How not to waste the NBFC crisis

Over the last nine months, a few non-banking financial companies (NBFCs) like Dewan Housing and Finance (DHFL), Infrastructure Leasing & Financial Services (IL&FS) and those of the Anil Ambani group are unravelling like a slow train wreck. This has caused enormous turbulence in the financial sector and in a small segment of the stock market. Additionally, banks and mutual funds are feeling the heat because they have lent to these troubled finance companies. How bad is the crisis and what are the lessons from it? The first thing we know, unsurprisingly, is that public sector banks (PSBs) are at the forefront when it comes to lending to finance companies. They include State Bank of India, at one time the elite among the PSBs, and now the poster boy of bad lending. 

Only a few bad apples

The second thing we know is that this crisis is not ravaging the entire NBFC sector as it did in the late 1980s and again in the mid-1990s. In those periods, dozens of leasing and finance companies, many of them small fly-by-night operations, went belly up. Over the years, the regulation of finance companies has vastly improved and most of them are led by a better quality of corporate managers. That is why only three NBFCs are affected by the current liquidity and solvency crisis. In all three cases, the debacle is an outcome of overambitious managements trying to boost capital, loan books and profits by hook or by crook. 

Just look around and you will see dozens of NBFCs like Bajaj Finance, Cholamandalam Finance, Shriram Finance, HDB Financial Services (a retail finance company of HDFC Bank), PNB Housing, Canfin Homes, and LIC Housing (in housing finance) are totally unaffected. Last year they improved their profits and loan quality. Only a few finance companies which lent indiscriminately to the real estate, which siphoned off money and played the market-cap game, are down in the dumps. These, and IL&FS, which is a category by itself, need to be liquidated systematically. So the Reserve Bank of India (RBI) is right; it is not a shadow banking crisis but a problem limited to a few bad eggs.

I cannot emphasise this enough since I see knee-jerk and even alarming policy prescriptions coming from sensible people. Speaking to a television channel, Ajay Piramal, who runs a large finance company called Piramal Enterprises and also has stakes in two Shriram group companies, said the RBI could open “a special window of funds that can be lent to NBFCs. Or if it can take the first loss of, let’s say, 10 per cent, and ask banks to lend more to NBFCs”. He also suggested that the “RBI can also look at a special purpose vehicle which can lend funds to NBFCs on short-term paper … besides, there is the ECB (external commercial borrowing) route. Today, housing finance companies can raise money as ECBs only for affordable housing companies. Can they (RBI) make it (available) for all real estate lending …”

Unless Mr Piramal knows something that no one else does, ideas like asking the RBI to take the first 10 per cent loss for the shenanigans of crooked managements seem extreme. So far, the RBI has kept a distance and said that no special support is needed. What I would like to see Mr Piramal doing (of course without talking about it) is to push the bad actors out of the system while he selectively picks on their better assets to strengthen his own formidable finance operations. This is how the system will be cleaned up and strengthened, not by asking banks to lend more to bad companies.

And which banks would lend more? Well, good private banks have been cherry-picking good assets already. So, when we say banks should lend more, we are really talking of PSBs, when they have lost quadrillions of rupees through corrupt and incompetent lending in multiple boom-bust cycles over the past 40 years. This policy prescription, of socialising losses after all gains have been privatised by a few crooked promoters, is exactly the opposite of how the capitalist system is supposed to work. Even if we need a bailout, the first thing to do is to sack current promoters and replace them with professionals with a mandate to liquidate the entity at the best price, as the government did with IL&FS. But our PSBs were unable to remove even Naresh Goyal in time and allowed Jet Airways to sink. Hence, a sensible bailout of NBFCs is a pipedream. 

The real lesson

The main lesson from this crisis is the role of mutual funds and credit rating agencies, which offered the highest rating to junk paper. Both are regulated by the Securities & Exchange Board of India (Sebi), which needs to pull them up. In the 2017 bull market, the fund industry couldn’t cope with the torrent of inflows from people, enticed by the mutual funds’ sahi hai campaign. The quality of investment declined. However, just as oceans return the garbage we throw in, the market has thrown back the trash that mutual funds sold to hapless investors during the boom. This will happen over and over again, unless Sebi forces rating agencies and mutual funds to have their skin in the game, by changing the basic structure of regulation. Let’s not waste this crisis with band-aid bailouts but look for a surgical cure.

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers