https://economictimes.indiatimes.co...stest-growing-nation/articleshow/66614832.cms
Shadow banking crisis is now starting to hit India's consumers
by Anirban Nag and Aashika Suresh
Karan Dua, an electronics shop owner in south-central Mumbai, placed his hope of crackling sales on Diwali -- the festival of lights when Indians splurge on everything from clothes to cars and jewelry to houses.
It hardly lit up business for the 35-year-old shop owner. Businesses like Dua’s are seeing sluggish sales this festive season in part because India’s shadow lending industry, which accounted for nearly 4 out of every 10 consumer loans in the last three years, has grown more more cautious about extending new credit amid a funding crunch of its own.
Loan volumes for some of these lenders dropped to 10 per cent of the levels seen before defaults by a troubled financier from August onward made it costlier for all non-bank financial companies to raise funds, according to Indostar Capital Finance Pvt. which makes loans to companies, and individuals for home and vehicle purchases. The cash crunch for the industry came at the start of the peak shopping season in India, threatening consumption, which is the backbone of the economy, say economists.
“The amount the non-bank finance companies are lending has come down considerably,” said R. Sridhar, an industry veteran and chief executive officer at Indostar Capital. “Particularly lenders which give loans for buying consumer durables, vehicles and gold.”
In India, NBFCs and lenders to the housing sector have become increasingly important in supporting consumer spending as the nation’s formal banking sector is weighed down by bad loans. Nomura Inc. estimates that the loan books of NBFCs and housing lenders have grown at a compounded annual rate of 17 per cent in the past two years, compared with 8 per cent for banks.
Such growth looks difficult to sustain as liquidity dries up, with the Bloomberg Economics India Banking Liquidity Index showing a nearly 1 trillion rupee shortfall of cash in the banking system. That, along with a 50 basis-point interest rate increase by Reserve Bank of India this year and the recent rise in borrowing costs in the credit market, is likely to have a ripple effect.
“With banks tightening credit to NBFCs and they in turn to retailers, transporters, and builders, there will likely be lower credit growth for the rest of the financial year and beyond,” said Anjali Verma and Raag Haria, analysts at PhillipCapital India Pvt. “Urban and semi-urban demand may be dented due to limited NBFC lending.”
Madan Sabnavis, chief economist at rating company Care Ratings Ltd, has penciled in an expansion based on robust consumption. But should demand falter because of tighter liquidity conditions, then growth would take a hit, he cautions.
The worst-case scenario is a 0.1-0.2 percentage point hit to growth, according to Sabnavis, who sees expansion dipping to 7.3 per cent from 7.5 per cent in the financial year ending March 2019.
Shadow Banks
But some disagree with the suggestion that lending will slow down for all. Those with a strong pedigree will be able to weather this phase out, according to Tata Capital Financial Services Ltd., a non-bank lender.
“We are witnessing liquidity tightness and we believe this is a temporary phase, more like a course correction phase,” said Kusal Roy, managing director of Tata Capital. “Surely, there will be a sharper and more select focus on customer profiles.”
IndoStar’s Sridhar estimates that non-bank lenders will be back to normal next quarter, with business already beginning to recover.
Others see a problem that extends beyond the crisis at NBFCs. What the shadow lenders are going through is more a reflection of a liquidity mismatch than any incremental contagious financial stress, said Sonal Varma, chief India economist at Nomura.
“We believe that the cyclical recovery has ended and the growth slowdown is now almost a certainty,” Varma said.
A slew of high-frequency indicators tracked by Bloomberg show economic growth in the July-September quarter may have retreated from the 8 per cent plus pace in the previous three months, as consumption cooled.
Still, fewer loans from shadow lenders would make automobiles, consumer goods and real estate sectors especially vulnerable.
Already, car sales have fallen in the three months ended September from a year ago and latest data from the local automakers’ group show sales were flat in October. In the real estate market too, things are looking tough and loans for buying consumer goods have fallen sharply.
