As India’s shadow banks brace for a tough 2019, the central bank and government will try and prevent a repeat of the IL&FS crisis by solving the data problem

• The near collapse of IL&FS precipitated a domestic liquidity crisis as the balance sheets of other housing finance companies and non-banking financial companies (NBFCs) came under the scanner.
  
• This revealed asset-liability mismatches and the companies were deemed too risky to qualify for loans from normal banks. To make matters worse, a number of NBFCs had invested in IL&FS’s debt instruments.
  
• The tough liquidity conditions for NBFCs are expected to persist this year and banks keep their purse-strings tight and funding costs increase as market borrowing declines.
  
• Moving into 2019, the central government and RBI are determined to regulate the NBFC sector better by establishing a system to collect lending and borrowing data from these institutions on a regular basis.

One of the big stories emanating from the Indian banking sector last year was the repeated defaults by IL&FS, India’s largest infrastructure lender, and its subsequent downgrades.

The near collapse of the lender precipitated a domestic liquidity crisis as the balance sheets of other housing finance companies and shadow banks, or non-banking financial companies (NBFCs), came under the scanner. This revealed asset-liability mismatches and the companies were deemed too risky to qualify for loans from normal banks. To make matters worse, a number of NBFCs had invested in IL&FS’s debt instruments.

Not only were commercial banks, insurance firms and mutual funds engulfed in the ensuing crisis engulfed banks, but the liquidity crisis also led to a showdown between the central government and the Reserve Bank of India (RBI), with the former asking the latter to open a special refinancing window for NBFCs.

Despite the fact that a compromise was reached and liquidity norms and lending restrictions on NBFCs were relaxed, the spat culminated in the resignation of former RBI governor, Urjit Patel, in the second week of December.

India’s shadow banks are of systemic importance because they provide a large portion of credit to the small-and-medium-enterprises (SME) sector. Hence, a drying up of funds at NBFCs leads to a lack of financing options for small businesses, which drags GDP growth downwards.

The operations of NBFCs, especially that of a lender like IL&FS, are especially vulnerable in a period of rising interest rates because they borrow short-term funds and lend on a long-term basis. Despite a potential moderation in RBI monetary policy, the tough liquidity conditions for NBFCs are expected to persist this year and banks keep their purse-strings tight and funding costs increase as market borrowing declines.

Moving into 2019, the central government and RBI are determined to prevent a repeat of the crisis. Their solution? Regular data monitoring.

At a conference this past weekend, Subhash Garg, the Secretary of Economic Affairs in the finance ministry, said that the government and the RBI were in the process of establishing a data collection system for the NBFC sector.

Garg explained that when the IL&FS crisis came to light, there were no comprehensive sources of monthly lending and borrowing data on India’s shadow banks, let alone real-time data. This prevented the government and regulators from implementing remedial measures quickly. Once a data collection system is in place, it will be easier for the central bank to enforce asset-liability management norms for the sector.

In addition, there is no organisation or industry group that represents NBFCs which makes the process of framing policies for the sector difficult since there are no groups to seek consultations with. Hence, establishing an industry organisation that represents the sector is expected to be an important priority in the immediate term.

Besides a data collection system, the Indian government, acting through the Securities and Exchange Board of India (SEBI), has also ordered ratings agencies to follow stricter protocols when it comes to assessing companies.

Under the new requirements, credit ratings agencies will have to include a special section devoted to “liquidity” in their ratings actions announcements. They will also have to disclose discrepancies between the assets and liabilities of an issuer, historical ratings information as well as cash flow issues and existing short-term credit lines.


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