Implications Of NBFC Crisis

Implications of NBFC Crisis

We are all aware about the recent crisis faced by the Non Banking Financial Sector(shadow banking sector), due to IL&FS crisis. To aggravate the problem, many other companies like Zee Group, Anil Ambani’s Reliance, Dewan Housing Finance Limited(DHFL)  have started defaulting on the payments and credit rating agencies downgrading their ratings to default category.  With the spate of such defaults, it becomes important to analyse the shortcomings in the present scenario and how can it be improved.

So, what is it about the NBFCs, one might well think. After all, they are secondary players. Well, nothing could be farther from the truth. The four groups mentioned above, back in March 2018, together owed Rs 3.6 lakh crore to lenders. To put things in better perspective, these four groups account for almost 15 per cent of the total assets parked by mutual funds in debt. The exposure of banks, similarly, is considerable.

What all this means is that this crisis has the potential to affect economic indicators across the board as a lot of money that would be potential loans is locked up here. It has also had an impact on the stocks of various NBFCs, as a result.

It was in August 2018 that the crisis became public, once the news of IL&FS came out. As a result, the government has asked the National Company Law tribunal to bar the previous and current auditors of IL&FS – Deloitte, and BSR, an affiliate of KPMG – for five years on charges of lapses in auditing the company. If this happens, more than 275 companies listed on National Stock Exchange will be affected, as they are audited by these two firms.

What had led to the IL&FS crisis was the general practice of the NBFCs in borrowing short term from banks and mutual funds and lending long term to their clients, often real estate companies. As long as everything chugged along, the weakness in the system was of little consequence, but the moment there was a hitch, the inherent imbalance between the short term borrowing and long term lending came to the fore. If the borrowing and lending terms were similar, the inflow and outflow would match. But, in this case, the NBFCs were borrowing often for six months, while lending for five years. So, when the project got held up for various reasons and the loans weren’t being repaid in time, the NBFCs had little margin and their potential default would happen in a matter of months.

In January 2019, one got to know of the troubles of the Essel group. Quickly, the problems facing Anil Ambani’s Reliance group companies also became known. The latest has been DHFL.

NBFCs play a big role as in-betweeners, filling up the areas where the banks don’t operate or at least aren’t involved at the level of demand in the market. With this crisis, banks and mutual funds lending the NBFCs started to fear that there could be more defaults. The consequence of this was that they became reluctant to lend to NBFCs; or, if they lent, it was at higher interest rates. This naturally means the NBFCs don’t have enough funds to lend, or the available funds were more expensive. And this affects sectors like real estate and the auto industry.

Though the crisis as of now isn’t a real worry, tens of thousands of crores are invested in real estate and infrastructure. Right now, the promoters are unable to borrow more, which means the projects are held up. That in turn means that there is a problem with money flow.

On top of that, there is a danger of the erosion of value of these companies. Their shares are held by their lenders, and they are now getting into “standstill” arrangements with them to hold on to the shares and not sell them.

One reason for this situation ruled by unsecured loans and loans against shares was the excess money in the system. After demonetization, a lot of cash flowed into banks and a part of it also went into mutual funds. This made a lot of money available to the NBFCs. Their growth zoomed and their loans grew at twice the rate that of the banks. All this led to a laxity in the underwriting of the loans, without which the loans, and the situation, would be better secured.

Now, with the NBFCs facing trouble and their ratings being downgraded, they will find it more difficult to access funds. The current situation can have the effect of reducing the flow of credit to various sectors in the economy. One of the sectors most affected would be the Medium Small and Micro Enterprises (MSME), which rely heavily on NBFCs. As a result, production would be affected, in turn affecting consumption, which could all contribute to a downward spiral of the economy in the near term.

The Reserve Bank of India has been doing its bit in the last year or so to help with the situation. The RBI bought government bonds from the market to the tune of Rs 3 lakh crore, which is a large part of the money tied up because of the problems in the four largest groups mentioned earlier. This infusion of liquidity is a temporary measure and can only address the credit shortage in the current situation. The vulnerabilities and weaknesses in the system still persist, and will take time to set right.