For the likes of Dua though, that means another difficult year. While in 2016, a surprise decision to ban high denomination notes hurt demand, the year after was lost in the mess following the chaotic roll out of the national sales tax. This festival season too seems no different.
“Diwali is an auspicious time for Indians,” Dua said. “It hasn’t been for me this time,’’ he said, referring to poor footfalls and sales that were just a quarter of what they were a year ago.
https://www.bloomberg.com/opinion/a...m-il-fs-group-bankruptcy-go-unheeded-in-india
India Is Missing the Wake-Up Call From Its Shadow-Bank Bust
Ratings companies and mutual funds refuse to heed lessons from the $12.8 billion bankruptcy of IL&FS Group.
Andy Mukherjee
Rana Kapoor’s diamond in the rough.
Photographer: Udit Kulshrestha/Bloomberg
Read more opinionFollow @andymukherjee70 on Twitter
India’s finance industry is letting a good crisis go to waste by not learning from it.
The sudden $12.8 billion bankruptcy of infrastructure lender IL&FS Group, currently sequestered under a government-blessed, out-of-court process, underscores India’s lack of preparedness to handle a big shift in lending in recent years — away from banks.
Before I illustrate that challenge with a little story about a banking tycoon’s fundraising, a little background:
Over the last several years, the state-run Indian banks’ capital constraints have seen them cede market share to nonbanks. Nothing wrong there except that shadow lenders are the riskiest of trapeze artists: They have to perform without the ropes of deposit insurance and the safety nets of central-bank liquidity — two things banks take for granted. One fall could be a showstopper.
When the IL&FS show did stop, risk management was nowhere to be found; fiduciary responsibilities were similarly absent. Mutual funds that had been lapping up commercial paper and non-convertible debentures issued by shadow lenders, as well as the rating companies pocketing fees by blindly certifying their safety, sleepwalked into the crisis. And though both are being prodded by regulators to wake up, neither is displaying any zeal of its own.
After IL&FS blew up, the funding market froze, and the credit industry cried mommy, begging the central bank to act as the lender of the last resort. The Reserve Bank of India’s refusal to do so added to its brewing tensions with the government. Amid this mess, the least the mutual funds and the rating companies could have done was to signal a change in their own behavior.
Now let me tell you what they’re up to instead. Yes Bank Ltd. is a private-sector lender, controlled by co-founder Rana Kapoor. The bank annoyed the RBI with its egregious misreporting of nonperforming assets. In September, the RBI rejected Yes Bank’s proposal to let Kapoor continue as chief executive officer. A new CEO has to be found by January. Meanwhile, there’s a stampede among board members to leave. Yes Bank’s stock has sunk 50 percent in just three months.
Cushion Is Gone
Yes Bank cofounder Rana Kapoor's family investment vehicles have raised millions of dollars on the strength of the bank's share price, which has plunged 50 percent since its peak this year
Source: Bloomberg
The jitters have reached the shadow banking world via Morgan Credits Pvt., one of the vehicles under which Kapoor’s family holds its Yes Bank stake. 1 Morgan Credits offers the Kapoor family a neat way to monetize its shares without pledging them. To raise money, Morgan issued zero-coupon, nonconvertible debentures maturing in 2021, and it promised that the borrowed amount plus accrued interest will always be less than half of the market value of its holdings in Yes Bank. A good margin of safety for mom-and-pop investors while they earn some interest from a rich banker?
Reliance Mutual Fund certainly thinks so. Across plans, the fund seems to own the entire 11.6 billion rupees ($163 million) raised by Morgan Credits.
