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The micro view of the liquidity crisis in the NBFC sector may be one of asset-liability mismatches at individual companies, but there are also macro factors at play, specifically the distribution of liquidity in the system.
Banks, at the top of the heap, are the largest supplier (and consumer) of liquidity at over 40 per cent of funds as per the RBI’s December 2018 Financial Stability Report.
Their problems are well known (massive bad loans, eroded capital and losses), but because they largely transact among themselves and deal in non-market instruments, the contagion effect is perhaps low. Mutual Funds (MFs) are the largest providers of liquidity (28 per cent) and it is their role that needs closer scrutiny.
MF-induced vulnerability
There are long-term resource holders such as pension funds and insurance companies, who, despite having larger corpuses than MFs are marginal providers of funds (17 per cent) because their resources are statutorily pre-empted. NBFCs and HFCs are the biggest consumers of liquidity, using up 44 per cent of all funds but depend wholly on banks and mutual funds. It is ironic that NBFCs find themselves stretched for liquidity.
They seem to have a more heightened vulnerability from short term debt.
It is the nature of the short term debt and its suppliers (mostly MFs) which probably holds the key. MFs now have significant exposure to the financial sector, particularly NBFCs, even as banks began reducing their share.
The problem is that the liquidity from MFs (CPs and short term debentures) is more volatile. SEBI data on MF exposures provides insights.
Over 54 per cent of the MFs total corpus of ₹24 trillion (as of March 2019) was in debt and income funds and over 40 per cent of it was in ultra-short term debt (less than 90 days tenor). The debt exposure to NBFCs especially was significantly short term — 70 per cent was less than a year and 50 per cent was ultra-short term, less than 90 days. Since NBFCs do not lend short term, it is unlikely they need such funding.
The key again is in the profile of MF clientele, another revelation — 40 per cent of the corpus comes from institutional investors looking to park short term surpluses; corporates hold 86 per cent of all liquid and 54 per cent of debt oriented schemes.
Even retail MF investors seem to regard MF schemes as substitutes for bank FDs. This virtually makes MFs surrogate banks but the marketable debt means redemption trouble if a borrower defaults; while for NBFCs, it meant the need to constantly rollover short term funding, since they have no matching short term inflows. In contrast, banks seem able to carry an over ₹10 lakh crore NPA portfolio without creating as much as a ripple. The loss of interest cash flow alone from NPAs at over ₹1 lakh crore (at a weighted average lending rate of 10 per cent) is large, but the unhindered flow of deposits, a significant part of which is transactional (CASA) ensures there are no liquidity hiccups.
The short-term play of MFs creates a few issues. Besides the problem of regulatory oversight when investors become lenders, volatility is the main concern. In the past RBI had viewed the flows into MFs as a stabilising factor to counter the volatility of FII portfolio inflows. But now it is their lending activities (ultra-short term, concentrated in the financial sector) that seem to cause problems.
Becoming banks
The inherently destabilising nature of financialisation is at work, with liquidity swirling around intermediaries- bank funds find their way into MFs, MFs invest into the financial sector and NBFCs borrow from banks and MFs. The RBI’s guidelines may not alter the liquidity situation in the short run, but perhapsthe subtle message there is for NBFCs to become banks (the LCR requirement, for instance).
A similar liquidity dependence had driven many microfinance institutions in the past to become banks. It would be unfortunate if that happens, because the founding philosophy of NBFCs was predicated, among others, on the diversity they would bring in terms of reach and cost.
The writer is an independent financial consultant
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