The NBFC financial crisis has posed a serious challenges for the entire non-banking financial sector. In recent case, the interest rates on short term borrowing has severely impacted the cycle of NBFCs and left them with IL&FS Cash Crunch challenge.
• India’s top 15 Non-Banking Finance Companies have together lost about more than Rs. 75000 crore on the stock market due to fears of a financial crunch in the sector.
• The slide in NBFC stocks started after reports that Infrastructure Leasing and Financial Services Limited (IL&FS) and its units have defaulted on payments due to asset-liability mismatch.
Non-Banking Financial Company (NBFC) in India:
• Definition: Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/ stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities.
• Ways of Borrowing: They can borrow from banks or by means of Commercial Papers (CP) (CP are unsecured instrument to borrow money for short-term period with maximum validity of 1 year).
How Asset-Liability Mismatch was Created:
• Funding long term projects by short term credit: Loans given by NBFCs are mainly to infrastructure projects which have longer gestation period. But, for themselves, NBFCs opted for short-term borrowing by means of commercial borrowing to fund these long-term projects, which widened the Asset liability gap.
• However, in recent case, the interest rates on short term borrowing has severely impacted this cycle of NBFCs and left them with cash crunch challenge.
Effects on Economy:
• Downgraded Credit Rating: After default, IL&FS rating has been downgraded from high investment grade to junk status.
• Spill-Over Effects: Default by the IL&FS would in turn adversely affect the banks, mutual fund, companies and investment companies that have lend the money to IL&FS.
Measures to bring IL&FS back to Normalcy:
• Three-Way Strategy of IL&FS to tide over crisis:
- Offer a rights issue,
- Sell assets to repay debt and
- Address liquidity issues till the asset sale starts.
• Open Market Operations: RBI has recently carried out open market operations to purchase G-Security to Infuse liquidity worth rupees 10,000 crore into the economy.
• Injecting more Equity: LIC, largest shareholder of IL&FS, with 25% stake, is planning to inject more equity into the company.