The Penchant Problems and Crudes of the Non-Banking Finance Sector of India'

“Development is about transforming the lives of people, not just transforming economies.”

― Joseph E. Stiglitz

The Indian Economy is a versatile and dynamic organism that has nurtured and blossomed the ethos of India’s growing stature. It has puzzled the most profound and intelligent minds over the years. It is constituted of a billion people, millions of whom will impact the economy as you read this humble attempt to diagnose one of the vices it has been inflicted with.

The 1960s witnessed the emergence of an alternate financial institution for savers and investors, done primarily to cater to the financial needs of the ones for whom banks weren’t apt. It was the beginning of an institution that could supplement banks by providing the infrastructure to allocate surplus resources to individuals and companies- The Non-Banking Financial Company (NBFC).

The business of financing initially, was regulated by the Companies Act. However, the need for a separate regulatory mechanism to deal with the complex nature of operations was soon fathomed. Consequently, Chapter III B was included in the Reserve Bank of India Act, 1934, assigning limited authorities to the Bank to regulate deposit-taking companies.

With its customer-amiable reputation, NBFCs, between the 1980s and 1990s, began to entice a humongous number of investors. Ever since then, NBFCs have gained paramountcy in the financial sector and have grown significantly in parameters like operations, instrument range, technological advancement, inter alia.

August 2016 paved way for another major leap, when Foreign Direct Investment was given an approbation. Over the years, NBFCs has been playing an exigent role in fostering inclusive growth, capital formation, meeting financial demands, employment generation, providing guidance and assisting in myriad akin channels.

This sector, with a size around $0.4 trillion, 13000+ players’ registration, annual financing of assets worth ₹15,000 crores is today, regrettably under peril. Tribulations began last year, when IL&FS Group unexpectedly defaulted, prompting broader shock that made it hard for many companies to refinance debt.

Today, India is passing through what market experts remark as the worst liquidity crisis or scarcity of money that India has ever seen. A liquidity crisis is a financial situation characterized by a lack of cash or easily-convertible-to-cash assets in hand across many businesses or financial institutions simultaneously, In simple words, a liquidity crisis occurs when those who need the money don’t get it on time or in adequate amounts. But in India, the problem is a bit complex because Indians are neither spending less nor saving less and, surprisingly, there is no shortage of cash currency in circulation. Contrastingly, according to RBI, the currency in circulation went up by 17 percent reaching a gross of Rs 21.1 lakh crore in FY19. This raises potent questions as to why there is a deficiency of demand, on the face of it and why the consumers’ behaviour is objectively going against the economy.

To understand this, it becomes essential to understand the functioning and importance of Non-Banking Finance sector in India. NBFCs majorly involve themselves in giving loans and advances to the public. NBFCs lend and make investments and hence, their activities are akin to that of banks; however, there are a few differences. NBFCs cannot accept demand deposits;NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself; the deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in the case of banks.

Another cogent factor here becomes the way deposits are received and disseminated by this sector. The crisis that is incumbent upon the indian economy has been fueled by the lack of deposits and an immense loss of trust in a few of the companies in this sector.

Non- Banking Finance Companies get more margin because their business is relatively unsafe as compared to banks and this risk is capitalised by them fairly. Moreover, it is key to note that 90% (including agriculture) of the Indian economy is made up of the unorganised sector and NBFCs are very crucial for the rural economies to function smoothly and without being perturbed by abysmal lack of resources. The flow and functioning of the Indian Economy, hence, banks upon the Non-Banking Finance sector, invariably.

The current situation, unfortunately, makes the dreadly picture clearer by the day. Banks have lost their capital over the decade owing to various contraries and complexities and are unable to lend because of the cumulative NPAs and the losses by way of bad loans, which are around 9.34 lakh crores, according to the official figures. The problem does not end here, bankers today are seen as a confused and chaotic lot, who are not confident of their abilities and are choosing not to lend, because of which, the credit growth rate of banks is around 10%, which is a matter of grave concern.

The mounting Non-Performing Assets and the commodities attached therein have been brought under a regulatory framework known as the Prompt Corrective Action which necessitates the banks to contemporarily focus only on the reconsolidation and recovery. Due to this, they are not able to expand their credit creation facility and this has provided a golden opportunity to the NBFCs to get a hold of the Indian markets and hence, NBFCs have manufactured their prevalence over the Indian Economy.

In the most tectonic shock, in and post-August 2018, the IL & FS faced severe liquidity crunch. This led to the selling-off in shares of several NBFCs, which in turn, caused redemption pressure on various mutual fund schemes. Thereafter, mutual funds stopped financing the loans of NBFCs and this created sharp troubles in the non-banking financial market.

Similarly, Essel Group’s debt troubles, degradation of Reliance Capital’s Debt programme by CARE ratings, defaults by Supertech etc., led to further sell-offs in NBFCs and this aggravated the problem of liquidity crunch.

Secondly, because of the high money demand, NBFCs started lending aggressively without engaging with the fact that the deposits they had collected were for smaller terms like 6 months, 1 year or sometimes, as low as 90 days. Not only did they go ahead and lend, they also invested this money in the long term securities (for example 5 years, 10 years, etc.) which in turn led to Asset Liability mismatch and NBFCs were left with no money to give back to their clients.

Third, since corporate groups in India are not allowed to run banks, they automatically entered into the NBFC space adding these companies to complement their business. For instance, Tata gave out loans through Tata Capital Finance Services. The same was done by Mahindra and Bajaj. The most astonishingly ordinary part of such complementary companies was that they functioned according to the whims and fancies of the corporate groups, leading to a lack of transparency in the lending mechanism and hence, a spread of fraudulent accustoms.

