A backbone-breaking crisis is “imminent” in the non-banking financial companies (NBFCs) sector, India’s Corporate Affairs Secretary warned in an interview last week calling this a defining moment for India’s economy.
Speaking to PTI news agency, Injeti Srinivas said a few recent misadventures by some large entities and a general credit squeeze will lead to the disaster, according to NDTV.
The country’s shadow banking system has been grappling with multiple crises in the wake of the massive turmoil at the IL&FS group, accompanied by other debt defaults by major entities. All this has left the NBFC sector facing issues of credit squeeze, over-leveraging, excessive concentration, a massive mismatch between assets and liabilities among others, the government official said.
These factors coupled with financial misadventures by some very large entities is “a perfect recipe for disaster,” Srinivas was reported as saying.
What else did the CSA say about the looming crisis?
Saying that corporate governance in India is being put to a test, Srinivas added that “responsible” companies are doing a good job at managing risks, thereby allowing them to avert a full-blown crisis. “It is a defining moment. The way things are moving, in the medium to long term it will be for the good. In the short term, there can be turbulence,” he said.
Praising those companies having strong corporate governance, the senior government official urged those those insistent on taking risks in this financial climate to manage those well, “so they don’t face such dire situation that some others are facing today,” Srinivas said.
With India’s burgeoning problem with non-performing assets (NPAs) being linked to external factors, Srinivas noted that that is neither a convincing explanation nor should it be used as a scapegoat to escape introspection and internal accountability.
“To say that the situation (NPA) can be attributed entirely to external factors and business risks is not a convincing answer because there is something known as responsible behaviour,” he emphasised.
What is the NBFC crisis?
According to Mint, while most banks have cleaned up their books and shored up balance sheets NBFCs that borrow from banks and mutual funds are not in the clear. Costs of operations have shot up, especially for small-scale NBFCs. Not only do they have no money to lend but banks now want NBFCs to promise higher returns on the loans they buy from them.
It is the latter, coupled with consequently higher interest rates, that stands to affect the construction sector, auto and jewellery firms, and consumption in fast moving consumer goods (FMCG). Maruti Suzuki’s car sales fell 18.7% in a year while some FMCG firms posted low volume growth in Q4FY19, Mint reported last week.
Many experts also claim that most of the intractable loans are concentrated in one sector that the government has neglected the most—power.
Former PM and current FM react
Interestingly, former Prime Minister and economist Manmohan Singh said earlier this month that the banking sector is “under severe stress.”
According to Hindu Business Line, he further suggested ways to remedy this “mess” by reversing some “gross distortions”, working closely with the Reserve Bank of India, resuming the process of credit delivery and ensuring sufficient liquidity and cash in circulation.
Singh also notably blamed demonetisation for shutting out all sources of informal credit, and the “one size fits all” approach for producing the NPA “scare.” It has brought lending to a virtual halt, he added.
Finance Minister Arun Jaitley, however, begs to differ. He not only dismissed the concerns, but also hit back at Singh saying, “When an economist turns into a politician, he loses sense of both economy and politics”.
“Dr Manmohan Singh left behind in 2014 an economic slowdown, policy paralysis and corruption. He brought down his party to lowest ever strength in Parliament. India was a part of the fragile five. Today he regards the world’s the fastest growing major economy as disastrous,” Jaitley said completely dismissing the real threats that are poised to bring the economy to its heel.
Crime and punishment
Anmol Agarwal writing for Money Control notes, “When the global financial crisis stormed financial markets, misconduct was found in financial institutions across countries from Lehman Brothers in the US to Barclays in the UK to several banks in Europe.” Key symptoms of that culture seem to be “cheating depositors to inflating credit rating agencies to manipulating Libor rates.”
SEBI’s 2014 order observing that the National Stock Exchange (NSE) did not exercise due diligence, marks a watershed moment in India’s response mechanism to bad loans and financial misconduct, according to Agarwal. The subsequent probe into NSE’s co-location services recently resulted in the exchange getting barred from launching its own IPO or new products for 6 months.
This was a crucial case because it was meant to set an example in the face of growing in the huge NPA crisis over the last few years. That is why, even though SEBI did not find much evidence against NSE, it still penalised the body to send a strong message for those elements that have contributed to the uptick in misconduct across several financial institutions of eminence.
SEBI along with RBI has since adopted a zero tolerance policy in such matters. With RBI as banking regulator penalising Indian banks banks and NBFCs, most of them are now summarised as non-compliance of the regulatory PCA guidelines. Recently, RBI also penalised prepaid instrument issuers and international remittance providers.
Case studies for the future
Agarwal notes that the only saving grace in the Indian financial landscape is that these events have not led to a systemic crisis like in many countries around the world. According to HDFC Bank’s managing director Aditya Puri, the danger of a full-blown financial crisis has passed; troubles among India’s non-bank financiers will not persist for more than a year, he told Mint a few days before the CAS’s prediction.
But systemic risks materialise faster than you can yell conflict of interest, especially in view of inflation rising for the third straight month, so it is better to watch one’s back.
The ongoing cases revolving around unfair loans from ICICI Bank to Videocon Group, and more notably, the huge loans made out to Nirav Modi by Punjab National Bank and those given by a consortium of banks to Vijay Mallya are excellent case studies for the future, depicting the extent of bad credit and losses that Indian lenders are currently battling. All borrowers in the above mentioned cases are facing charges ranging from money laundering to conflict of interest.
The IL&FS saga
For the purposes of this analysis, however, there is no better analogy than the recent problematic solvency position of Infrastructure Leasing and Financial Services (IL&FS)
At a time when Indian banks are already faced with a total NPA of Rs 10.03 lakhs Cr (nearly 11.6% of the total lending of the banking industry), the IL&FS filed for bankruptcy, to which the banks have a total exposure of Rs 57,000 Crs.
“The group as a whole has total outstanding liabilities of Rs 91,000 Crs comprising of term loans, debentures, commercial papers, cash credits etc. The trouble for the markets and the economy as a whole increased when the company started defaulting on its obligations due to extreme cash crunch. The defaults ranged from term loans, inter-corporate deposits, commercial papers, letter of credit etc which rattled the markets completely, ” wrote Akash Baruah for Qrius.
“IL&FS defaulting would mean that the NPA situation further worsens to a great extent, all the mutual funds who were holding CPs issued by the company would be at loss, while the NBFC’s who had lent money to the company would also require to face loses. This would have a cascading effect on the whole economy and the financial system will also have to bear the burnt of it. Investors factored this growing volatility into their valuations and resulted in massive sell offs across asset classes, ” Baruah further noted.
In April, the Serious Fraud Investigation Office (SFIO) arrested Hari Sankaran, former managing director and vice-chairman of IL&FS for abuse of power through fraudulent conduct.
The controversy justly drives home the significance of a financial monitoring and regulating system that not only deters such wrongdoing but also holds miscreants to account when deterrence fails.
Prarthana Mitra is a Staff Writer at Qrius.