Crack the whip

It is time to order some healthy private banks and financiers to divide the assets and liabilities of IL&FS among themselves

That the equity market is forward-looking is now an accepted wisdom. Outlook overwhelms a stock’s present or past, however glorious or bleak. Headline indices scaled new highs after GDP data put India’s growth at a five-year low of 6.8% in the fiscal year ended March 2019 and intensifying trade wars threatened to derail the world economy. Instead of causing concern, the distress signal was greeted with relief due to the assumption that interest rates are bound to soften to promote consumption. Subsequently, the Reserve Bank of India cut the lending rate by a quarter percentage point and the US Federal Reserve has hinted that, instead of a hands-off policy for 2019, it will wield the scissor. Encouraging growth figures, on the other hand, create panic on fear the central bank will become hawkish to keep the resultant inflation in check. The message from the market is clear: policy makers have to ensure ease of liquidity at all times. The wish is based on the response to past crises. The out-of-the-box solution to pull the US economy out of the housing bubble burst of 2008 due to low-cost mortgages was making available more cheap money. In India, banks and mutual funds starved NBFCs of funds after the debt default by IL&FS. The RBI’s two auctions to release rupees by buying dollars have not squashed the clamor for pumping more cash into the system. 

Entry into the banking space is after vigorous scrutiny of the governance and financial track record of the promoters. In comparison, anyone with sufficient capital to meet the minimum requirement can start a shadow bank. If there are solid financing vehicles set up by corporate groups to push their products, there are also many entrepreneurial-backed ventures that are vulnerable to changes in regulations and market tastes. Instead of reliance on retail deposits that require investment in infrastructure and branding, bulk funds are on tap from institutional lenders in search of higher yields in a short span. If rollover of loans to crony capitalists without proper due diligence was the cause of grief for banks dependent on small savers, NBFCs’ woes are due to seeking resources from wholesale financiers for the short term to deploy them for a longer duration with buyers of consumer durables. Their survival problem is a horrible reminder of the plight of the ordinary investor in income instruments. Banks will return only up to Rs 1 lakh of the money surrendered for fixed returns. Mutual funds cannot even guarantee the principal. Regulations on capital adequacy and exposure norms framed to withstand headwinds are often found to be inadequate. Players grapple with the conflicting obligation of keeping customers in search of cheap loans and the shareholders looking for high capital gains satisfied.  Investment-grade paper offers poor yields. The search for lucrative assets has led to shares of unlisted companies and infrastructure projects promoted by government. If the upside is fat margins, the downside is the absence of a secondary market for exit.

 The reflex action of monitoring agencies faced with a blowout is to clamp down. The RBI has ordered NBFCs to set aside more emergency capital. The sensible move is to avoid defaults and curb panic in the market. The collateral damage is less money to lend. A better approach is to encourage a shake-up. Consolidation will weed out weak outfits. The global financial meltdown was used by the US Treasury department to browbeat too-big-too-fail financial institutions to merge. The Fed, on its part, turned on the credit pipeline to avoid recession. India is in a better position. The slowing economy has not spurred talk of recession despite the Indian central bank’s revision of its outlook for interest rate to accommodating from neutral led to the tanking of the stock market.  The monetary authority is awaiting a committee to suggest how to meet the fund requirement of non-bank players. This is inadequate. The March 2019 quarter numbers of companies and sales of automobiles in the first two months of the new fiscal year have created urgency for proactive measures. It should supplement its recent action by slashing the benchmark rate to the 5% level, considering the projection for consumer price inflation is around 3% for H1 of FY 2019, and complement it by reducing the mandatory cash-keeping requirement by at least 50 basis points. The salvaging of IL&FS is taking too long, with no end in sight. Sitting out any longer for resolution is not an option anymore. The finance ministry should order healthy private banks and some sound NBFCs to divide the lender’s assets and liabilities in return for plum PSU accounts and making them the financiers of choice for government employees. The time to dangle a carrot is over. Now bring out the stick.

-Mohan Sule