In the wake of a looming crisis in the shadow banking sector in India, the Reserve Bank of India (RBI) on June 30, relaxed the end-use restrictions related to external commercial borrowings (ECBs), permitting corporates and non-banking financial companies (NBFCs) to approach external lenders to raise funds for working capital requirements, general corporate purposes and debt repayment.
This move is one of the central bank’s recent initiatives after it got sweeping powers over housing finance companies and NBFCs, as granted through the Union Budget 2019-20.
While this initiative widens the scope for NBFCs to raise more funds in times of default, it undermines the fact that the way the NBFCs accumulated money for their business has contributed to the tremendous rise in their non-performing assets (NPAs), which is central to the crisis in the sector.
On top of this, the central government has also encouraged public sector banks to buy high-rated pooled assets of up to Rs 1 trillion of NBFCs, guaranteeing that it will provide a one-time six-month partial credit guarantee for the first loss of up to 10%. In other words, government will bear a risk of Rs 10,000 crore if 10% of the securitised pool defaults.
Simply put, both the government and the RBI are encouraging banks and other lenders to fund NBFCs to save the sector from crisis. In her maiden budget speech, Finance Minister Nirmala Sitharaman said: “NBFCs play an extremely important role in sustaining consumption demand as well as capital formation in small and medium industrial segment.”
According to RBI data, gross NPAs or bad loans of NBFCs stood at 6.6% at the end of March 2019 against 5.3% at the end of March 2018. On the other side, bank lending to NBFCs has also seen a substantial rise. Consider these figures: NBFCs owe an outstanding amount of Rs 6,412 billion at the end of March 2019. This is a 22% increase compared with the previous year when the debt was Rs 4,964 billion. This figure was Rs 3,910 billion in March 2017.
As per official estimates, NBFCs received 44% of total funds from banks, followed by 33% from asset management companies managing mutual funds (AMC-MF), and 19% from insurance companies in 2018. When the crisis in the sector came to light in September 2018 following the collapse of Infrastructure Leasing and Financial Services (IL&FS), mutual funds have tightened financing norms for NBFCs. The sudden behaviour from mutual funds is just one of the reasons for the current liquidity crunch for NBFCs.
Behind the fall of IL&FS, which had nearly a Rs one lakh crore outstanding debt, are a set of financial irregularities involving the group’s top management, auditors and rating agencies.
The irony is that the government agency, Serious Fraud Investigation Office, is also probing into why few RBI’s officials turned a blind eye despite the bank’s own inspection reports finding irregularities in the group’s lending operations.
Analysts have also pointed out that IL&FS’s fall was also aided by one of its main operational strategies -- borrowing short-term loans and lending for long-term projects, such as infrastructure and real estate.
But, official data shows that the problem is spread across the sector. It is astonishing that 99.7% of shadow banking in India makes long-term loans against short-term funding, primarily carried out by NBFCs and housing finance companies.
This suggests that the crisis in the shadow banking sector has been fostered by the fact that the lending operations of NBFCs or HFCs are poorly regulated and the uncertainty associated with the strategy -- borrowing short-term loans and lending for long-term projects -- needs a critical regulation. But the government and the RBI’s handling of the crisis by only encouraging borrowings for NBFCs and not monitoring their lending operations may only delay the crisis but not solve it.