These problems have lent India a time of serious depravity, as far as the financial and economic realm is concerned.

Challenges Posed to the different Sectors of Indian Economy by the NBFC Crisis

The sectoral effects therein can be understood individually as follows -

Precious Metal Sector: Amid this financing crunch which shows few signs of abating, shadow banks which exchange cash for precious metals, especially gold, are benefiting galore. The share prices of Manappuram Finance Ltd. and Muthoot Finance Ltd., cash-for-gold lending firms have seen a profound jump in their prices and is a barometer for the reaction to the sector in this context. The gold price increase, along with the fact that most of these loans get repaid within the first six months, have provided a continuous stream of money to repay debts have helped these firms avoid Asset-Liability Mismatch. These sectors are heavily relied upon the prices of precious metals; a reversal in the uphill course of gold prices, these firms’ quality of business and assets could get deeply damaged. While this sector is providing temporary relief to the credit sectors, it is evidently not structurally meant ro save the damsel in distress.

Automobile Sector: Having a strong foothold in semi-urban and rural automobile financing, NBFCs are detressing all parts of the value chain due to their liquidity plight. The noteworthy dip in consumption-demand of automobiles, in tandem with the recent sector-wide slowdown, has an immensely negative effect on the Gross Domestic Product. Inventory management costs have burgeoned and production plants have either been closed or drastically reduced production, as seen in the cases of Tata Motors, Mahindra & Mahindra and Maruti Suzuki. To avoid the rear-ending of the automobile sales, the giants of the industry like Skoda, Mahindra, Hyundai and Fiat have built the personal leasing model to temporarily tow the sector back. While this is in its nascent stage in India, this is needed to keep cash incoming in a period of illiquidity for the auto makers and a period of inaccessibility to large capital for customers.

Construction Sector:

The promoters and developers of large-scale infrastructure projects are in a quagmire: providing shares to NBFCs as contingent on loans for the development of projects, they now face a critical situation wherein they are not able to borrow more money for the completion of projects. These have now resorted to signing standstill agreements with Mutual Funds and other credit providers. There is no assurance that the developers would not encounter loses due to the fluctuation of prices..

MSME Sector: The characteristic informality in this sector, which contributes nearly 29% to the GDP, has made them the principle lenders from the NBFCs. The lack of account books make disqualify them from banks’ strict norms of lending. After IL&FC defaulted, there was a cascading effect to this sector.

The entire chain through which money is received by the lenders has had detrimental effects due to the loan delinquencies and defaults because of the squeeze.

Already burdened with the prolonged effects of demonetisation and the Goods and Service Tax, this crisis may severely severe the entrepreneurial drive in our country.

The entire NBFC Credit System is one built on unstable scaffolding, for there is a lack of monetary policy transmission, high public-sponsored deposit rates and stretched balance sheets. This segment of the economy is the bloodstream to the sectors which banks are unwilling to cater to, yet, the tighter access to liquidity is affecting the macro- economic growth and the overall consumption. The hemorrhaging of the consumption demand, along with the drying up of lines of credit, will lead to a slowdown effect which would proliferate non-performing assets.

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Banks are helping NBFCs by buying the loan portfolios of NBFCs. NBFCs at present have got a total aggregate asset portfolio of more than 5 lakh crore and banks as lenders would pick up these portfolios and give money to NBFCs so that they have money to lend further, this kind of infusion is required but it is not a solution, it is a stop-gap arrangement and will fail in the long run.

Government and banks have been infusing money in markets or even RBI through its open market operations but the real problem is related to banking. Till the time there are problems with organisational and operational structure of banks and banks are not revived and made robust, lending will continue to suffer and If lending will suffer, there will be a mismatch in the economy and liquidity strains will prevail.

At this juncture, considering the fact that the problem is not the lack of liquidity, it becomes key to note the other ills that surround and ignite this crisis. The most important of them is the severe loss of faith in most of the NBFCs and the corresponding abrogation of the trustworthiness of their balance sheets. One of the most evident ways is for the regulatory body, that is the Reserve Bank of India, to analyse and assess their balance sheets and vet them, thereby legitimising the trust and faith that they may or may not deserve. This would enhance the credit rating agencies’ figures thereby causally increasing the NBFCs’ legitimacy.

Moreover, the RBI can create a window which can infuse capital in selected bank(s). This infused capital can then be used to fund NBFCs.

In addition to this, a system of monthly or quarterly vetting of balance sheets should be constructed by not just the RBI, but by the other regulators like IRDAI as well. This would produce the reports of credit ratings in the public domain thereby making the mutual fund investors and other agencies more aware of the current situation of the said company and would also assure them the very important ‘returns’ on their money with dividends.

Additionally, the RBI can open avenues for FDI and FII that will essentially inject more money into these lifeless NBFCs. Moreover, a scheme for fusion of a few NBFCs, which are currently deficient of funds can be done so as to accumulate and collectively do away with the problem.

India was in a pompous upswing of economic growth uptil Q2 of FY19 which meant that the business turnovers were growing up, and when business turnovers grew, they required more finances to support their growth and to conduct business not just at the domestic level and beyond as well. The inability to do the same has led to the devastating state of affairs that the Indian Economy is facing as of now. Ergo, it becomes key to note the current strands of development in the economy, revitalise our thoughts and contribute to the advancements of policies that cumulatively aid in the elimination of vices such as these.

Written By :

Jasjeev Singh Sahni (1st Year- BA Programme)

Siddharth Gulati (1st Year- BA Programme)

Tilak Bhardwaj (1st Year, BA History Honours)

Zinnia Aurora (1st Year, BA Programme)