C&B Notes

India’s Shadowy Lending

Borrowing short and lending long are typically ingredients for a financial disaster.  India’s shadow banking system, which gets its name because participants are more lightly regulated, is creating problems in the country’s formal banking sector.  The tone of this piece is alarmist, but any credit contagion bears watching in a slowing Indian economy.

The woes at Indiabulls come only a year after the collapse of another shadow bank, IL&FS, sparked panic known as India’s “Lehman moment”.  With the funding crunch since spreading to many of India’s 10,000-odd NBFCs — which are broadly less regulated than conventional banks — analysts say last year’s scare may not be a one-off.

A Reserve Bank of India report estimated that the failure of the largest NBFCs or housing finance companies could cause defaults in up to two banks.  Nervousness about the financial sector rose this month after the RBI, responding to troubles at a small co-operative bank, issued a statement that the “Indian banking system is safe and stable and there is no need to panic”…

Some say the problems in India’s financial companies, many of which lent heavily to real estate, echo the collapse of the housing bubble that contributed to the 2008 US financial crisis.  “You could almost take the Big Short, change the American names to Indian names, change Wall Street to Dalal Street, and you have got the best description of the NBFC crisis in our country,” said Saurabh Mukherjea, founder of Marcellus Investment Managers.

Start-up shadow banks such as Indiabulls grew to play a crucial role in India’s fast-growing economy over the past decade, coming to account for a fifth of new credit for everything from car purchases to education and luxury real-estate development.  Many borrowed cheaply from traditional banks and booming mutual funds on a short-term basis while financing long-term projects.  But the scare following AAA-rated IL&FS’s defaults in September 2018 prompted the traditional institutions that fuelled the NBFCs’ rise to curtail funding sharply. Between August 2018 to September this year mutual funds cut their exposure to the sector by around 30 per cent to Rs2.9tn ($41bn), according to Credit Suisse, and exposure to Indiabulls fell 86 per cent over the same period.  Another big shadow bank, Dewan Housing Finance, meanwhile, is negotiating with creditors after its rating was downgraded to default in June because it missed interest payments.  Its stock has lost 97 per cent since its pre-IL&FS peak.

As a result, shadow banks have slashed their own lending by about a third, according to the Finance Industry Development Council, prompting a severe credit crunch that has hurt everything from car to housing sales.  Authorities have announced a $10bn recapitalization of public-sector banks designed to get liquidity flowing again.