Not just liquidity: on NBFCs crisis

Not just liquidity: on NBFCs crisis

News:

1. Non-banking financial companies are stuck in a liquidity crises which has now reached to the tumbling stock prices.

Important Facts:

2. About the crises:

• It started with defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS), which has been classified as core investment company by RBI.
• This infrastructure lender (IL&FS), has a total consolidated debt close to Rs 1 lakh crore and it started to miss its debt obligations beginning from August 27, 2018.
• It has also defaulted on Rs 450 crore worth of inter-corporate deposits to Small and Development of India (SIDBI) .
• Following the defaults, rating agencies like ICRA, CARE etc abruptly downgraded IL&FS and its subsidiary from high investment grade (AAplus and AI plus) to junk status, indicating actual or imminent default.
• So many banks, mutual funds, corporates who have stakes in IL&FS debt instruments are fearing liquidity crunch as they funds are locked in debt instruments of IL&FS.

3. Steps taken to revert the crises:

• Recently Government of India took complete control of the company to arrest the spread of the IL&FS crises to financial markets.
• A new board for IL&FS was constituted and appointed six new directors to look into the matter and resolve the crises after directed by the National Company Law Tribunal.
• The Reserve Bank of India, the National Housing Bank and the State Bank of India also decided to increase the supply of liquidity in the market to keep interest rates under control.
• The RBI has also urged NBFCs to make use of equity rather than debt to finance their operations.

4. Concern:

• While offering easy money may be a welcome measure in the midst of the ongoing liquidity crisis, the prolonged supply of low-cost funds to the NBFC sector also creates the risk of building an unsustainable bubble in various sectors of the economy.
• Defaults associated with any such bubbles will eventually only affect the loan books of lenders.
• State bailouts could also fuel the problem of moral hazard as other financial institutions may expect a similar lifeline in the future.

5. Way forward:

• Policymakers should thus try to focus on taking steps to address structural problems that contributed to the crisis.
• This includes steps necessary to widen the borrower base of NBFCs which have been banned from accepting deposits.
• This would allow NBFCs to tap into more reliable sources of funding and avoid similar liquidity crises in the future.