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In the backdrop of the ripple effects of the default of commercial papers by some of IL&FS’ arms on non-banking finance companies and mutual funds, the Reserve Bank of India said all financial firms should consider placing greater reliance on equity and other modes of long-term finance for funding of long-term assets, rather than relying excessively on short-term wholesale paper.
“Chasing lower marginal cost of funding to retain or acquire market share in lending is a myopic strategy. It is associated with significant rollover risks in the medium term, and this practice appears to have led to a form of maturity rat-race in the financing of the financial sector,” said Viral Acharya, Deputy Governor, RBI, at the briefing on the fourth bi-monthly monetary policy.
Financial stability
Increase in asset-liability mismatch in this manner can be a particularly imprudent policy at a time of global and domestic tightening conditions, Acharya cautioned, and added that it is best to avoid this to safeguard financial firms’ own balance sheets as well as for overall financial stability.
“I would like to encourage, in fact, urge, all financial firms to place greater reliance on equity and other modes of long-term finance for funding of long-term assets rather than relying excessively on short-term wholesale paper,” said the Deputy Governor.
NBFC sector
Referring to the rapid growth of the non-banking finance company (NBFC) sector in the last couple of years, NS Vishwanathan, Deputy Governor, said NBFCs used diverse sources of funds for this expansion.
He elaborated: “They (NBFCs) also tapped the market. And to keep the marginal cost of funds down, some of them resorted to increased market borrowing in the form of CP (commercial paper), and that could result in asset-liability mismatch, more so for companies that finance long-term assets like infrastructure.”
IL&FS
In the context of IL&FS, Vishwanathan observed that core investment companies (CICs) are there for the purpose of making investments in group companies. “So, the regulatory framework for them (CICs) is that 90 per cent of their exposure should be to the group entities, of which, at least 60 per cent should be in equity. The framework for them is that they must work on a debt-equity ratio of 2.5,” explained Vishwanathan.
Pointing out that the RBI is closely monitoring the NBFC sector, the Deputy Governor said the NBFC sector is quite strong overall and the regulatory-supervisory framework is robust.
Urjit Patel, Governor, RBI, said the well-structured institutional measures taken by the government in the IL&FS case have been timely and appropriate.
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