Economic Survey 2020: In the aftermath of a huge stress in NBFCs, the Survey suggests setting up of prudential thresholds on the extent of wholesale funding allowed for shadow banks. The Survey highlights over-reliance of shadow banks on short-term wholesale funding which led to the sector’s liquidity crisis.
“Such a norm would be consistent with macro-prudential regulations that are required to internalise the systemic risk concerns arising due to an individual NBFC’s financing strategy. These norms could be counter-cyclically adjusted, because the seeds of a liquidity crunch are sown during good times,” the Survey said, stating that NBFCs must maintain a minimum cash buffer to meet short-term obligations.
Over the past one-and-half years, two shadow banks, IL&FS and DHFL, defaulted on large amounts of repayments. The impact of the failure of these two giants rippled across the entire system, especially on debt MFs.
Subsequently, it led to a liquidity crisis in the shadow banking sector. “Coinciding with the news of payment defaults by IL&FS and DHFL being known to the wider market, September 2018 and June 2019 saw the highest net outflows from liquid debt MFs and money market funds,” the Survey stated. DSP mutual fund, for instance, sold DHFL commercial papers worth Rs 300 crore at a steep discount in September 2018.
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The Survey found that the reliance of NBFCs on cheaper short-term finance to fund long-term investments causes issues in asset liability management. “Asset side shocks expose financial institutions to the risk of being unable to finance their business,” the Survey stated.
Additionally, NBFCs that raise short-term debt through CPs and NCDs) face a “rollover risk” arising from refinancing of this debt. The reliance on short-term debt also amplifies asset-side shocks, the Survey stated. Housing finance companies particularly face a larger asset liability management risk as they invest in longer-term assets, with 15- to 20-year horizon.