Home / Opinion / Views /  Opinion | Liquidity buffers for our shadow lenders

A familiar story seems to be playing out in the Indian financial sector—a crisis is brewing in one part of the inter-connected system, and the regulator, ironically disparaged by the industry for not allowing a free rein, is now being invoked to bail out stuck players. The regulator, the Reserve Bank of India (RBI), has responded but its reaction is unlikely to help players immediately. Sadly, that’s the way it has been for this industry for a while. Cut to the 2008 financial crisis, and its post-mortem, which focused multiple searchlights on “shadow banks"; remedial measures thereafter tried to constrain these entities through enhanced regulation and reduced operational freedom. In India, shadow banks are known as non-banking financial companies (NBFCs), which, barring the odd slip-up, have been useful in expanding the footprint of formal finance. Therefore, while India did agree with global regulators to circumscribe shadow banks, or NBFCs, the reality has been slightly different. Their regulation has been calibrated over time, specifically after the mid-1990s when a firm called CRB Finance collapsed and failed to pay out money to small depositors. Since then, the intensity of RBI’s regulations has varied depending on the prevailing circumstances: An imminent crisis, global alignments, government pressure or turf wars with other regulators. It appears RBI is once again being bullied to not only relax its regulatory regime, but also throw a lifeline to them. The demand—primarily from the industry and some disparate voices, including the government think tank, NITI Aayog—is to provide a special credit window. NBFCs have been caught in a squeeze ever since Infrastructure Leasing and Financial Services (IL&FS) defaulted on debt repayments; unable to refinance maturing debt, many of them stare at rating downgrades and possible defaults.

The RBI has responded by issuing draft guidelines on a liquidity risk management framework for NBFCs. Although this addresses the origin of the problem that has led to their current impasse, it is unlikely to help them sort out their short-term problems. NBFCs have been borrowing short to fund long-term assets, and this asset-liability mismatch posed no problem as long as there was sufficient liquidity in the system to allow for continual refinancing. Things started getting sticky once RBI decided to move from surplus to negative systemic liquidity. The central bank’s current draft guidelines, whenever they get finalized, will make for better liquidity management in NBFCs and cushion them against crises that arise from asset-liability mismatches.

But how does it help the current logjam? It doesn’t, and thereby hangs a lesson. Under pressure from the government and industry, RBI had adopted light-touch regulation, ostensibly to promote the financing of asset creation. Clearly, that has not helped because the NBFC industry, on its part, has been slipshod in implementing prudential norms or risk mitigation standards. Opening a liquidity window for bailing out negligent NBFCs is not part of RBI’s remit—maintaining financial stability is. Therefore, the regulator has a three-fold path ahead of it. One, increase systemic liquidity and allow for the hassle-free sale of NBFC assets so that proceeds can be used to repay existing debt. Two, tighten NBFC regulation by bringing the regulatory framework on par with scheduled commercial banks. Three, prescribe higher capital norms and make boards answerable.

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