It is in the nature of India’s political economy and policy architecture to act only once confronted with a crisis. This was evident in 1991 when, pushed to the wall, the Indian government had to undertake large-scale economic reforms. A crisis has been brewing in the non-banking financial companies (NBFC) sector for a while, and the regulatory response seems to have been rather tepid so far. It almost seems like sector regulators are waiting for some catastrophe to occur before they muster their crisis-management skills. The long-drawn tragic story began with infrastructure lender IL&FS defaulting on its loans which, due to market linkages, also affected a larger number of banks, mutual funds and NBFCs. The financial system, already reeling under the burden of bad loans, gummed up completely. This was followed by a series of scandals at Yes Bank and ICICI Bank, the emergence of a crisis at housing and asset finance companies due to questionable lending practices, liquidity pressures and serious asset-liability mismatches, plus the shock revelation of a fiduciary breakdown in mutual funds which had lent large sums of investor money to dubious Indian industrialists against the tenuous security of their shares. Over the past few weeks, credit rating agencies have downgraded a large number of NBFCs, raising fresh questions over the sector’s health. Logically, all this should have prompted the regulator to come down hard on NBFCs and squeeze out risk from their books to prevent another contagion. In reality, the regulator is still in wait-and-watch mode.
So, is Reserve Bank of India (RBI) waiting for matters to reach a tipping point before calling in the cavalry? There is reason to be worried: Calculations by securities firm Credit Suisse show that ₹1.3 trillion of repayments will be due for the NBFC sector this quarter. Some NBFCs have already defaulted and rating agencies have downgraded their debt paper to “Default" grade. RBI has largely focused on repeated liquidity infusions to keep financial flows going. There is nothing wrong with that, except for the timing and the philosophy that undergirds such an action.
Ideally, the regulator should have continued with its liquidity injections in conjunction with a tightening of the system; this would have ensured that healthy NBFCs continue to finance asset creation efficiently without hitches while simultaneously mitigating risks emanating from the legion of misgoverned and corrupt NBFCs. The word “corrupt" has been used advisedly here because it is well known how unscrupulous NBFCs indulged in round-tripping—in league with banks and other unprincipled NBFCs—to evergreen loans taken by wilful corporate defaulters. The central bank seems to be in denial, believing that the only solution is to keep systemic liquidity high. It is difficult to ignore the politics of RBI’s sustained obsession with currency sufficiency, especially since its use tends to spike during elections. Unfortunately, RBI is not the only negligent regulator here. The Securities and Exchange Board of India has also soft-pedalled the issue of mutual funds lending investor money against share pledges in gross violation of fiduciary propriety, and their defaulting on redemption payments. The bigger danger is that neither regulator seems to have its sights on retail investors, small savers or on broader financial sector stability. They seem driven by a larger political-economy agenda. This could turn out to be harmful for the economy in the long run.