Is Indian shadow banking on the road to recovery?
Through Cary Springfield, international banker
Shadow banking in India has grown in popularity over the past 30 years or so, following financial deregulation in the early 1990s which resulted in the growth of non-bank financial corporations (NBFCs) across the country. During this period, the NBFCs have consistently succeeded in gaining market share, often at the expense of the public banking system; nevertheless, commercial banks remained one of the most important sources of finance for the sector. But a major crisis has emerged in recent years, which has caused many people to worry about the risks that shadow banking poses to the Indian financial system as a whole.
Indian NBFCs typically perform many tasks of a commercial bank, such as credit intermediation, liquidity transformation, and maturity transformation. They can be thought of as a disaggregated network of financial institutions and vehicles that direct funds from savers to investors through a wide range of securitization and secure funding methods, and they typically operate in an unregulated or under-regulated environment. . Savers are often linked to investors through short-term borrowing facilities such as the issuance of commercial paper, which is used to finance longer-term infrastructure projects, such as roads, power plants and buildings. real estate. Much of the demand for these funds is driven by their lower borrowing costs compared to long-term bond issues. And with interest rates trending down in recent years, savers have been more inclined to turn to shadow banking, especially NBFCs, in search of higher returns.
But with the possibility of higher returns, the risks are higher, which has been the central problem with shadow banking in India in recent years. Indeed, the debate around the country’s NBFCs has been heated for some time, with calls for the sector to clean up, especially in terms of cash crunch, rising levels of bad debts and high costs of capital. And with asset quality steadily deteriorating since 2018, if not before, and the collapse of several systemically important NBFCs during that time, these calls only intensify amid the more challenging operating environment. created by the coronavirus pandemic.
Concerns over India’s shadow banking sector began to gain momentum in mid-2018, when a major infrastructure financier, IL&FS Group (Infrastructure Leasing & Financial Services Limited), ended up failing. payment obligations for commercial paper and unsecured debt facilities worth around $ 60 million, before defaulting again later that year on a small, short-term loan that triggered downturns rating of a number of agencies. Reports revealing that IL&FS Group’s sources of short-term cash, which it used to fund long-term projects, had dried up, triggering a large investor sell-off that impacted a number of of leading NBFCs, driving down their stock prices and pushing their borrowing costs much higher.
This was then followed in 2019 by two more significant defaults from Dewan Housing and Altico Capital India. Mutual funds – a long-standing stable source of funding for NBFCs – had also become increasingly conservative around this time, which further increased their borrowing costs. In early 2020, however, things seemed to be improving. “For the past two years we’ve been doing some cleaning and cleaning. So we are getting out of it, ”Rajnish Kumar, Chairman of the State Bank of India, told CNBC in January 2020.“ Some (NBFC) who may be weak or facing credit problems, which may still be a source of concern, and which should be washed. But today we are in a much better position. But by April 2020, mutual fund firm Franklin Templeton Investments had closed six debt programs with around 300 billion rupees ($ 4.1 billion) in assets under management (AUM). “Mutual funds only lend to a select few NBFCs because there is risk aversion in the market. And now they are facing redemption pressure, so how are they going to lend money to other entities? Pankaj Naik, associate director of India Ratings and Research Private Limited, said at the time.
According to a May 2020 report by rating agency Moody’s, the inability of borrowers to repay their loans amid the COVID-19 pandemic – as well as the six-month moratorium approved by the central bank on repayment that was in place at the time – would likely lead to disruption of entries for NBFCs, as exits are to continue. “Most NBFCs do not have substantial liquidity on the balance sheet because they primarily manage liquidity by matching cash inflows from loan repayments by customers with cash outflows to repay their own debts,” the report notes. .
Are things improving for the sector in 2021? It’s hard to come to a conclusion one way or the other at this point. Despite the repeated cut in rates by the Reserve Bank of India (RBI) last year, loan growth fell to a more than two-year low in February. And non-performing assets had already hit their highest rate in at least five years, at 6.3% in March 2020, which was before the worst of the pandemic’s impact, the RBI explained in its report. January. To complicate matters, the central bank expects that number to increase further this year. The report also mentions that NBFCs and housing finance companies are the largest borrowers of funds from the Indian financial system, with a substantial portion of the funding coming from banks. So the failure of any shadow lender could impose a major solvency shock on their banks.
The RBI itself has not escaped criticism for its role in the developing crisis. “The RBI has indicated that it regularly assesses the quality of the assets of banks and NBFCs as part of its monitoring process,” Finance Minister Nirmala Sitharaman recently admitted to the Indian Parliament. “No asset quality review has been performed for NBFCs in the last lifetime [five] years. The RBI further informed that at present it does not provide for an additional asset quality review requirement for NBFCs. “
However, new measures are being implemented. In December, the central bank announced that it would introduce risk-based internal audits at large NBFCs and rigorously monitor 100 of the country’s largest NBFCs to ensure continued financial stability. He also proposed a four-tier structure to regulate NBFCs that targets their capital levels and lending and governance practices with the aim of preventing further defaults. The new regulatory framework would consist of a “base layer, middle layer, top layer and possible top layer”, with no NBFCs falling below the top layer unless the perception of risk reaches an acute level. And the entry requirements of the NBFC could be tightened, the minimum threshold of funds held in net being multiplied by ten, the RBI also proposing the alignment between the banks and the NBFC of the identification of the bad assets by lowering the classification. to 90 days instead of 180 days.
Additionally, largely as an anti-money laundering measure, the RBI announced on February 12 that new investors who operate in jurisdictions that are not in compliance with the Financial Action Task Force (FATF) – the global watchdog on money laundering and terrorist financing – must hold less than 20% of the voting rights in non-bank financial corporations. “New investors from or through non-FATF-compliant jurisdictions, whether existing NBFCs or companies seeking certification of registration (COR), should not be allowed to acquire directly or indirectly a “significant influence” in the issuing entity, as defined in the applicable accounting rules. standards, ”said the Reserve Bank of India, after proposing stricter regulations on the parallel lending sector in India a few days earlier.
The governor of the central bank, Shaktikanta Das, recently said that the situation of the shadow bank has improved. Das now estimates that only four financiers remain a “cause for concern”, with these four having less “interconnectivity with other entities”, such as banks and mutual funds. “Bank financing for the NBFC sector has shown a very good improvement. The liquidity situation has improved, ”Das told Bloomberg.