It was the Lok Sabha Elections 2019 that took center stage not just in India, but across the globe today. And now that the NDA government has retained power thoughts have turned to the Indian economy and what needs to be done during the next five years. The revival in NBFC is definitely high on this list along with bank recapitalisation. Data compiled by ICICI Securities revealed that, banks’ non-food credit growth hit a five year high of 13% in FY19. However after stripping out loans to NBFCs, lending grew by only 11.1%. In the six months to Match 2019, loans to shadow banks made up 14.4% of incremental loans compared to historical range of 5-6%.

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Further, ICICI Securities said that it seems a lot of the problems faced by NBFCs and other financial intermediaries may boil down to quality of specific collateral viz. property and shares. Loans against property and/or shares may be facing the greatest amount of stress. Shadow banks not engaged in such activities are still able to access funding markets and grow although contagion risks are spreading due to lack of information and distinction between ‘normal’ and ‘stressed’ NBFCs. 

Thus, Prasanna A and Abhishek Upadhyay, analysts at ICICI Securities said, “The government should ask regulators to identify and ring fence the ‘normal’ NBFCs and the RBI may consider a liquidity window for them via the banking channel. The stressed balance sheets that are heavily engaged in lending against questionable collateral should be asked to mark assets down to fair value and bring in capital to plug the capital hole. Only then should these stressed NBFCs be allowed to access any RBI window.”

Also, a fast-track resolution authority for financial firms may be needed to speed up this process in NBFCs where fresh equity capital is not forthcoming. 

That said,the duo says, “The constraint is that RBI or govt cannot force banks to participate in any credit window for NBFCs. In absence of eligible collateral with NBFCs i.e. SLR securities, the demand for RBI to provide liquidity to these entities is moot. Perhaps this is another area for regulators to deliberate and put in place a long term solution once the dust settles.”

In regards to PSBs, the duo says, “Steps to improve governance and risk management capabilities of public sector banks should be a priority and all options including privatization should be looked at on a case by case basis. Policymakers should also carefully consider the effect of consolidation of PSU banks that will reduce competition in banking system and could impede transmission. Linking of lending and deposit rates to external benchmarks also needs to be fast tracked to bring transparency to the transmission process.”

An environment where system draws down excess liquidity might be more conducive to financial stability than one in which system waits for RBI to respond to actual deficit. Needless to say such a shift in operating strategy will have to take into account movements in RBI’s forex assets, decision about any transfer of surplus capital and overall monetary stance, as per ICICI Securities.