Was India's NBFC crisis a myth or a reality?

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MUMBAI: When Infrastructure Leasing & Financial Services Ltd (IL&FS) imploded last year, some described it as India’s Lehman moment, referring to the collapse of the storied Wall Street firm that had triggered the 2008 Global Financial Crisis. Sixteen months later, what we have here is the failure of just two shadow banks and several others turning smaller, rather than a full-blown crisis that would have warranted a bail-out funded by taxpayers.IL&FS’ balance sheet of nearly Rs 1 lakh crore created such a scare that almost everyone in the industry said that nothing short of a bail-out plan or a special liquidity window could save the Non-Banking Finance Companies and that the failure of NBFCs could lead to a domino effect.While industry was in panic, the Reserve Bank of India and the government stood on the sidelines and watched the re-adjustment in the financial markets play out, rather than coming to the rescue of firms that were facing difficulties in raising funds to roll over their commitments.Many have cricitised the RBI’s reluctance to open a special window, but the central bank did open the liquidity spigot that turned a system liquidity deficit into one of surplus at Rs 52,500 crore between April-December. When there were just two failures which the industry dealt with without the bailout they demanded, what does it indicate? Was it really a Lehman-like moment?”Government and RBI have gone and done what they could do,” says Rajeev Jain, MD and CEO Bajaj Finance. “There will be 10 more things that the industry would want but the challenge before RBI and the government is that they do not want to create a moral hazard. If they go and save a bad institution, what is the incentive for a good institution,” he asks.No doubt India’s NBFCs had in 2019 their worst year in a decade as they struggled for funds. But only during times of stress do corporations correct their mistakes and cut the flab — and that turned out to be true in the case of NBFCs too.The end of easy money from mutual funds led to some soul-searching by NBFCs and changed the way they fund themselves. The so called ‘asset-liability mismatch’ that was the root cause of the problem, began correcting. Companies that were borrowing at a lower cost for a short term — say, six months or one year — and lending for 5 or 10 years, realised their folly.As short-term funding became difficult, many went in for longer-term borrowings to fund their long-term lending.”The line of credit is for a short duration while NBFCs lend ahead for longer periods and this creates a dangerous mismatch that ultimately goes out of control,” said Thomas John Muthoot, CMD, Muthoot Pappachan Group. “The companies will have to infuse long-term funds and keep a close watch on their ALM profiles. We are also looking forward to the apex bank to carry out structured interactions with NBFCs to discuss their issues related to funding, liquidity and functioning,” he added.NBFCs have remodelled the management of business. They changed their borrowing profile over the last one year where share of commercial paper halved to 5% from 10% and bank borrowing rose from 37.4% to 44%. The availability of funds, especially from capital markets, remains low and only for a few NBFCs with strong parentage and diversified AUMs. The struggling ones have been heavily dependent on securitization or assignment tools to manage their books. Their margins and profitability have fallen with the focus on long-term borrowing.The regulator has been unequivocal in its stand on how it would deal with NBFCs’ troubles. Governor Shaktikanta Das has said that he would do everything to avoid a systemic crisis, but would not bail out companies that are facing issues due to mismanagement. Troubles in the non-banking finance companies were due to inherent frailties and not because of liquidity constraints, the RBI said in its latest Report on Trends and Progress of Banking in India.The defaults and rating downgrades of IL&FS and Dewan Housing Finance Company (DHFL) are the reasons for liquidity constraints in the sector. Balance sheets of NBFCs expanded at a slower pace in the first half of 2019-20, in the aftermath of IL&FS’ default and rating downgrades of a few NBFCs like DHFL and Reliance Capital. Money supply to the sector has been tight. The actual credit flow from banks to NBFCs has declined since October 2018 and is primarily only available for highly-rated NBFCs.The government and the Reserve Bank of India have taken several steps to alleviate the liquidity stress and strengthen the confidence in the sector by opening a refinancing window and coming up with a backstop for potential losses via the partial credit guarantee scheme.”The government is announcing measures without creating a moral hazard. The government has done what it should and what it could for the sector,” says Jain of Bajaj Finance.While it is true that the size of the NBFC industry has shrunk in the past few quarters, they are also reinventing themselves with better models where they originate loans but don’t keep the book with them but sell to banks which are flush with funds.The new year may bring in a new dawn for the sector. “2020 brings hope because we expect gradual improvement in both demand uptake and liquidity by mid-year,” says Abhijit Tibrewal, analyst at ICICI Securities. According to him, “This would come on the back of improvement in consumption resulting from all the policy, regulatory interventions made by the government and the RBI.”

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