Mumbai: The Reserve Bank of India (RBI) on Friday advised financial firms against relying on short-term sources for funding long-term projects saying it leads to a “maturity rat race".

Deputy governor Viral Acharya said that chasing lower marginal costs of funding in order to retain or acquire market share in lending is a myopic strategy and is associated with significant rollover risks in the medium term.

The liquidity crisis was witnessed after IL&FS, which had funded long-term infrastructure projects through short-term funds, defaulted on payment obligations and was downgraded by credit agencies over the past two months. On 17 September, rating agency Icra downgraded IL&FS’s credit rating to default, after it failed to meet repayment obligations of 12,000 crore in short-term and long-term borrowings. This practice, Acharya said, appears to have led to a form of “maturity rat race in the financing of the financial sector".

“RBI, along with the government of India and the Securities and Exchange Board of India (Sebi), has been closely monitoring the situation. I would like to urge all financial firms to place greater reliance on equity and other modes of long-term finance for funding of long-term assets rather than relying excessively on short-term wholesale paper," said Acharya.

He added that increasing asset-liability mismatch can be particularly imprudent when global and domestic conditions are tightening. “It is best to avoid this in order to safeguard financial firms’ own balance sheets as well as for financial stability," he added.

Mint reported on 4 October that IL&FS will see maturity of 835 crore of commercial paper (CP) by March 2019, of which 250 crore of CPs will come up in December, according to a private placement prospectus issued by the company in May.

Acharya said that post demonetization, system liquidity—or liquidity in the money market— remained in surplus till March 2018 and has largely remained neutral for most of the first half of this fiscal. “The weighted average call rate (WACR) or the rate at which banks and primary dealers borrow and lend in the unsecured money market has been 10 basis points (bps) below the policy rate, reflecting the comfortable liquidity," he said.

Acharya added that system liquidity remained largely neutral in August and entered into a deficit zone in mid-September as anticipated.

Meanwhile, deputy governor, N.S. Vishwanathan said that RBI is closely monitoring the non-banking financial company (NBFC) sector and added that the NBFC sector plays a critical role of meeting the credit needs of different segments of the economy, more so of the informal sector.

Vishwanathan said that the last couple of years have seen a rapid growth of the NBFC sector and it has used diverse sources of funds for this expansion. The modes, he said, include tapping the market—in order to keep the marginal cost within check some of them have resorted to increasing market borrowing in the form of commercial paper (CP) and that could result in asset-liability mismatch (ALM).

“There is an ALM guideline for them but we are looking at strengthening them so that we can avoid this rollover risk going forward. We believe that isolated events should not be seen as having any system-wide indications," said Vishwanathan.

Vishwanathan said the RBI has synchronized the NPA (non-performing assets) recognition norms of NBFCs with the banking sector now. Speaking on core investment companies (CIS)—NBFCs investing in group companies—he said that 90% of their exposures should be to a group entity, of which at least 60% should be in equity. “The framework for them is that they must work on a debt-equity ratio of 2.5 at the entity level not at the group level," said Vishwanathan.

Mint reported on 5 October that experts had pointed to the need for tightening regulations pertaining to CICs. “Currently, these NBFCs have a light-touch regulation, which is likely to change post the IL&FS crisis," a senior banker said, asking not to be identified. He added that it is to be seen how RBI effectively regulates holding companies like IL&FS which are involved in both financial services business and real sector activities.

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