Unravelling The Reasons For The Current Liquidity Crunch for the NBFCs

November 21, 2018
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Infrastructure Leasing and Financial Services (IL&FS), a leading blue-chip infrastructure lender recently made a default on their short-term debt payment. This incident has produced a ripple effect and resulted in a rough patch for the Indian Non-Banking Financial Companies (NBFCs). Concerns over NBFCs repayment ability are preventing the market lenders from releasing funds to this sector.

The Crisis

When the IL&FS group defaulted on payments, several corporates, insurance companies and mutual funds were also in trouble. These companies had invested in the short-term instruments of IL&FS group such as non-convertible debentures and commercial papers. These borrowings add to nearly ₹63,000 Crores according to their balance sheet. In this money, a large share is expected to be of NBFCs. Nearly ₹2 Trillion of NBFCs and HFCs (Home Finance Companies) debt is due for recovery by the end of this year. These two facts have stoked fear among the lenders about NBFCs ability to pay their dues. The result was a liquidity squeeze crisis among the NBFCs.

How Did It Happen?

Most NBFCs acquire short-term loans from the market lenders and provide long-term loans to their customers. Obviously, this leads to a mismatch in the duration of liabilities and assets. In normal days, NBFCs stick to refinancing their current debts to a new short-term debt. This style of operation always posed a certain level of risk to the companies. Such risk is greater when the lenders are feared. In the current crisis situation, this fear is present and the companies are unable to roll over their debts.

RBI’s Role

The reserve bank of India was blamed for a late stepping-in and injection of funds. RBI announced that they will inject ₹40,000 Crore into the system by buying government securities on top of the ₹36,000 crore they injected through the open market operations in October. But the RBI refused the notion for a special window for the NBFC sector pushed by the industry and the government. RBI argued that there is enough liquidity available for the sector through the banks.

The Future of NBFCs

The current scenarios suggest that the funding for NBFCs will remain tight. The borrowing costs for these companies are expected to grow higher following the recent adverse sentiment in the bond market. That means reduced growth and margins ahead. Also, the guidelines for these companies are likely to be tighter and closer to the commercial banks in terms of regulations. Since the 2008 crisis, RBI has urged tighter prudential norms for NBFCs. With the government showing enthusiasm to prevent an escalation of the crisis, RBI will neutralise the current liquidity squeeze. Few scholars believe that as a last resort government will act as a lender and bailout the companies. However, such bailouts will further inspire NBFCs to continue to provide long-term loans with their short-term debts and expect the government to save them when they get in trouble.

Even though the crisis is expected to settle soon, many analysts believe that the easy money-making period of this sector is not coming back soon.

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