One Fund Has It All
Two debenture issuances this year by Morgan Credits, one of Yes Bank cofounder Rana Kapoor's family investment vehicles, raised 11.6 billion rupees; one fund house seems to have all the notes
Source: Reliance Mutual Fund monthly portfolio report for Sept. 30, 2018
Note: The total exposure exceeds the issue size because it includes accrued interest on the zero-coupon bonds
Reliance Mutual isn’t alone in doing such bilateral deals. As much as 3.27 percent of Yes Bank stake is with Yes Capital India Pvt., another of Kapoor’s vehicles. The family has monetized that stake, too, by issuing 6.3 billion rupees in zero-coupon notes. Most (if not all) of that is once again held by one fund: Franklin Templeton. 2
Let's Just Call It a Loan?
Franklin Templeton seems to have the entire stock of zero-coupon debentures sold by Yes Capital, one of Yes Bank founder Rana Kapoor's vehicles
Source: Franklin Templeton fact sheet for Oct. 30, 2018
But things haven’t gone according to plan. The RBI swung its regulatory bat, and the debt ceiling for Morgan Credits was breached. At current prices, 3.04 percent of Yes is valued at less than two times the money the mutual fund has lent to Morgan. As the bank’s shares swooned, the Kapoor family fulfilled its promise to bring in liquid funds to make up the shortfall.
However, why let cash lie idle in a loan-servicing account? So, to allow this fund infusion to be reversed, a new version of the covenant was drummed up. The debt limit still holds, though now it would be busted only when the debt and accrued interest exceed half of Morgan’s 3.04 percent plus the 4.33 percent Kapoor owns in his own name. Satisfied by the legal strength of Kapoor’s personal guarantee, Care Ratings Ltd. reaffirmed the notes’ rating at A minus on Nov. 19.
One can understand why the family may not want to keep bringing fresh cash into Morgan, especially if it means selling Yes Bank stock. Doing so would only add to market panic. Kapoor took to Twitter in September to take a dig at the other co-promoter who had sold some shares. “Diamonds are forever,” he quipped.
Yet retail investors probably have no idea they’re the ones financing Kapoor’s diamonds, on the basis of debt covenants as fluffy as cotton candy. These are essentially unsecured loans to private investment companies, not suitable for mutual funds. Should fund managers use the cover of high credit ratings to mask the fact that no market exists for them whatsoever? That two months after the IL&FS debacle India’s financial industry should still be so unresponsive to risk-reward and fiduciary duties makes one wonder if these wild-swinging acrobats even deserve a safety net.
To contact the author of this story:
Andy Mukherjee at amukherjee@bloomberg.net
To contact the editor responsible for this story:
Rachel Rosenthal at rrosenthal21@bloomberg.net
LEARN MORE
https://www.economist.com/business/2018/11/08/indias-banking-system-is-flirting-with-a-lehman-moment
India’s banking system is flirting with a Lehman moment
The collapse of a shadow bank has sparked fear and financial contagion
an hour ago
WHEN NARENDRA MODI was elected prime minister of India in 2014, his plan was to revive its GDP growth rate back to the near-double-digit figures seen in the mid-2000s. Few would have guessed that the biggest threat to that goal was the financial industry. For several years state-run banks have failed to get to grips with a $100bn mountain of dud loans. Now panic has seized parts of the privately run system. One bank boss says the situation is as bad as the Asian crisis of 1998 or the global crash of 2008.
Get our daily newsletter
Upgrade your inbox and get our Daily Dispatch and Editor's Picks.
In September IL&FS, a financial firm that owns and finances roads and power plants, defaulted on some of its $13bn of debt. The contagion has struck India’s shadow banks, which rely on $250bn-300bn of borrowing to fund themselves. Their market value has collapsed by a median of 40% this year. A bitter row about how to respond has erupted between the government and the Reserve Bank of India (RBI), the largely independent central bank. Over a billion people depend on an emergency being avoided.
India’s financial system has both Chinese and American characteristics; it faces a blend of a slow-motion banking crisis at government-run lenders, plus a high-speed liquidity run of the kind that hit Wall Street in 2008. That the industry has taken on a hybrid character over time reflects the conflicting aims of the forces that shaped it. The state wants pliant banks, ready to lend to the rural poor and to infrastructure projects, and that will buy government bonds. The RBI emphasises stability, so is paranoid about wheeler-dealers taking risks or ripping off the vulnerable. Entrepreneurs want capital and to start financial-services firms themselves. And consumers want loans and whizzy new banking technologies.
