NBFCs Add Risk To Slowing Economy

Banks are significantly upping lending to risky NBFCs, forcing RBI to sound an alarm.

- PRASANNA MOHANTY

MONTH AFTER MONTH, finance ministry and Reserve Bank of India (RBI) have been citing improved asset quality of banks, robust credit offtake and strong earnings growth as evidence that the economy is on the right trajectory. On the face of it, this may be true, but disaggregated data paints a different picture. Before getting into that, here is a brief back-grounder.

Recall how three big NBFCs, IL&FS, DHFL and HDIL, collapsed one after the other beginning 2018. This also led to collapse of Punjab And Maharashtra Cooperative Bank (in 2019) and Yes Bank (in 2020). The chain of events created panic in the economy as credit dried up and a fresh NPA crisis emerged. Central government asked SBI and LIC to pump in money to save IL&FS and Yes Bank. DHFL, HDIL and PMC went into bankruptcy.

What caused the collapse of NBFCs and banks together? Their finances were interlinked and all of them were done in by massive fraudulent activities involving mala fide loans and money laundering. Hundreds of shell companies, supposedly rooted out by government, also tumbled out, further demonstrating lax regulations. Since NBFCs source a big chunk of their funds from banks, lax regulation meant financial risks travelled to banks and the rest of the economy. RBI's Financial Stability Report (FSR) of July 2020 pointed out that NBFCs' bank borrowings went up from 23.1% in March 2017 to 28.9% in December 2019.

Since then, RBI has taken several measures to tighten oversight of NBFCs, but its ineffectiveness is all too evident.

Quantum Jump In Bank Credit To NBFCs