Over the last four to five years the assets under management (AUM) of shadow banking (NBFCs/mutual funds) spurted from around ₹20-lakh crore to over ₹50-lakh crore — a massive increase of around ₹30-lakh crore. Such a rapid expansion was either not noticed or taken as business as usual by regulators and policy-makers. Stakeholders had been preoccupied with resolving NPAs (non-performing assets) at banks.

Many an NBFC sought emergency liquidity support and regulatory forbearances. Recently, the RBI constituted two committees to help deepen and widen markets for secondary sales of corporate and housing loans.

The reasons for the sticky situation are not far to seek. Chief among them are: triple blind lending — banks, shadow banks and non-banks having huge exposures among themselves through ownership or otherwise and lending to same corporate groups who have already borrowed from banks; b) poor governance and risk management practices; c) corporates and financial institutions chasing yield through debt funds (not risk adjusted); d) asset-liability mismatches; e) pathetic record of rating agencies; and f) shallow and narrow market for trading in risk by way of products like CDS, interest rate futures, etc.

Likely solutions

This begs the question: Who shall help whom and how? Here is a potential framework for solution.

Firstly, the recent RBI announcement to create a specialised supervisory force is necessary but not adequate to unravel the present problem. To unravel interconnectedness, a system-wide horizontal AQR (asset quality review) of all non-banks and mutual funds by a unified agency of all the five regulators (RBI, SEBI, IRDAI, NHB and PFRDA) needs to be undertaken without further delay. This will also identify systemic risks lurking at the intersection of banks and shadow banks, mutual funds and insurance lenders.

Secondly, a soundness scorecard/index for each of the NBFCs may be prepared across dimensions like quality of governance, risk management practices, promoter background/performance, size, etc., and this shall be a guiding factor for appropriate policy intervention.

Based on the insights from the AQR and soundness scorecard/index, the following solutions may be implemented:

Some of the well-governed, bigger and sound NBFCs may be graduated to small bank status. In fact, some of the NBFCs are bigger than small finance banks. This would take away a major chunk out of the NBFC fold and bring them under better regulatory radar.

The next level of NBFCs may be allowed to accept public deposits with necessary safeguards and deposit insurance cover.

If it is purely a case of liquidity mismatch and the asset quality is sound, either asset sale may be encouraged or some refinance provided by the RBI with a proviso that further asset creation shall not take place till the asset-liability mismatch is sorted out. Haircuts need to be applied even for refinance and liquidity mismatch.

Consolidation or orderly winding down may be resorted to on case-by-case basis.

Markets for risk transfer/trading like CDS, interest rate futures may be developed so that banks do not get to warehouse all the risk constraining capital and further growth.

The current crisis must be seen as an opportunity to design a new financial architecture. There are no binary answers and no universal solutions across the shadow banking landscape.

The writer is a former Director and CEO of IDRBT

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