The banks are still wary of lending to the NBFCs. The NBFCs will also first have to find funds to get out of the mess they are in, because the money locked up in projects is not likely to be released soon. This means they will end up borrowing at higher rates. The sale of their assets, which is happening at IL&FS, and is also underway at Essel and DHFL. Essel is scouting for a buyer to sell a minority stake in its group company, Zee Entertainment Enterprises Ltd, so that it can meet the payment dues coming up in the next couple of months.

All this, however, is likely to only address their current liabilities. The Essel group has a total debt of over Rs 16,000 crore, and owes more than Rs 7000 crore to mutual funds. The funds have for now agreed to not sell the pledged shares of Essel group companies, allowing Essel to handle the issue by the end of September.

Dewan Housing, meanwhile, is in similar straits. Its stock has been hammered at the markets, going below Rs 100 earlier this month. In the last one year, the stock has gone down by a whopping 83-odd percent, with two thirds of its loss coming in 2019. The company is being watched closely because of the quantum of its debt, which stands at over Rs 1 lakh crore. Dewan Housing has already defaulted on the payment of Rs 960 crore of interest due on bonds, and is being watched closely to see whether it will be able to meet its current month obligations of Rs 125 crore. It is selling one of its units and expects payment from Blackstone for this. UTI Mutual Fund and Reliance Mutual Fund have the highest exposure to Dewan Housing Finance. Reliance MF has stated that DHFL has fulfilled its obligations for payments for the period of June 4-7.

Concrete steps seem to have been taken to see to it that the crisis does not deepen, and that confidence returns to the credit market and eventually strengthens the economy, which has now reached a five-year low in growth. However, for all these NBFCs, this is just the beginning of a new beginning. The repair work will first have to be done before operations can be brought back to normal. The best case scenario, according to agencies monitoring the situation, is that this will take a year.

One important consequence of all this is that the NBFCs, which had gained market share in the wake of the liquidity post demonetization, could lose it to the banks once again. With the NBFCs facing a crunch, the banks are in a position to cover shortage. In fact, banks are already addressing the changed situation, with Axis Bank having raised capital and HDFC Bank mulling plans to raise Rs 50,000 crore.

However, in the middle of all this, things may not be all that bad after all. The government, for one, doesn’t seem to be all that worried, if its recent moves are to be considered. The Centre has decided to just let things play out for now. That seems to indicate it thinks things are not that bad, or not likely to go pear-shaped all that soon.

Another point is that foreign investors have been positive about the capital markets this month. In the period of June 3-7, FII inflow was more than Rs 7000 crore. Out of this, more than Rs 5000 crore was invested in debt instruments. The election results that have promised a stable government, and also the Centre’s meeting the fiscal deficit target of 3.4% seems to have helped in this.

The RBI has also relaxed regulations, making it easier for NBFCs to raise money. The Central bank has also raised the single party exposure limit from 10% to 15 %, making it possible for banks to finance the NBFCs to a higher extent. However, these steps need to be followed up in terms of willingness to fund the NBFCs. This is not expected to happen in a hurry, and we have something of a Catch-22 situation. Till confidence returns, the interest rates the NBFCs are charged will remain high, but as long as interest rates are high they will not be able to borrow optimally, which in return can infuse confidence.

This cycle will need be to be broken. As Madan Sabnavis, chief economist at CARE ratings, said, “If we look at NBFCs, there is no problem in terms of assets. We have very good quality assets. The NPA levels are very low. The problem appears to be more in terms of liquidity.” So, with the fundamentals being in place, it may take just that little step for the cycle to be broken.

The government, on its part, believes that though the liquidity crunch will impact growth in the short term, a full-blown crisis is unlikely. This stands against the worry of analysts and market watchers who fear that this situation could snowball and affect many more finance companies. The lack of funds could lead to more defaults, and end up having a further deleterious effect on construction and infrastructure firms.

The government position, though, suggests confidence. It believes, based on its close monitoring ever since IL&FS blew up, that this contagion will not spread. There will be short-term pain for the affected NBFCs and for the economy, a company might even collapse, but in the long run the sector and the economy will both come out of this stronger. That said, the government is also prepared to step in if things do go south.