About half the system, measured by loans, consists of state-run banks. They are usually listed but the government appoints their top brass and often influences them to disastrous effect. Another 25% comes from private banks; some of which are among Asia’s best-run lenders—HDFC Bank and Kotak trade on about four times their book value, compared with below one times for the zombie state banks. The other quarter is from a motley crew of 50-odd shadow banks that have expanded quickly. They are less heavily regulated and lend in particular areas such as housing. They are usually prohibited from taking deposits so fund themselves with debt. Last, there are innovative digital firms, such as Paytm, a mobile-payments firm. Overall, the system straddles the 19th and 21st centuries, featuring subsiding bank branches protected from the monsoon by tarpaulins, but also virtual mobile chatbots.
The present troubles have their roots in 2005-12, when state banks went on a lending bender, extending credit to dubious tycoons and to infrastructure projects. Net bad debts are 9% of state banks’ loan books. The government has not properly recapitalised these zombies and the flow of credit from them has slowed. Accidents keep happening. In February PNB, the second-biggest state lender, disclosed a $2bn fraud involving diamond merchants.
A second phase began after 2012. Between 2012 and 2017 more capital flowed into India than flowed out. In 2015 interest rates began to fall and in November 2016 the government replaced the stock of bank notes overnight, leading savers to switch from physical money into deposits with banks, and into debt mutual funds. Flush with cash, and with rates low, they looked for ways to lend the money out again and part of the answer was to fund the shadow banks, which went on a binge—the top 50 have doubled their debts and assets in the past five years. Perhaps as much as $50bn-100bn of their debts comes due within 12 months.
Borrowing short and lending long is a high-stakes game. After the IL&FS collapse, confidence has evaporated. The group has 348 opaque subsidiaries, including India’s longest tunnel. It has now been taken over by the government, which indirectly owned 40% of it. Mutual funds and banks are reluctant to lend to other shadow banks—most report solid capital ratios, but can anyone be sure they do not have time-bombs buried in their balance-sheets? For weeks the shadow banks have faced a liquidity crunch.
They are big enough to damage India’s entire financial system. Mutual funds, which are sold to the public, have $55bn of exposure to them, or 11% of total assets under management. Conventional banks have loaned $70bn to shadow banks, the equivalent of two-fifths of the former’s core capital. Among private lenders the mood is already jittery: ICICI’s boss has just departed after claims of conflicts of interest (which she denies). Yes Bank is replacing its boss after the RBI refused to approve an extension of his term. Even if a full crisis does not erupt shadow banks may be forced to shrink. When combined with the rotten state banks, that would mean that 75% of India’s financial system is on crutches.
Bazooka time
A sell-off in global markets could easily trigger a new wave of panic. The government, facing a general election next year, wants the central bank to lend more freely to the shadow banks. But the RBI does not want to reward failure and has so far injected liquidity only indirectly, by buying government bonds and allowing banks to guarantee some new bonds issued by shadow banks. It blames the government for its endless meddling in state-run lenders and for its failure to recapitalise them, despite years of warning signs.
In the short term the government is right—unless the liquidity squeeze abates soon, the central bank will need to set aside its natural reluctance and act boldly. In the long term the RBI is right. A “big bang” reform is needed to privatise the state banks and extract them from the government’s tight grip. India also must end the regulatory arbitrage that allows shadow banks to raise most of their funds from retail investors and deposit-taking banks. Either shadow lenders should come out of the dark and be turned into banks, or a firewall will have to be erected around them to protect the rest of banking. And if India does not get its financial system back on its feet, the economy will not grow fast. It is that simple.
