How To Solve The Ongoing Liquidity Crisis In NBFCs

By Moderator June 29, 2019 15:06

Ila Patnaik is an economist and a professor at the National Institute of Public Finance and Policy expressed her views on a possible solution to NBFCs crisis

Present Issue with NBFC

  1. Liquidity stress of NBFC is turning into a solvency issue.
    • A liquidity issue is one when a company has good assets but is unable to borrow against them due to conditions in the market.
    • A solvency issue is one in which the value of the underlying assets against which it has borrowed is less than the value of the debt.
    • In other words, even if it sells off the assets, it will not be able to repay the debt.
    • A liquidity issue can turn into a solvency issue through delays, the accumulation of interest, and tough business conditions.
  2. Lending by NBFCs continues to contract
  • The real effects of the NBFC crisis are visible, for example, in the auto sector, Car sales have been declining for some months, in which both showrooms and customers depend on NBFC financing

Impact of NBFCs crisis

  • NBFC crisis is kind of vicious cycle that we are seeing today: financial stress that makes banks and NBFC wary of lending, and then their borrowers (the real estate firms) get into distress, and this distress feeds back into the asset quality of banks and NBFC.
    • Suppose the real estate company needed a flow of money to complete the project, but the NBFCs and banks from which it has been borrowing shut off that tap due to their liquidity issues.
    • This may hit its construction plans and its half-built flats may not have as much value as it had expected.
    • A decline in the value of the project then reflects on the portfolio of the real estate company and on the NBFC portfolio.

Possible responses to the problem

  • In the short run, the industry argues that to solve the liquidity crisis, the Reserve Bank of India (RBI) and the government should make banks lend more to NBFC
    • Banks are themselves frail, they find it difficult to choose which NBFCs are healthy, and they are already lending to NBFCs and buying out healthy assets which assist the downsizing of NBFCs.
  • To have a private equity firm invest in the NBFC
    • Private equity funds, particularly those that take up a substantial stake, do a thorough job of studying the firm before investing. Lenders can feel safer when they see large stakes by private equity funds in an NBFC.
  • Improve Regulations:
    • The regulation of NBFCs has been falling through the cracks. Under the present laws, NBFCs are regulated by the RBI. The RBI does not have the regulatory capacity to perform these functions.
    • The Financial Sector Legislative Reforms Commission, 2011, had proposed a unified regulatory agency for NBFCs, equity and bond markets, insurance, pensions, mutual funds, etc. It is time to revisit this proposal.

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By Moderator June 29, 2019 15:06