India banking

Why India’s NBFC bailout is no long-term solution

New Delhi will fall into the same situation facing the banking sector if it relies on government funds to support non-bank financial companies. An overhaul of funding channels is necessary.

India’s troubled shadow banking sector can heave a sigh of relief after the government announced plans last week to grant Rs1 trillion ($14.6 billion) of credit guarantees to struggling non-bank financial companies (NBFC), the latest attempt by New Delhi to avoid a full-blown financial crisis.

The six-month programme, announced as part of India’s 2019/20 budget, will allow state-owned banks to use the funds to buy high-quality assets from NBFCs, many of which have been struggling from a liquidity crunch.

This liquidity crisis erupted late last year after Infrastructure Leasing & Financial Services (IL&FS), an unlisted infrastructure lending giant, defaulted on a number of debt obligations after being downgraded to "junk" status by international and local credit rating agencies.

Since then the troubles of other non-bank lenders such as Dewan Housing Finance and Reliance Capital have also been exposed after they too missed debt repayments this year.

Some industry experts dub the situation a "mini-Lehman crisis" and have warned that it may emerge as a nationwide financial crisis if not taken care of properly. This is because NBFCs, although little-regulated, form a significant part of India’s financial system by being a major mortgage provider and corporate lender, particularly to small- and medium-sized enterprises and infrastructure projects.

The new credit guarantee announced by finance minister Nirmala Sitharaman provides some short-term relief by providing a new source of funding for NBFCs, reducing their reliance on bank borrowings and commercial paper. The hope is that the fresh capital will eventually be channelled through to homebuyers and SMEs, thus restoring property prices and bringing small businesses back on track.

LONG-TERM SOLUTION

As Moody’s pointed out in a research note this week, “the temporary credit guarantee facility to alleviate tight liquidity for NBFCs are measures that are credit-positive for the relevant entities, and should encourage the flow of credit to the economy and support growth.”

However, the Indian government will fall into a trap of relying on short-term bailouts and loan write-offs if it does not overhaul the banking system to allow more sustainable liquidity flows into NBFCs.

That has already happened in the public bank sector, where the government has a recent habit of pumping capital into cash-strapped state-owned banks to keep them alive. This year already, the government has agreed to another $10.2 billion of bailout for debt-burdened state lenders.

Raman Aggarwal, chairman of the Finance Industry Development Council (FIDC), an industry body that oversees NBFCs, said the government should create a long-term financing channel for NBFCs to obtain capital on a sustainable basis.

“We are not asking for any bailout; this was done in 2009 and 2013," Aggarwal said. “What we are saying is a message from the regulator or government would really do the trick." 

Among the measures proposed by the FIDC is a permanent lending window from National Housing Bank, and the establishment of an alternative investment fund to channel institutional funds to NBFCs.

There are of course concerns over the quality of some of the NBFCs, which are holding back the government from providing more funding. In particular, some infrastructure-focused NBFCs may struggle to get funds due to the country’s lacklustre infrastructure planning and execution abilities.

Such measures, even so, would be a better alternative to long-term bailouts that will likely duplicate the country’s banking sector woes.

There is little doubt that any mishandling of the NBFC crisis will aggravate India’s deeply-troubled banking industry. So before New Delhi seeks to address India's long-standing banking woes, it might be better advised to solve the country's shadow banking crisis first.

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