This article appeared in the Business section of the print edition under the headline"India’s shadow-banking crisis"
Shadow banking crisis is now starting to hit India's consumers
by Anirban Nag and Aashika Suresh
Karan Dua, an electronics shop owner in south-central Mumbai, placed his hope of crackling sales on Diwali -- the festival of lights when Indians splurge on everything from clothes to cars and jewelry to houses.
It hardly lit up business for the 35-year-old shop owner. Businesses like Dua’s are seeing sluggish sales this festive season in part because India’s shadow lending industry, which accounted for nearly 4 out of every 10 consumer loans in the last three years, has grown more more cautious about extending new credit amid a funding crunch of its own.
Loan volumes for some of these lenders dropped to 10 per cent of the levels seen before defaults by a troubled financier from August onward made it costlier for all non-bank financial companies to raise funds, according to Indostar Capital Finance Pvt. which makes loans to companies, and individuals for home and vehicle purchases. The cash crunch for the industry came at the start of the peak shopping season in India, threatening consumption, which is the backbone of the economy, say economists.
“The amount the non-bank finance companies are lending has come down considerably,” said R. Sridhar, an industry veteran and chief executive officer at Indostar Capital. “Particularly lenders which give loans for buying consumer durables, vehicles and gold.”
In India, NBFCs and lenders to the housing sector have become increasingly important in supporting consumer spending as the nation’s formal banking sector is weighed down by bad loans. Nomura Inc. estimates that the loan books of NBFCs and housing lenders have grown at a compounded annual rate of 17 per cent in the past two years, compared with 8 per cent for banks.
Such growth looks difficult to sustain as liquidity dries up, with the Bloomberg Economics India Banking Liquidity Index showing a nearly 1 trillion rupee shortfall of cash in the banking system. That, along with a 50 basis-point interest rate increase by Reserve Bank of India this year and the recent rise in borrowing costs in the credit market, is likely to have a ripple effect.
“With banks tightening credit to NBFCs and they in turn to retailers, transporters, and builders, there will likely be lower credit growth for the rest of the financial year and beyond,” said Anjali Verma and Raag Haria, analysts at PhillipCapital India Pvt. “Urban and semi-urban demand may be dented due to limited NBFC lending.”
Madan Sabnavis, chief economist at rating company Care Ratings Ltd, has penciled in an expansion based on robust consumption. But should demand falter because of tighter liquidity conditions, then growth would take a hit, he cautions.
The worst-case scenario is a 0.1-0.2 percentage point hit to growth, according to Sabnavis, who sees expansion dipping to 7.3 per cent from 7.5 per cent in the financial year ending March 2019.
Shadow Banks
But some disagree with the suggestion that lending will slow down for all. Those with a strong pedigree will be able to weather this phase out, according to Tata Capital Financial Services Ltd., a non-bank lender.
“We are witnessing liquidity tightness and we believe this is a temporary phase, more like a course correction phase,” said Kusal Roy, managing director of Tata Capital. “Surely, there will be a sharper and more select focus on customer profiles.”
IndoStar’s Sridhar estimates that non-bank lenders will be back to normal next quarter, with business already beginning to recover.
Others see a problem that extends beyond the crisis at NBFCs. What the shadow lenders are going through is more a reflection of a liquidity mismatch than any incremental contagious financial stress, said Sonal Varma, chief India economist at Nomura.
“We believe that the cyclical recovery has ended and the growth slowdown is now almost a certainty,” Varma said.
A slew of high-frequency indicators tracked by Bloomberg show economic growth in the July-September quarter may have retreated from the 8 per cent plus pace in the previous three months, as consumption cooled.
Still, fewer loans from shadow lenders would make automobiles, consumer goods and real estate sectors especially vulnerable.
Already, car sales have fallen in the three months ended September from a year ago and latest data from the local automakers’ group show sales were flat in October. In the real estate market too, things are looking tough and loans for buying consumer goods have fallen sharply.
For the likes of Dua though, that means another difficult year. While in 2016, a surprise decision to ban high denomination notes hurt demand, the year after was lost in the mess following the chaotic roll out of the national sales tax. This festival season too seems no different.
