Interest Rate Sensitivity of Non-banking Financial Sector in India

 -Vikalpa: The Journal for Decision Makers

In the pre-financial liberalization era, interest rates were administered and exhibited near-zero volatility. The easing of financial repression in the 1990s generated experience with interest rate volatility in India. Thereafter, administrative restrictions on interest rates in India have been steadily eased since 1993. This has led to an increased interest rate risk for financial firms. Stock returns sensitivity to interest rates was theoretically advocated by Stone (1974).

He developed the two-index model by incorporating the interest rate risk as an extra factor for explaining the stock returns of financial companies. Interest rate risk is an important concern for financial firms because the returns and costs of financial institutions are directly dependent on interest rates. Various authors have, therefore, examined the empirical sensitivity of stock returns of financial institutions to changes in market interest rates.

 Literature too shows a strong relationship between the stock returns of financial institutions and interest rates. The bulk of the research has almost exclusively focused on developed countries especially the banking sector in the United States. This study contributes to the related literature by studying the interest rate sensitivity of non-banking financial company’s (NBFC) stock returns in India.

OBJECTIVES OF THE STUDY

1. To examine whether stock returns of NBFCs in India exhibit significant sensitivity to interest rate changes.
2. To examine whether stock returns of NBFCs in India exhibit significant sensitivity to unanticipated changes in interest rate.
3. To examine whether the interest rate sensitivity is uniform across financial institutions examined in the study.
4. To investigate possible determinants that the account in favor of cross-sectional heterogeneity, if uniformity is rejected.

In the Indian context, interest rate risk was studied by Patnaik and Shah (2002) for a sample of 43 major banks. They found evidence for significant interest rate sensitivity of Indian banks. The two largest banks, SBI and ICICI bank, carried relatively little interest rate risk when compared to other banks in the sample. Size served as the hedging instrument for large banks.

Hence, cross-sectional heterogeneity exists across banks for their interest rate exposure. Literature provided substantial evidence for stock returns exhibiting statistically significant inverse relationship with interest rate changes (Alam & Salahuddin, 2009; Asprem, 1989; Ballester, Ferrer, & Gonzalez, 2011; Ballester et al., 2009; Benink & Wolff, 2000; Kasman, Vardar, & Gokce, 2011; Kwan, 1991; J. D. Moss & G. J. Moss, 2010; Park & Choi, 2011).

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