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Shadow-Banking Crisis -- ISI Emerging Markets
The document discusses the shadow banking crisis in India during 2018, focusing on the defaults of Infrastructure Leasing & Financial Services (IL&FS) and its consequences on the economy, particularly the non-banking financial companies (NBFCs). It outlines how credit rating downgrades, liquidity issues, and market reactions led to significant declines in equity markets and increased borrowing costs for the NBFC sector. The text also highlights the complex regulatory framework and the relationship between NBFCs and the broader Indian economy, emphasizing the challenges posed by deteriorating investor trust and rising non-performing assets.
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Shadow-Banking Crisis -- ISI Emerging Markets
- 1. Shadow Banking Crisisand the Indian Economy Rohini Sanyal, Research Economist, India
- 2. September 2018 –The Crisis DSP Mutual Fund starts selling commercial papers of DHFL in the secondary market at a discount Credit Rating agencies downgrade IL&FS debt instruments IL&FS defaults on a series of payment obligations Total Debt – INR 910bn
- 3. India’s own Near-LehmanMoment Lehman Brothers, an investment bank, invested in mortgage-backed securities (MBS) and collateral debt obligations (CDOs) in 2003 Defaulted on subprime mortgages, starting 2007, due to poor credit appraisal Moody’s Investor service announced review of credit rating Filed for bankruptcy on September 15, 2008 $639 billion in assets and $619 billion in debt The systemically important NBFC, IL&FS, had undertaken many important infrastructure project Financed long term projects by raising short and long-term bonds Defaulted in meeting its payment obligation Credit Rating Agencies downgrade company’s credit rating Subsequent stock market crash No bail-out package from Government Rapid intervention by Government helped
- 4. What led tothe payment defaults? Complex organizational structure – operating through: 24 direct subsidiaries 135 indirect subsidiaries 6 joint ventures 4 associates Ambitious infrastructure projects that IL&FS had invested in had their own inherent risk issues such as cost overruns, protracted implementation, delayed or withheld regulatory approval, natural calamities, and other contingencies • Spillover effects from IL&FS • DSP MF selling DHFL commercial papers at discounted rates sent warning signals to investors • DHFL Net Debt had considerably increased in FY2018 On September 21, 2018, the benchmark NIFTY 50 index plummeted by more than 100 points over the previous day, and the DHFL stock plummeted by 42% the very day In January 2019, rumors of DHFL siphoning money through shell companies impacted its reputation, and led to subsequent downgrades by rating agencies.
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- 6. Equity Markets andSovereign Bonds 6,500 7,500 8,500 9,500 10,500 11,500 12,500 Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct 2014 2015 2016 2017 2018 2019 National Stock Exchange – NIFTY 50 Right after the crisis, intraday NIFTY 50 plunged by 480 points, breaking the 11,000 mark Events such as the US-China trade war may have also impacted the equity markets to some extent 69 70 71 72 73 74 75 2023272931 4 6 10121719242628 3 5 9 11151722242630 1 5 9 Aug Sep Oct Nov Foreign Exchange Rate, INR/USD, Daily, 2018 Upward bias on bond yields as market moved to short term treasury bills Indian Rupee was reeling under a depreciating bias and tight liquidity conditions added more stress
- 7. Corporate Bonds andLiquidity Trading in Corporate Bonds Corporate bond and debentures market faced rising yields and a shortage of liquidity Yield differential of AAA-rated NBFCs and government papers with similar maturity spiked after the crisis Net Liquidity Injection or Absorption, INR Bn, 2018 Primary lending source – Banks and Mutual Funds, which became risk averse after the crisis Banking system recovering from severe NPAs stopped lending to NBFCs and HFCs Sharp increase in cost of funds for the NBFC sector due to asset liability mismatch -2,000 -1,500 -1,000 -500 0 500 1,000 20 24 29 1 5 10 13 18 21 26 29 4 8 11 16 19 23 26 31 3 7 Aug Sep Oct Nov 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 1,006 1,206 1,406 1,606 1,806 2,006 2,206 2,406 2,606 2,806 Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct 2017 2018 2019 Amount, in INR Bn (P) Number of Trades, in Thou (S)
- 8. Mutual Funds 0.0 5.0 10.0 15.0 20.0 25.0 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 2018 2019 Redemption- Private Redemption - Public Total Redemption 0 500 1,000 1,500 2,000 2,500 3,000 Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 2017 2018 2019 Commercial Paper Corporate Debt Debt mutual funds are a major source of credit for NBFCs Both retail and institutional investors reduced the amount of investments in mutual funds Crisis caused a redemption pressure and mutual funds had to liquidate their high-quality debt papers to meet the sudden surge in redemption requests, impacting the quality of returns Exposure of mutual fund to the NBFC sector through debt funding declined by INR 795bn from July 2018 to October 2019, more prominently in commercial papers Percentage of total debt deployed by mutual funds to the NBFC sector has fallen to 12.75% by the end October 2019 from 19.04% in July 2018