“Diwali is an auspicious time for Indians,” Dua said. “It hasn’t been for me this time,’’ he said, referring to poor footfalls and sales that were just a quarter of what they were a year ago.
https://www.bloomberg.com/opinion/a...m-il-fs-group-bankruptcy-go-unheeded-in-india
India Is Missing the Wake-Up Call From Its Shadow-Bank Bust
Ratings companies and mutual funds refuse to heed lessons from the $12.8 billion bankruptcy of IL&FS Group.
Andy Mukherjee
Rana Kapoor’s diamond in the rough.
Photographer: Udit Kulshrestha/Bloomberg
Read more opinionFollow @andymukherjee70 on Twitter
India’s finance industry is letting a good crisis go to waste by not learning from it.
The sudden $12.8 billion bankruptcy of infrastructure lender IL&FS Group, currently sequestered under a government-blessed, out-of-court process, underscores India’s lack of preparedness to handle a big shift in lending in recent years — away from banks.
Before I illustrate that challenge with a little story about a banking tycoon’s fundraising, a little background:
Over the last several years, the state-run Indian banks’ capital constraints have seen them cede market share to nonbanks. Nothing wrong there except that shadow lenders are the riskiest of trapeze artists: They have to perform without the ropes of deposit insurance and the safety nets of central-bank liquidity — two things banks take for granted. One fall could be a showstopper.
When the IL&FS show did stop, risk management was nowhere to be found; fiduciary responsibilities were similarly absent. Mutual funds that had been lapping up commercial paper and non-convertible debentures issued by shadow lenders, as well as the rating companies pocketing fees by blindly certifying their safety, sleepwalked into the crisis. And though both are being prodded by regulators to wake up, neither is displaying any zeal of its own.
After IL&FS blew up, the funding market froze, and the credit industry cried mommy, begging the central bank to act as the lender of the last resort. The Reserve Bank of India’s refusal to do so added to its brewing tensions with the government. Amid this mess, the least the mutual funds and the rating companies could have done was to signal a change in their own behavior.
Now let me tell you what they’re up to instead. Yes Bank Ltd. is a private-sector lender, controlled by co-founder Rana Kapoor. The bank annoyed the RBI with its egregious misreporting of nonperforming assets. In September, the RBI rejected Yes Bank’s proposal to let Kapoor continue as chief executive officer. A new CEO has to be found by January. Meanwhile, there’s a stampede among board members to leave. Yes Bank’s stock has sunk 50 percent in just three months.
Cushion Is Gone
Yes Bank cofounder Rana Kapoor's family investment vehicles have raised millions of dollars on the strength of the bank's share price, which has plunged 50 percent since its peak this year
Source: Bloomberg
The jitters have reached the shadow banking world via Morgan Credits Pvt., one of the vehicles under which Kapoor’s family holds its Yes Bank stake. 1 Morgan Credits offers the Kapoor family a neat way to monetize its shares without pledging them. To raise money, Morgan issued zero-coupon, nonconvertible debentures maturing in 2021, and it promised that the borrowed amount plus accrued interest will always be less than half of the market value of its holdings in Yes Bank. A good margin of safety for mom-and-pop investors while they earn some interest from a rich banker?
Reliance Mutual Fund certainly thinks so. Across plans, the fund seems to own the entire 11.6 billion rupees ($163 million) raised by Morgan Credits.
One Fund Has It All
Two debenture issuances this year by Morgan Credits, one of Yes Bank cofounder Rana Kapoor's family investment vehicles, raised 11.6 billion rupees; one fund house seems to have all the notes
Source: Reliance Mutual Fund monthly portfolio report for Sept. 30, 2018
Note: The total exposure exceeds the issue size because it includes accrued interest on the zero-coupon bonds
Reliance Mutual isn’t alone in doing such bilateral deals. As much as 3.27 percent of Yes Bank stake is with Yes Capital India Pvt., another of Kapoor’s vehicles. The family has monetized that stake, too, by issuing 6.3 billion rupees in zero-coupon notes. Most (if not all) of that is once again held by one fund: Franklin Templeton. 2
Let's Just Call It a Loan?
