The Great Indian NBFC Crisis

The Non-Banking Financial Companies (NBFCs) are quasi-banking institutions in India. They are allowed to make loans just like banks do. However, they are not allowed to take deposits from people in order to make these loans. Hence, these Non-Banking Financial Companies (NBFCs) borrow money from the bond market in order to make loans.

Traditionally retail as well as institutional borrowers in the Indian market preferred to borrow from banks. However, of late, this has changed because of the precarious financial situation that the banks find them in. The Indian banking sector was already struggling with bad loans which have been made because of kickbacks and nepotism. This is the reason why Non-Banking Financial Companies (NBFCs) performed better than banks for the first time in 2017.

However, in the second quarter of 2018, the Non-Banking Financial Companies (NBFCs) seem to have come across a perfect storm. They are now at the epicenter of a massive stock market crisis. Some analysts are calling it India’s Lehman moment. In this article, we will have a closer look at the details of India’s Non-Banking Financial Companies (NBFCs) crisis.

The Background of the Crisis

One fine day, the market was no longer bullish about Non-Banking Financial Companies (NBFCs). Instead, their stocks were being hammered. DHFL which is considered to a blue chip NBFC stock suddenly saw its stock price decline by 60% in one day! The same was the case with IL&FS which is supposed to be a stalwart in this field. The main reasons behind the decline of the Non-Banking Financial Companies (NBFCs) stocks are as follows:

• Timing Mismatch: Indian Non-Banking Financial Companies (NBFCs) have been playing a very risky game. They have been borrowing money short term and have been lending it out long term. This asset liability timing mismatch is obviously a recipe for disaster. However, the NBFCs have been able to roll it over and pay their debts when due. This is the reason the Non-Banking Financial Companies (NBFCs) were able to function without too many problems.

  The problem started when IL&FS, i.e. one of the NBFC’s mismanaged its funds. As a result, it is now not able to pay back its creditors. The end result is that IL&FS stands exposed, and so does this faulty business model of the NBFCs. Since the IL&FS panic has scared the investors away, the Non-Banking Financial Companies (NBFCs) are not able to issue new debt in order to roll over the old debt.

• Mutual Funds: These Non-Banking Financial Companies (NBFCs) also heavily relied on funds available from debt mutual funds. The problem is that the NBFCs have caused a market crash. As a result, both retail and institutional investors have reduced the quantum of investments in mutual funds. As a result, the supply of funds from there has died down as well. This has added to the woes of the Non-Banking Financial Companies (NBFCs).
• Asset Quality Issues: A lot of these Non-Banking Financial Companies (NBFCs) are classified as housing finance companies. They lend money either to the developers or to the homebuyers. The end result is that the money lent out by these companies is heavily invested in the housing sector. The problem is that the Indian housing sector has gone bust.

  Stalwarts like Amrapali group, Supertech, Unitech, etc. have all gone bust. This is the reason why the asset quality of these Non-Banking Financial Companies (NBFCs) is also in question. These companies are facing a double whammy with both their assets and liabilities under increasing scrutiny. This is putting pressure on the net worth of these companies and driving them towards insolvency.

RBI’s Bailout

The Reserve Bank of India (RBI) has taken some steps to prevent the conversion of this Non-Banking Financial Companies (NBFCs) crisis into a full-fledged financial crisis. The RBI has changed its rules in order to make it easier for Non-Banking Financial Companies (NBFCs) to obtain capital. Banks were earlier restricted in the number of loans they could make to NBFCs. Banks were earlier allowed to lend a maximum of 10% of their loans to NBFCs. This limit has been temporarily raised to 15% for a few months. The immediate effect of this step has been to release close to $10 billion worth of liquidity to the cash-starved NBFC sector. RBI’s decision will help Non-Banking Financial Companies (NBFCs) to raise cash in the short term and roll over their debts. The fear of defaults will be quelled for the time being.

However, critics have questioned the suitability of this policy for the long run. RBI’s plan is to use banks which already have a lot of problems to deal with the NBFC problem! Many analysts are worried that this could spell doom for the banking sector as well. This liquidity infusion will end up transferring many bad assets from Non-Banking Financial Companies (NBFCs) to the banks. Given the fact that the Indian banking system is already facing a non-performing assets crisis, this move could severely damage the banking sectors ability to recover.

To sum it up, the RBI’s move is a very temporary step. Also, it is extremely inefficient. It is like postponing a problem till it blows out of proportion.