The profitability of the finance company sector declined and some companies made losses last year because of high interest rates and heightened credit and liquidity risks, it said in its Financial System Stability Review 2009.

But it said the sector remained resilient and able to withstand shock as shown by the capital adequacy ratio of the RFCs which stayed significantly above the minimum regulatory requirement.

The minimum capital requirement for RFCs was increased to 200 million rupees in 2008 and most firms have complied.

The banking regulator said most large and medium size RFCs are well capitalised and profitable and are “rebounding strongly” although their recovery has been inhibited to some extent by reduced lending by banks.

But these conditions are expected to improve with the expansion of economic activities in the second half of the year.

“A few small loss-making RFCs with lower capital levels need to build up their capital base to improve their viability,” the Central Bank said..

A number of reforms to strengthen the finance and leasing company sector will be implemented in 2010 which would require higher levels of capitalisation.

“In this context, consolidation and mergers of companies may be necessary to ensure the viability of small companies in the future.”

The Central Bank also said the current financing model of RFCs and specialized leasing companies exposes them to considerable interest rate risk.

This was because of the maturity mismatch between their assets, mainly leases, which are longer term and their liabilities such as deposits and bank loans which are shorter term.

The regulator suggested the RFCs and leasing firms should raise more medium and long-term funds by securitizing their lease receivables.

Public confidence in finance companies was eroded after the collapse of unauthorized firms engaged in finance business, such as Golden Key Credit Card Company of the Ceylinco group.

But confidence was restored by action by the regulator to support the weaker firms and put some under new management.

“The rest of the RFC sector is now rebounding after the stresses experienced in the early part of the year,” the Central Bank said.

Credit facilities provided by the RFC sector grew marginally for the quarter ending June 2009.

“The high interest rate environment prevalent in 2008 and in the first half of 2009 and the slowdown in economic activities also affected earnings of the RFC sector through a narrowing of interest margins and an increase in non-performing loans.”

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