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The ripple effect of the NBFC crisis on the economy

  • NBFCs had borrowed short term from banks and mutual funds while lending to developers of long-term projects, which got held up because of various factors
  • Trillions of rupees are locked in real estate, construction and infrastructure projects

Non-banking financial companies (NBFCs) are facing a crisis, particularly the smaller ones that are struggling with asset-liability mismatch amid corporate governance issues. Mint takes you through the crisis, resolving which should be the new government’s priority.

What is the NBFC crisis?

Most banks have cleaned up their books and shored up balance sheets but NBFCs, which borrow from banks and mutual funds, are in trouble. Their costs, particularly those of smaller ones, have shot up and they don’t have money to lend. Banks want NBFCs to promise higher returns on the loans they buy from them. The squeeze at the NBFC end and the consequently higher interest rates could hurt the construction sector, auto and jewellery firms, and consumption in fast moving consumer goods (FMCG). Maruti Suzuki’s car sales fell 18.7% year-on-year in April. Some FMCG firms posted weak volume growth in Q4FY19.

What caused it?

NBFCs had borrowed short term from banks and mutual funds while lending to developers of long-term projects, which got held up because of various factors. They also lent to unscrupulous developers and wilful corporate defaulters indulging in round tripping of funds and ever-greening of loans. As cash flows dried up, NBFCs couldn’t repay their lenders. The crisis started in September when IL&FS Financial Services failed to meet its commercial paper redemption obligations. A government-appointed panel is now trying to recover the money by selling assets of the group. However, this will not be easy.

Is there a need to panic?

There is no need to panic, but certainly a reason to be watchful. Debt schemes of several mutual funds have seen their net asset value erode. It is good to have an investment adviser guide you.

What happened after the crisis broke out?

Trillions of rupees are locked in real estate, construction and infrastructure projects. The promoters, who had pledged shares of their firms to borrow money, are neither able to borrow more to complete projects nor sell them to others. They are entering into “standstill agreements" with banks and mutual funds to ensure those shares are not sold and they continue to run the firm. There is no guarantee that the lenders and investors will not end up poorer as they have no control over the price movement of these shares.

What could happen in the next six months?

The central bank has pumped a huge amount of liquidity into the system over the last eight months. It has also eased some norms to give NBFCs more room in fundraising. But some market players continue to blame tight liquidity for not being to raise funds and then lend. This doesn’t look good for NBFCs as there is a fear of demand destruction. The market share that had moved to NBFCs may go back to banks, which have since raised capital. Axis Bank has done so and HDFC Bank plans to raise 50,000 crore.

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