Uncovering the state of India’s financial sector

The global outburst of the COVID-19 pandemic has put an end to some de facto relationships, such as countries’ reliance on America, and shifting the geopolitical paradigm towards the Eastern economies. It has revealed that the infrastructural facilities available are futile until and unless the countries are efficiently utilizing them. China is supplying materials to all the countries today, even though it is interpreted as political propaganda. Time has truly tested the priorities of governments when it comes to choosing between the economy and the lives of humanity.

India has taken a commendable stance by enforcing the strictest and longest lockdown ever witnessed by any country. It has even surpassed developed countries like Italy and China. However, this alone will not ensure the success story of India.

India’s fiscal balance of both the center and the state stood at -7.4% in FY 20. The Government is already dealing with a debt heavy balance sheet. Nonetheless, it has made the undaunted decision to provide a financial stimulus package worth approximately 3% of our nation’s GDP, to ease the economic burden of the epidemic. Presently, only a handful of industries have been left unscathed by the crisis – the Insurance sector, the Healthcare sector, and the Telecom sector. In order to prepare the country for the post-pandemic situation, there needs to be a cleansing of the current financial services situation in the country, as this would have the most significant role in normalizing the economy when the lockdown ends.

In its attempt to do just that, the RBI introduced a slew of measures to provide relief to the financial sector, paying special attention to NBFCs and NBFC-MFIs. In India, NBFCs indisputably play a quintessential role in the financial inclusion vision of our Prime minister. However, the liquidity crunch faced by NBFCs has long haunted our economy, ever since the IL&FS crisis broke out in September 2018. Post the turmoil; banks have been wary of extending credit to this shadow-banking member. Moreover, the current wave of measures also proves to be inadequate in solving the liquidity problems that are being faced by this segment. The RBI has introduced a moratorium period of 3 months as a relief to the borrowers. This is problematic for NBFCs as they have no option but to grant this moratorium as most of their repayments take place in liquid cash, which currently isn’t feasible. However, flipping the coin, banks have not passed an order to grant this same moratorium to NBFCs. This situation leads to NBFCs not receiving any payments but yet having to make payments. They are also borrowers from mutual fund houses (MFs) and MFs have also been constantly reducing their exposure to NBFCs. As per a Credit Suisse Report, Fund houses have reduced their exposure to NBFCs by as much as 14% in March 2020 alone.

The micro finance institutions (MFIs) are another valuable segment of this sector. As per the data collected from SIDBI, the MFIs have been responsible for extending credit to 64 million individuals, who fall outside the reach of traditional banking. They have provided a rock sold support to low income families and boast a loan portfolio of USD 1.785 trillion as on November 2019. They will play an even more significant role post the lockdown as a number of individuals from tier 2 and tier 3 cities are dependent on these MFIs.

The Covid-19 crisis is posing a tough time for MFIs because the current lockdown has hit the vulnerable section of the society the most, and this section happens to be the customer base of MFIs. Hence, loan repayments are a far-fetched dream for these institutions. Moreover, MFIs employ around 2 lakh people who are primarily involved in field visits. Hence, one of the major concerns of high operational cost persist, as they cannot cut down the salary of individuals who are connecting these institutions to their borrowers. The acquisition of customers by MFIs happens mainly through door-to-door strategies and maintaining personal touch with customers. Therefore unlike banks and big NBFCs who can expand their loan book even during a lockdown by leveraging their tech-savvy target group, MFIs don’t have that option. A majority of the small and mid-sized MFIs borrow from NBFCs, which are further dependent on banks, and well, the moratorium issue has already been stated above.

According to a research conducted by ICRA, if MFIs are not provided a cushion to defer their payments to the lenders -mainly banks and NBFCs- their liquidity coverage would fall below 1, as can be seen in the table below.

Table 1, source: ICRA

The much awaited, Rs. 50,000 Crore TLTRO(Targeted Long Term Repo Operations) provided by the RBI is yet to prove its worth as the central bank isn’t essentially lending directly to NBFCs and MFIs but rather relying on banks to do so. As events unfold, it is being revealed how the banks are reacting to the second version of TLTRO. The first tranche of the offer by RBI has received bids worth Rs. 12850 Crore, which is only 50% of the Rs. 25000 crore. Below is a snapshot of the same.

Chart 1, source: Edelweiss

Private sector banks have stayed completely away from the bids. Banks are currently maintaining a united goal of sticking to their existing loan portfolio and staying away from fresh exposures, which might increase their NPAs. The risk aversion of banks can be clearly seen as they are parking more than Rs. 7 trillion liquidity surplus with the RBI even after a 115 basis point reduction in reverse repo rate, but are shying away from extending credit to the shadow banking sector. This is partly because banks are facing difficulties to find investment grade paper for categories of NBFCs under Rs. 500 crore and would be willing to lend more if no such category restriction was mandated. However removing these restrictions will defeat the whole purpose of lending to the not-so-big NBFCs.

We are still yet to see how the RBI’s measure of extending Rs. 25,000 crore to NABARD, Rs. 15,000 crore to SIDBI and Rs. 10,000 crore to NHB will play its cards in meeting their sectoral needs. In order for SIDBI to grant loans, there are two set criteria: a minimum investment grade of BBB is required as on 31st March, and the loan needs to be repaid in 90 days. These two criteria will automatically remove a good number of MFIs from the eligibility list. According to a recent report by the Micro Finance Institutions Network (MFIN), only 60% of the 52 MFIs in the country have an investment grade rating (BBB or above). Additionally, only 23 MFIs are eligible for the refinancing offered by NABARD.

The Financial sector is a sector, which is indispensable to save both the lives and livelihoods of the citizens of India. With the kind of problems stated above, if the remaining measures by the central bank prove tepid as well, it is clear that the RBI would have to find a way to directly step in to provide relief to NBFCs and MFIs. One should not forget that the country was witnessing a slowdown much before the pandemic struck, hence all efforts should be directed towards not entering the post-lockdown in a worse (if not better) condition than the country was in before the lockdown. A healthy and smooth functioning of the financial sector is imperative for India to achieve this goal.

Written By – Anjali Agarwal (Editor, TJEF)

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