Everyone is at risk from a wall of mistrust that threatens to feed through to microlenders, hurting the poor and dragging down consumption.
It’s time India’s policy makers acknowledged the real problem facing the country’s shadow banks. What they are experiencing is no longer a vanilla liquidity shortage; the entire industry has crashed against a wall of mistrust.
On the other side of that wall are a clutch of wealthy property developers and their middle-class customers, as well as teeming multitudes of poor. Everyone is at risk.
A crisis of confidence has made financiers’ own borrowing costs jump. The excess yield over government securities that the bond market is demanding from double A-rated firms is three standard deviations higher than the five-year average.
The collapse of the highly rated infrastructure operator-financier IL&FS Group exposed the fault lines under Indian shadow banks’ impressive credit edifice. Nonbank lenders contributed 30 percent of all advances in the economy over the past three years, with a fifth of their funding coming from commercial paper and short-maturity nonconvertible debentures, the bulk of which were lapped up by yield-hungry mutual funds.
The panic attack from sudden IL&FS defaults in September made the funding markets wary. If the concerns were only about liquidity, they should have subsided by now. Yet shadow financiers’ borrowing costs are refusing to budge. This is despite authorities sequestering IL&FS’s $12.8 billion debt under a bankruptcy process; pumping $33 billion of durable liquidity into the banking system; marshaling state-run lenders to buy finance firms’ assets; and replacing a hawkish central bank governor with a former bureaucrat willing to cut interest rates and ease risk weights for bank advances to specialist lenders.
But why stop at just the lenders? Their borrowers, too, deserve attention. As I recently noted, shadow banks like Dewan Housing Finance Corp., whose share price has fallen 84 percent since early September, now pose a spillover risk by being forced to curb their exposure to the construction industry. Property analytics firm Liases Foras reckons that India’s top 90 builders need $6 billion a year to service their debt yet they are earning only a little over $3 billion before interest, taxes and depreciation annually. Refinancing from shadow banks is crucial to their survival. Real-estate bankruptcies would boomerang back on nonbank lenders’ balance sheets.
The collateral damage may include India’s poor. Microfinance lenders are only now turning the page on Prime Minister Narendra Modi’s November 2016 ban on most currency notes. Back then, women borrowing small sums of money for sewing, food delivery or flower supplies were crippled when their cash-only businesses collapsed for lack of notes. The going rate for weaving golden threads into a sari crashed to 4,000 rupees ($56), from 7,000 rupees. Defaults became rampant. Companies like M Power Micro Finance Pvt. wrote off bad debt and gave new advances to help women entrepreneurs get back on their feet. When I visited one of the firm’s collection centers in Thane on the outskirts of Mumbai recently, only about 146 of the 4,000 accounts were delinquent. About half of these had remained unpaid for less than 90 days.
Demonetization notwithstanding, access to credit at the bottom of the pyramid has been one of India’s successes over the past several years, largely following the model of Bangladesh’s Grameen Bank in lending to groups of women. Whereas lenders were hamstrung earlier by the absence of credit histories, loan reporting to registries like Equifax Inc.’s India unit or its rival TransUnion CIBIL is mandatory now.
The availability of data has allowed for faster and cheaper client acquisition as well as better risk management. institutions usually shy away from first-time borrowers who already have two existing lenders. Someone who has repaid one loan finds it easier to tap three credit providers. Collection efficiency at Bharat Financial Inclusion Ltd., which is merging with a bank, is back to 99.7 percent on loans provided after the currency ban scare had subsided.
Given the nervousness in the funding markets, it won’t be easy for the microlenders to raise fresh equity. In a place like Thane, borrowers have a choice of half a dozen credit providers. Spreads are regulated. The 25-percent plus interest rates on microloans can’t keep rising with the lenders’ cost of capital if the base rate of conventional banks doesn’t also move up.
Originating loans and selling them on as securities to better-capitalized institutions like State Bank of India is an option. But smaller financiers can’t get rating firms to certify that loan losses on portfolios will remain low. While the creditworthiness of the poor is high, it’s vulnerable to natural calamities, political intervention like farm-debt waivers, and policy disasters like demonetization.
The net result may be a tightening of lending standards and curbs on fresh credit. Value addition from selling vegetables or making papadums may not matter much to GDP, but the consumption boost from tiny enterprises – for instance, for two-wheeler demand – would become painfully evident if it were to go away. That’s one more reason to mind the shadow banks’ funding gap.