms) and reporting, we don't expect it to be implemented prior to 2020.

Taiwan

Our 'bb+' anchor for fincos in Taiwan is two notches lower than our anchor for domestic banks. This reflects that NBFIs in Taiwan are mostly regulated by the Financial Supervisory Commission, which has prudential financial requirements and reporting standards that we view as less robust than those for banks. In general, we believe Taiwanese fincos have adequate profit margins and stable market shares for leading players, suggesting sufficient entry barriers. However, given that most fincos in Taiwan rely on wholesale funding and don't have direct access to the central bank's funding, their funding capability is weaker than those of banks, which benefit from diversified retail funding sources.

The U.K.

Our anchor for our ratings on U.K. fincos is 'bb+', standard three notches below the anchor for banks. NBFIs don't have access to the central bank's funding, which limits their financial flexibility, particularly during times of financial stress. They face strong competition from banks and from each other, and given their concentration in fewer business lines, revenues can be volatile. fincos in the U.K. are regulated by the Financial Conduct Authority, as opposed to the Bank of England's Prudential Regulatory Authority. In general, they have weaker regulatory requirements than banks and are subject to less intensive oversight.

The U.S.

Our anchor for our ratings on fincos in the U.S. is currently 'bb+'. We initially set the anchor for fincos three notches below the anchor for banks in the same country to reflect the typical lack of access to the central bank's funding, lower regulatory oversight, and higher competitive risk for fincos relative to banks. U.S. fincos typically rely on bank credit facilities, secured and unsecured debt, and other wholesale funding, whereas U.S. banks mainly rely on deposit funding. While consumer finance companies generally are subject to consumer protection laws, U.S. fincos are not subject to the significant prudential regulatory oversight of banks' capital and liquidity, which we view as generally supportive of creditworthiness. While U.S. fincos may compete with banks, they often focus on higher-risk lending than banks and are subject to greater cyclical volatility. Like banks, the U.S. fincos' anchor reflects the country's diversified and high-income economy.

U.S. Business Development Companies (BDCs)

The anchor for ratings on BDCs is currently 'bb+'. The anchor is three notches below the U.S. bank anchor to reflect the lack of access to the central bank's funding, lower regulatory oversight, and higher competitive risk relative to banks. BDCs are subject to some regulation, but they're not subject to the significant prudential regulatory oversight of banks' capital and liquidity, which we view as generally supportive of creditworthiness. BDCs typically focus on higher-risk lending than banks and are subject to greater cyclical volatility. The Small Business Credit Availability Act lowered the asset coverage requirement for BDCs to 150% from 200%, if approved by their boards of directors or shareholders. For those BDCs that don't adopt the modified asset coverage requirement, we revise the anchor upwards by one notch on an entity-specific basis.

Primary Credit Analysts:Matthew T Carroll, CFA, New York (1) 212-438-3112;
matthew.carroll@spglobal.com
Ricardo Grisi, Mexico City (52) 55-5081-4494;
ricardo.grisi@spglobal.com
Secondary Contacts:Toshihiro Matsuo, Tokyo (81) 3-4550-8225;
toshihiro.matsuo@spglobal.com
Victor Nikolskiy, Moscow (7) 495-783-40-10;
victor.nikolskiy@spglobal.com
Lisa Barrett, Melbourne (61) 3-9631-2081;
lisa.barrett@spglobal.com
YuHan Lan, Taipei (8862) 8722-5810;
yuhan.lan@spglobal.com

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