Franklin Templeton seems to have the entire stock of zero-coupon debentures sold by Yes Capital, one of Yes Bank founder Rana Kapoor's vehicles
Source: Franklin Templeton fact sheet for Oct. 30, 2018
But things haven’t gone according to plan. The RBI swung its regulatory bat, and the debt ceiling for Morgan Credits was breached. At current prices, 3.04 percent of Yes is valued at less than two times the money the mutual fund has lent to Morgan. As the bank’s shares swooned, the Kapoor family fulfilled its promise to bring in liquid funds to make up the shortfall.
However, why let cash lie idle in a loan-servicing account? So, to allow this fund infusion to be reversed, a new version of the covenant was drummed up. The debt limit still holds, though now it would be busted only when the debt and accrued interest exceed half of Morgan’s 3.04 percent plus the 4.33 percent Kapoor owns in his own name. Satisfied by the legal strength of Kapoor’s personal guarantee, Care Ratings Ltd. reaffirmed the notes’ rating at A minus on Nov. 19.
One can understand why the family may not want to keep bringing fresh cash into Morgan, especially if it means selling Yes Bank stock. Doing so would only add to market panic. Kapoor took to Twitter in September to take a dig at the other co-promoter who had sold some shares. “Diamonds are forever,” he quipped.
Yet retail investors probably have no idea they’re the ones financing Kapoor’s diamonds, on the basis of debt covenants as fluffy as cotton candy. These are essentially unsecured loans to private investment companies, not suitable for mutual funds. Should fund managers use the cover of high credit ratings to mask the fact that no market exists for them whatsoever? That two months after the IL&FS debacle India’s financial industry should still be so unresponsive to risk-reward and fiduciary duties makes one wonder if these wild-swinging acrobats even deserve a safety net.
- Morgan Credits has a 3.04 percent stake as of Sept. 30.
- But in that case at least, the debt cap in the covenant is more restrictive. The equity cover has to be at least 3.3 times the borrowings plus accrued interest.
To contact the author of this story:
Andy Mukherjee at amukherjee@bloomberg.net
To contact the editor responsible for this story:
Rachel Rosenthal at rrosenthal21@bloomberg.net
LEARN MORE
https://www.economist.com/business/2018/11/08/indias-banking-system-is-flirting-with-a-lehman-moment
India’s banking system is flirting with a Lehman moment
The collapse of a shadow bank has sparked fear and financial contagion
an hour ago
WHEN NARENDRA MODI was elected prime minister of India in 2014, his plan was to revive its GDP growth rate back to the near-double-digit figures seen in the mid-2000s. Few would have guessed that the biggest threat to that goal was the financial industry. For several years state-run banks have failed to get to grips with a $100bn mountain of dud loans. Now panic has seized parts of the privately run system. One bank boss says the situation is as bad as the Asian crisis of 1998 or the global crash of 2008.
Get our daily newsletter
Upgrade your inbox and get our Daily Dispatch and Editor's Picks.
In September IL&FS, a financial firm that owns and finances roads and power plants, defaulted on some of its $13bn of debt. The contagion has struck India’s shadow banks, which rely on $250bn-300bn of borrowing to fund themselves. Their market value has collapsed by a median of 40% this year. A bitter row about how to respond has erupted between the government and the Reserve Bank of India (RBI), the largely independent central bank. Over a billion people depend on an emergency being avoided.
India’s financial system has both Chinese and American characteristics; it faces a blend of a slow-motion banking crisis at government-run lenders, plus a high-speed liquidity run of the kind that hit Wall Street in 2008. That the industry has taken on a hybrid character over time reflects the conflicting aims of the forces that shaped it. The state wants pliant banks, ready to lend to the rural poor and to infrastructure projects, and that will buy government bonds. The RBI emphasises stability, so is paranoid about wheeler-dealers taking risks or ripping off the vulnerable. Entrepreneurs want capital and to start financial-services firms themselves. And consumers want loans and whizzy new banking technologies.
