NBFC crisis and its domino effect
on Indian economy
The most important thing to do now is not to shock the system, give
confidence to the industry, bring liquidity into the system and reduce
interest rates.
Many non bank firms have become defaulters
There is a decline in consumption which has led to a decline in the GDP growth. There is no
recession because recession means two-quarters of negative growth. We don't have negative
growth, we have a 5% growth rate. We have to go back to September 2018 when the IL&FS
scandal happened.
When it happened those who got caught were debenture holders of the company-- pension
fund, mutual fund and the lenders from the NBFCs who had lent to IL&FS. 40% of the
incremental consumer financing last year was done by the NBFCS, not banks. 25 - 30% of
the NBFC money was coming through funding or Mutual Funds spots.
The exposure to the NBFC sector came down hence IL&FS happened in the quarter of
October-Dec, 2018 saw a decline in consumption and decline in its financing and
subsequently, the GDP growth rate in Jan-March came down to 5.6 %. It saw the impact
there. In the month of October, November and December, late former finance minister Arun
Jaitley was not well, so there was not much of action happening. RBI was not even thinking
about it because it was undergoing some changes.
In the month of January, February and March we had new a Finance Minister who was busy
with the budget. Then the government went to election mode. In the months of April, May
and June (2019) nothing happened, and after the NDA2 government was formed they had to
make the budget and then the Kashmir problem happened, which kept the government
occupied further. We had no action from the government all this while.
The problem was that lending to consumers was not done by the banks, it was done by the
NBFCs who from September last year till now (2019) have withdrawn Rs 3 lakh crore from
the market, which means about Rs 1.5 to 2 lakh crore has been paid back by them towards
their liabilities.
Reliance Capital itself paid back Rs 40,000 crore and DHFL also paid back Rs 40,000 crore
and whatever money they were lending they were not getting back to lend further. So there
has been a liquidity squeeze in the market.
What should be done?
The government has to come out with a scheme where the NBFCs can sell their assets and
raise liquidity but if they sell goods, their balance will shrink and they will have to put up
margins. The better thing is to find out which are the good NBFCs to which banks can give
good credit lines to lend, particularly to the auto and real estate sector where they can put up
25% of their money and get 75% in return. The banks can explore receivables so that the
money that comes can be used to payback the bank loans and not diverted.
We need liquidity to be pumped up at the point of lending which is an NBFC. Now, that is
not happening as the SBI Chairman Rajnish Kumar said very clearly that he has Rs 1 lakh
crore surplus money which he is not ready to lend. However, the problem is that he cannot
lend. He is scared to do so because he has to lend to the NBFCs only and has to find out
which ones to lend to and give the lines of credit to. That's how it has to be done.
What we see is a liquidity squeeze in the economy. Consumption has come down because of
this. There is not enough liquidity in the system. At present, the total bank lending in the
system is Rs 97 lakh crore out which the total NBFC book is Rs 24 lakh crore.
The RBI should monitor the total lending including NBFCs apart from the banks on a
fortnightly basis. The apex bank only monitors banks currently. It should also oversee the
NBFCs and look at the system liquidity including both NBFCs and banks so that the
borrowings can pick up in the economy. This, however, is a challenge the government has to
address urgently. Unless the NBFCs are given the lines of credit, they are not going to pick
up pace.
Talking about the Iron & Steel industry, the auto and real estate sectors are the biggest
consumers of building material like cement which is used by a lot of companies and creates a
lot of jobs. Hence, jobs could also come down in other sectors of the economy.
IMPORTANT
• NBFCs are facing a liquidity crunch. In other words, they don’t have money to lend
or are facing enormous difficulties in raising funds. NBFCs typically borrow money
from banks or sell commercial papers to mutual funds to raise money. They on-lend
these money to small and medium enterprises, retail customers and so on. When
NBFCs don’t have money to lend, that reduces the credit flow to the economy, hits
economic growth and causes many borrowers to default on loans.
What led to this?
There are a couple of things to consider here. One, the NBFC business
model itself is flawed, to begin with. It relied on raising short-term
funds which were then lent out as long-term loans. This leads to a
situation called an asset-liability mismatch. For example, an NBFC
raises money by selling 6-month debt papers and on-lends this as a
car loan with a tenure of 5 years. This leads to a situation where the
NBFC has to roll over (or renew) the 6-month debt paper or raise
fresh loans to repay the debt paper. In good times, this happens as a
matter of course. But when times are tough, this cycle is broken.
That leads us to the second factor. The cycle was broken by a default
of some firms of the IL&FS group. There were fears that this would
turn out to be a contagion. Simply put, banks, mutual funds and their
investors were afraid that more such entities wouldn’t default. As this
fear took hold, many institutions refused to give money to NBFCs. The
cost of funds rose by as much as 150 basis points for NBFCs.
Why is the crisis a big deal?
As explained earlier, NBFCs are playing an increasingly important part in the economy.
Their share of credit has increased because they were lending in sectors where banks refused
to go or did not want to go. The used commercial market is a good example here.
Now that NBFCs are finding it difficult to raise money or having to pay a huge cost for doing
so, this will choke the flow of credit to the economy. It will hit the MSME sector which is
already suffering from the twin blows of demonetisation and the goods and services tax.
More importantly, it will hit consumption demand in the economy. With investment demand
yet to pick up and exports flagging, consumption was the primary engine driving the
economy. A reduction in credit further adds to economic slowdown pressures, which are
already visible.