NBFCs with strong fundamentals have weathered the stress on the sector to effectively manage their liquidity, though funding costs have grown, the Reserve Bank of India said in its financial stability report released on Thursday.

However, the central bank expressed concern over their credit appraisal processes given the fact that loans have been concentrated in four segments in the consumer credit category — auto loan, home loans, loans against properties and personal loans.

“Given the substantial growth rate in exposure to these sectors (consumer credit), a possible concern is dilution in credit standards. A look at the evolution in delinquency levels in each of the segments shows that NBFCs as a group have been leading delinquency levels in almost all the sub-segments of consumer credit, except in loans against property where it stands a close second to PSU banks,” the report said.

The recent developments in the NBFC sector have led to greater market discipline as the better performing companies continued to raise funds. Those with asset-liability mismatch (ALM) issues or asset quality concerns were subjected to higher borrowing cost. The RBI, however, called for a greater survelliance over the sector.

“Solvency contagion losses to the banking system due to idiosyncratic housing finance company/NBFC failure show that the failure of the largest of these can cause losses comparable to those caused by the big banks, underscoring the need for greater surveillance over large HFCs/NBFCs,” the report said.

On NPAs , the report said the financial system “remains stable” despite recent setbacks and the bad loan cycle has “turned around”, with a sharp reduction in the ratio of such loans to 9.3 per cent of assets in March 2019 from 11.2 per cent a year ago. The NPA ratio is expected to narrow down further to 9 per cent by March 2020. The share of state-run banks in overall NPAs was high at 12.6 per cent, but is likely to come down to 12 per cent by March 2020.