Even as the country is seeking to slowly get out of the physical lockdown in an organised and gradual manner, another serious impending crisis stares it in the face — a financial sector meltdown. If that were to happen, getting the economy back on its feet would become a humongous task.

The prospects of things getting acute became clear when fund manager Franklin Templeton closed six of its schemes. Loss of investor confidence and a mass exit from mutual funds became a reality and the ability of funds to honour commitments was up in the air.

Aware of this, Reserve Bank of India has opened a ₹50,000 crore liquidity window for mutual funds to enable them to keep their head above the water. Banks can pass on the liquidity by lending to mutual funds or buy commercial paper and corporate debentures.

NPA crisis

What we are now seeing is the latest denouement of the crisis in the financial sector which began with the RBI asking banks to come clean on the true dimensions of their non-performing assets. Once these began to come out of the woodwork the officially admitted NPA levels shot up, seriously disorienting bank managements and creating a mental block for them on further lending.

Then came the IL&FS collapse, making banks hugely cautious about lending to non-banks or NBFCs, housing finance companies (under pressure from a demand slump in retail housing) and microfinance institutions.

This was followed by a well regarded private bank like YES Bank getting into trouble resulting in pressure from deposit withdrawal, a pressure that got quickly transmitted to other equally respected private sector banks like IndusInd Bank.

The bottom seems to have finally fallen out for the financial sector with the unfolding of the coronavirus pandemic and the lockdown, leading to the Franklin Templeton fiasco and fear of that contagion spreading to the entire mutual fund industry.

What is the way out? There will be no light at the end of the tunnel until the infection rate is seen to stabilise and fall and economic activity slowly begins to resume. As that happens there will be a demand for credit which the financial sector will have to meet.

Reluctance to lend

The RBI can open as many lines of credit as it likes and this has been happening, but things will not move unless banks end their reluctance to lend.

The government can exhort them and lay down timelines to ensure prompt credit disbursal in a time- bound manner but this will not help unless bankers feel more confident about lending.

Right now they see a sword hanging over their heads, real or imaginary, of vigilance enquiry and action on past loans gone sour which has made them so reluctant to lend.

Fresh lending in scale will not happen unless the whole level of confidence in business improves and firms come forward to ask for credit and the political establishment signals there is nothing for bank managers to fear. Easier credit for NBFCs, housing finance companies and microfinance organisations will aid the return to normality.

Till such time as the infection threat recedes and economic activity resumes, the RBI can only provide lifelines and palliatives. It has to ensure that the various lines of liquidity reach the right entities. The tools that it has are credit enhancement, credit guarantee, issuing tax-free bonds and direct corporate bond purchase. To meet the specific needs of MSMEs, the RBI can start a special fund or an SPV which can take over MSME liabilities.

There is a virtuous cycle which has to start sometime. As economic activity begins to revive and government handouts are hopefully forthcoming, demand will begin to pick up, bottom up.

This will cause businesses to revive and ask for credit. Seeing demand in general and for credit revive in a healthy manner, banks will become confident about lending.

The positive sentiment will be aided by loan repayments getting back on course. Once the flow of bank credit improves and economic activity picks up further, it will hopefully be business as usual as it was till a couple of years ago when the economy was booming.

W-shaped curve

But for the virtuous cycle to start a key change must first come. The coronavirus threat must recede, allowing lockdowns and restrictions to be slowly lifted, enabling economic activity to slowly pick up. But there will be one danger to guard against.

The economy must not be allowed to adopt a W-shaped curve. This is made up of the following stages.

Rising levels of infection will cause a lockdown to be imposed; slowly infection levels will go down, allowing a lifting of restrictions; then after a time with more dense human interaction, infections levels will begin to rise again.

Countries and regions which have beaten this cycle offer the following nuanced roadmap. In order to ensure that relaxations do not cause infections to rise again, the Kerala model is worth studying. It is made up of screening, tracing, quarantining, isolating and treating. But most importantly, the people must be educated to follow responsible health behaviour.

What will help in this process is coming up with innovative tools to detect, treat and prevent infection. The Arogya Setu app and similar ones in use across Asia ride on GPS and Bluetooth-enabled smartphones and available databases to track and trace symptomatic persons and those who have come into contact with them in order to ensure quick identification of infections and treatment.

So to get started on the cycle — kill infections, restart economy and let it carry the financial sector on its back.

The writer is a senior journalist

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