Banks spiked loan exposure to NBFCs by one lakh crore in March, months before IL&FS crisis hit financial markets

The Infrastructure Leasing and Financial Services (IL&FS) crisis and its tremors in the non-banking financial company (NBFC) space happened only last month. Logically, banks have been cautious ever since to look at NBFCs with the same love. Even now, after a series of assurances from the Reserve Bank of India (RBI) and the government, top lenders have indicated that further exposure to NBFCs will be primarily through portfolio buyouts not directly.

But if one looks at the RBI data, NBFCs have been the darling of banks till just before all hell broke loose with the IL&FS fiasco. In the 12 months till August 2018 (till when the data is available), bank lending to NBFCs grew by a whopping 43.9 percent to Rs 4.9 lakh crore - the highest in six years. In the corresponding 12-month period before that, the loan growth to NBFCs was nearly flat, at 0.3 percent.

Why did this happen? Most NBFCs were having a dream run in terms of growth in the backdrop of banking sector being gripped in non-performing asset (NPA) problems and facing severe capital crunch. Also, banks failed to foresee what’s going on in the money markets and the impending liquidity crisis.

Now, when exactly did the sudden jump in the NBFC exposure of banks happen? It was in March 2018 when banks lent an additional Rs one lakh crore to NBFCs (from Rs 3.9 lakh crore to Rs 4.96 lakh crore), a record monthly hike in at least 10 years. A spike in bank lending to NBFCs towards the end of the fiscal is not unusual. The trend is seasonal.

 Banks spiked loan exposure to NBFCs by one lakh crore in March, months before IL&FS crisis hit financial markets

Representational image. Reuters.

Banks need to bulk up their lending portfolios and NBFCs need liquidity, hence a give-and take-transaction. But that doesn’t explain the kind of jump seen in March this year. This was unusually on the higher side and is a curious trend in the context of what happened after that. Of course, as fresh data arrives, it will be known that banks have scaled down lending to NBFCs post-August but that will be a natural response to a crisis situation.

On hindsight, one can ask how did banks fail to get a wind of what’s happening in the NBFC space, in which case the sharp escalation in lending exposure would not have happened. Bank lending is the mainstay for NBFCs with bond issuance and securitisation transactions constituting the remaining. Unlike banks, most NBFCs aren’t allowed to raise public deposits. This constrains their liquidity positions whenever banks close the tap.

Between August 2010 and August 2018, banks’ exposure to NBFCs have grown four-fold from Rs 1.1 lakh crore to Rs 4.9 lakh crore during which period banks’ total non-food credit outstanding just doubled from Rs 31.3 lakh crore to Rs 77.7 lakh crore. NBFCs captured the space vacated by capital-constrained banks to dominate the mortgage lending market and vehicle finance market. Banks too were more than happy to lend to NBFCs.

What is happening now in the NBFC space is largely a crisis of confidence. Lack of trust in NBFCs prompted large investors to dump their stocks and banks to stay away while the likelihood of hardening interest rates began to reflect in the money market.

According to analysts, the ongoing crisis of confidence will last for a while and except for select NBFCs, others will have to cut down their growth projections and aggressive expansion plans. As this writer said in a column yesterday, the NBFC crisis opens up a huge opportunity for large well-capitalised banks to significantly gain back their lost advantage in mortgage and vehicle financing markets.

What lies ahead? A lot will depend on how the RBI manages the liquidity situation. BofA Merrill Lynch Global Research expects the RBI to do large-scale OMO (open market operations) to push the G-sec market into excess demand by March 2019. According to the research house, the RBI has to inject $33 billion of reserve money to support 6 percent FY19 old series GDP growth. It’s a wait-and-watch game now.

(Data support from Kishor Kadam)

Updated Date: Oct 23, 2018 13:18:35 IST