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Big credit freeze - article

The document summarizes the liquidity crisis facing India's financial system. It describes how a cleanup of banks, the IL&FS default, and a slowdown in key sectors like real estate and automobiles disrupted the flow of funds from non-bank financial companies to these sectors. This led to a liquidity deficit as banks and mutual funds withdrew financing from NBFCs. The RBI and government have since taken steps to inject liquidity but the credit system remains fragile, highlighting the need for policies to support both the financial system and the real economy.

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The Big Credit Freeze Akash Balram
Introduction 2 After 10 months of liquidity deficit for banks, the RBI liquidity tap is back to surplus in the last two months, but will it stay there for long?
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Events leading up to the current liquidity crisis in the Indian financial system 4 Clean up the system Asset quality review (AQR) of banks Close to a dozen banks did not have the wherewithal to continue lending without cooking books Prompt corrective action (PCA) watch - and forbade them from lending afresh unless their capital adequacy was shored up
Role of NBFC’s and HFC’s • High Growth experienced by non-banking financial companies (NBFCs) and housing finance companies (HFCs) • Provided funds to not only troubled sectors but also small and medium enterprises incapable to receive loans from Banks 5
6 ILFS Crisis • In June last year Infrastructure Leasing and Financial Services (IL&FS) subsidiaries defaulted, setting off a chain reaction. • NBFCs raising short-term commercial papers (CPs) from banks and mutual funds who rolled over their previous borrowings, found it difficult to access the money. • No liquidation of their assets - loans to projects that were long term and incomplete.
Direct hit Automobile Real estate and Construction Sector Gems and Jewellery Infrastructure industry SME 7
Real estate and Construction Sector There is credit squeeze Banks and NBFCs are staying away from early and mid-stage real estate project funding they prefer to lend to a project once the building is half finished or where some sale has taken place. "There is simply no money available even for good businesses to expand," 8
Automobile Sector This sector is under a slowdown. The auto industry used to generate a lot of sales via the financing route. NBFC has 30 % market share with lending book of Rs 1.22 lakh crore. 271 dealers have shut shop over the past 18 months, which has made bankers more cautious. 9
Gems and Jewellery Demonetisation and GST Nirav Modi and Mehul Choksi frauds in the banking sector coming to light. Outstanding bank credit to the sector has been stagnant at Rs 72,000 crore. 10
Infrastructure industry The infrastructure industry saw lending from banks dry up. • Bank and (PSBs) have turned extremely cautious in lending . • Recent Challenge • Liquidity crunch. • Less demand. • Project construction or big infrastructure projects have come to a standstill. 11
Small Medium Enterprise (SME’s) Banks focus is more on micro loans, especially Mudra loans. NBFC gave High level of loan against property (LAP)given by them. LAP market with 53 per cent market share and outstanding lending at Rs 1.85 lakh crore as of March 2019 liquidity squeeze has closed the doors to this source too for SMEs. 12
Crisis of Confidence 13 Introduction of IL&FC which in turn affects NBFC sector HFC collapse Big names selling off shares Comparison with 2008 US credit crisis Big companies have been put under rating watch for a possible downgrade later.
Tight Squeeze Stepping up of NBFC for giving loans and funding purposes Slowing down of NBFC after the IL&FS crisis The money flow from large investors in the market decreased De regularization of the market and inviting foreign investors 14
The Clogged NBFC Tap 15 NBFC`s – largest source of funds for corporates in India Pool resources from mutual funds & Insurance Their insurance jumped to Rs. 25.96 lakh crore from Rs. 11.50 lakh crore in past 2 years CP – depends on short term funds from NBFC Supply was much more than the demand
The Clogged NBFC Tap Acc. to The Economic Survey mutual fund deployment of CPs was at negative 12 per cent in April 2019 Most NBFCs are facing asset liability issues The ability of India to raise funds from the market has also been affected 16
Banking flows run dry PSBs are the biggest supplier of credit. Central bank reported de-growth of about 5% in its loan book. Government has promised to pump in capital. As demand for credit was already weak, those who did need money found it difficult. 17
Domestic Savings Leakage The fall in the household savings is mainly due to a decline in physical savings The overall savings rate in the economy has fallen from 33% of GDP to 30%. Savings rate falling from 23% to 17%. 18
Private sector & Public sector Companies Both are not encouraging The corporate saving rate looks better despite GST and other disruptions 19
System Liquidity Deficit Liquidity Deficit Liquidity deficit means shortage of cash. It occurs either due to limited market participation or because of decrease in cash held by financial market participants. System liquidity RBI adds liquidity into the system by lending to banks and reduces liquidity into the system by borrowing from banks. 20
System Liquidity Deficit A broken credit system ,decline in deposit growth & falling domestic savings rate all reflect in liquidity crunch. The liquidity in the system was in a deficit mode since July last year, peaking at 1 lakh crore in December last year. This showed that banks were not getting adequate liquidity from the RBI window for their daily mismatches, which affected money flowing from banks to NBFCs and to other key sectors of the economy. 21
Post-demonetisation Intervention by the RBI in the foreign exchange market to protect the rupee’s value against the US dollar. 22 Other two factors that contributed to liquidity deficit : -
Lessons for policy makers… The steps taken by the government and the RBI to infuse liquidity. NBFCs need a boost as they play a crucial role. A permanent liquidity window for NBFCs on the line of the National Housing Bank. The cost of liquidity or funding has gone up substantially. There is also an issue of financial stability. 23
Lessons for policy makers. The economy and the financial system are two sides of the same coin. The economy cannot succeed if the financial system is collapsing. Crisis fighting and macroeconomic policies have to work together. Government's ability to limit the intensity of a financial crisis. 24