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The Collapse of India’s $400Bn ShadowBanking Sector- Kannak SharmaEvery colossal crisis humankind haswitnessed started as mere neglect andsnowballed into an irreversible wreck,dismantling several lives. India saw onesuch instance in 2018 with the Non-Banking Financial Companies crisis whenmany feared that it was the next Lehmanbrothers dodged out of sheer luck.these unpalatable results are directly orindirectly due to the impending crisisfaced by the Non-Banking finance sector.Non-Banking Financial Companies(NBFCs) were constantly facing theproblems of the credit squeeze, excessiveconcentration, over-leveraging, massivemismatch between assets and liabilities,and the reluctance of lenders. With a sizeof around $0.4 trillion and consideringthat one-fourth of the credit flow iscoming from non-banks, the sector’spotential can’t be ignored.It began in Sept 2018, when financingbehemoth Infrastructure Leasing &Financial Services (IL&FS) collapsed.Unemployment in the followingOctober rose to 8.5%, and tomake it worse, India’sinfrastructureo u t p u tcontractedby 5.6%. AllOne of the primary reasons for thiscatastrophe was ‘Impingement on thebanking system,’ i.e., NBFCs continueddependence on bank funding and mutualfunds, meaning more enormous risks tothe banking system last decade. NBFCsalso carry out credit intermediationthrough maturity transformation bylending their resources like loans andassurances, thereby creating liquidityrisk. Thus, when non-bank financialentities undertake bank-like functions,significant risks can destabilize the entiresystem. As a result, banks and reputedmutual funds would hesitate in renewingtheir contracts with the non-banks andshoot up their interest rates. This absenceof funds could worsen the scenario.The Fundamental flaw, which was theleading cause of the crisis, was thatNBFCs borrow short term and lend a longtime, but smaller NBFCs need to accessthe long-term resources. This is a riskystrategy that works till the interest rate6
scenario is benign but hurts when ratesstart to climb, which can pose severe risksto investors and depositors. Adding fuel tothe fire, the Government did not receivedefaulter lists from Banks. The nonavailabilityof defaulter databases leavesNBFCs vulnerable to credit risk becauseof the absence of critical information.How could this have been avoided?If we were to think of one word thatcaused all this, that would be ‘Ignorance.’This crisis mushroomed as a resultof loose supervision, but the centralGovernment did not adequately addresssuch a severe mishap. It significantlyaffected Foreign direct investment dueto lost global confidence, and manysuffered unemployment and heavydebts. Disclosures and consequentmarket scrutiny would have forced aspecific discipline in the maintenance ofprudential limits.NBFCs should have been allowed to availof refinance facility under a modifiedversion of the Mudra scheme becausebanks have access to refinancingthrough various means like RBI,EXIM Bank, NABARD, andSIDBI. Still, NBFCs, onthe flip side, haveto depend oncompetitors,banks forraising resources. This sharp rise inoverall credit share should have beensufficient for Government to realize therole of NBFCs and their increasing interconnectednesswith banks.There was and still is a need to streamliningthe System and Current Laws and reevaluateregulation and supervision tomaintain financial stability in the short,medium, and long term. Though we hadlaws to regulate them, many were justbound to paper and not implementedaccordingly.Present government measures have failedto stem the slide in NBFC credit, and thereis a dire need for reformation if we don’twant the ‘NBFCs Crisis’ to be on the list ofthe worst economic crisis faced by India.However, on the bright side, India hashad a history of meeting such challengesand effectively overcome them.7
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