About half the system, measured by loans, consists of state-run banks. They are usually listed but the government appoints their top brass and often influences them to disastrous effect. Another 25% comes from private banks; some of which are among Asia’s best-run lenders—HDFC Bank and Kotak trade on about four times their book value, compared with below one times for the zombie state banks. The other quarter is from a motley crew of 50-odd shadow banks that have expanded quickly. They are less heavily regulated and lend in particular areas such as housing. They are usually prohibited from taking deposits so fund themselves with debt. Last, there are innovative digital firms, such as Paytm, a mobile-payments firm. Overall, the system straddles the 19th and 21st centuries, featuring subsiding bank branches protected from the monsoon by tarpaulins, but also virtual mobile chatbots.
The present troubles have their roots in 2005-12, when state banks went on a lending bender, extending credit to dubious tycoons and to infrastructure projects. Net bad debts are 9% of state banks’ loan books. The government has not properly recapitalised these zombies and the flow of credit from them has slowed. Accidents keep happening. In February PNB, the second-biggest state lender, disclosed a $2bn fraud involving diamond merchants.
A second phase began after 2012. Between 2012 and 2017 more capital flowed into India than flowed out. In 2015 interest rates began to fall and in November 2016 the government replaced the stock of bank notes overnight, leading savers to switch from physical money into deposits with banks, and into debt mutual funds. Flush with cash, and with rates low, they looked for ways to lend the money out again and part of the answer was to fund the shadow banks, which went on a binge—the top 50 have doubled their debts and assets in the past five years. Perhaps as much as $50bn-100bn of their debts comes due within 12 months.
Borrowing short and lending long is a high-stakes game. After the IL&FS collapse, confidence has evaporated. The group has 348 opaque subsidiaries, including India’s longest tunnel. It has now been taken over by the government, which indirectly owned 40% of it. Mutual funds and banks are reluctant to lend to other shadow banks—most report solid capital ratios, but can anyone be sure they do not have time-bombs buried in their balance-sheets? For weeks the shadow banks have faced a liquidity crunch.
They are big enough to damage India’s entire financial system. Mutual funds, which are sold to the public, have $55bn of exposure to them, or 11% of total assets under management. Conventional banks have loaned $70bn to shadow banks, the equivalent of two-fifths of the former’s core capital. Among private lenders the mood is already jittery: ICICI’s boss has just departed after claims of conflicts of interest (which she denies). Yes Bank is replacing its boss after the RBI refused to approve an extension of his term. Even if a full crisis does not erupt shadow banks may be forced to shrink. When combined with the rotten state banks, that would mean that 75% of India’s financial system is on crutches.
Bazooka time
A sell-off in global markets could easily trigger a new wave of panic. The government, facing a general election next year, wants the central bank to lend more freely to the shadow banks. But the RBI does not want to reward failure and has so far injected liquidity only indirectly, by buying government bonds and allowing banks to guarantee some new bonds issued by shadow banks. It blames the government for its endless meddling in state-run lenders and for its failure to recapitalise them, despite years of warning signs.
In the short term the government is right—unless the liquidity squeeze abates soon, the central bank will need to set aside its natural reluctance and act boldly. In the long term the RBI is right. A “big bang” reform is needed to privatise the state banks and extract them from the government’s tight grip. India also must end the regulatory arbitrage that allows shadow banks to raise most of their funds from retail investors and deposit-taking banks. Either shadow lenders should come out of the dark and be turned into banks, or a firewall will have to be erected around them to protect the rest of banking. And if India does not get its financial system back on its feet, the economy will not grow fast. It is that simple.
This article appeared in the Business section of the print edition under the headline"India’s shadow-banking crisis"