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- 10. Classification of NBFCs NBFIs NBFCs AllIndia Financial Institutions (AIFI) Primary Dealers NBFCs are a type of Non-Banking Financial Institution (NBFIs) Liability Structure Systemic Importance Activity Investment and Credit Company Infrastructure Finance Company Systemically Important Core Investment Company Infrastructure Debt Fund Micro Finance Institution Factor Non-Operative Financial Holding Company Mortgage Guarantee Company Account Aggregator Peer to Peer Lending Platform
- 11. Credit Growth inNBFCs Highest credit flow to Industry Followed by retail sector and services sector Worsening NPAs of NBFCs Investors could not trust the account books of companies; led to a demand for a regulatory asset quality review of NBFCs 4,375.0 4,785.0 5,128.0 3,885.0 4,055.0 4,405.0 1,455.0 1,964.0 2,439.01,266.0 1,756.0 2,226.0 1,035.0 1,675.0 1,942.0 958.0 1,257.0 1,337.0 847.0 857.0 923.0 680.0 813.0 841.0 354.0 476.0 596.0 0 5,000 10,000 15,000 20,000 25,000 March 2017 March 2018 September 2018 Large Industry Industry other than MSME & Large Retail Loans other than Vehicle Services other than CRE Vehicle/Auto Loans Commercial Real Estate (CREs) Other Non-food Credit MSME Agriculture and Allied Activities 2.6 4.1 4.5 6.1 5.8 1.4 2.5 2.5 4.4 3.8 FY2014 FY2015 FY2016 FY2017 FY2018 Gross NPAs, % Net NPAs, %
- 12. Debentures 31.8% Banks 30.3% Public Deposits 11.9% Comercial Papers10.6% Subordinat ed Debts 5.5% Others 5.4% Inter- corporate 2.8% Fis 1.7% Borrowing Outlay of NBFCs Debentures 45.4% Banks 41.1% Others 8.2% FIs 3.0% Interest Accrued 2.2% Debentures 39.7% Commercial Papers 19.2% Others 17.5% Banks 11.6% Inter- corporate 8.8% Interest Accrued 2.4% FIs 0.5% Relatives 0.4% Secured Borrowings Outlay Unsecured Borrowings Outlay NBFC-ND-SI September 2018 NBFC-D September 2018 Total Borrowings Outlay
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- 14. The Multi-Regulator Model Securitiesand Exchange Board of India Merchant Banker, Venture Capital Fund Company, Stock-Exchanges, Stock Brokers or Sub-Broker Reserve Bank of India Housing Finance Companies, and all others State Governments Chit Fund Companies Ministry of Corporate Affairs Nidhi Companies National Housing Bank Earlier governed Housing Finance Companies Insurance Regulatory and Development Authority Insurance Companies
- 15. Credit Provision andRegulation Risk Weight Risk Weightage now assigned on the basis of risk ratings Exposure Norm Under Large Exposure Framework, exposure limit for NBFCs increased to 20% Liquidity through FALLCR Banks permitted to treat Government Securities (G-Secs) as Level 1 High Quality Liquid Assets (HQLAs) under the Facility to Avail Liquidity for Liquidity Coverage Ratio CIC Guidelines Recommendations of Working Group to Review the Regulatory and Supervisory Framework for Core Investment Companies to RBI Others • Partial Credit Enhancement through Banks • Harmonization of NBFC categories to activity base from entity base • Appointment of Chief Risk Officer for NBFCs with asset size of INR 50bn or more Insolvency and Bankruptcy Code Corporate Affairs Ministry now includes permission for NBFCs with asset size of INR 5bn or more to file for insolvency resolution and liquidation proceedings. This can be initiated only by application from the appropriate regulator.
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- 17. Relationship of NBFCswith Indian Economy Complementing the Banking System • Short term liability mix of the banking system creates room for NBFCs to step in for long-term investment projects • Fall in credit flow from NBFCs by 19% and 31% y/y in Q3 and Q4 FY2019 30 44 53 15 Auto Home Property Personal Loans disbursed by NBFCs as a percentage of total loans to the sector, December 2018 Auto Industry Retail Housing NBFC
- 18. Relationship of NBFCswith Indian Economy -30% -20% -10% 0% 10% 20% 30% 0 500 1000 1500 2000 2500 3000 3500 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 2018 2019 -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 0 2000 4000 6000 8000 10000 12000 14000 Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct 2017 2018 2019 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 FY2015 FY2016 FY2017 FY2018 Assessment Price Market Prices for Under Construction Properties Auto Sales Finished Steel Production Housing Price Index by NHB
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- 20. Balancing between Regulationand Innovation 28 46 105 125 110 215 210 169 224 900 FY2015 FY2016 FY2017 FY2018 FY2019 Registrations Cancellations Cancellations spiked in FY2019 72393.01 72535.74 73389.78 76884.23 76884.23 75803.92 75837.58 76325.44 76275.9174 77703.8 79774.44 80025.81 80931.39 81641.72 82042.9132 83065.21 86334.18 84810.32 84512.39 84763.77 84957.59 85323.67 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 2017 2018 2019 Total Bank Credit Credit to NBFC Spike in cancellations but strong credit growth to NBFCs from banks As a result of government’s announcement of special financing window by banks for NBFCs to receive credit through partial credit guarantee, partial credit enhancement, change in risk weighing norms
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