RBI supplies liquidity to Indian shadow banks ‘to avoid systemic risk’

India’s central bank has started providing liquidity to the country’s embattled shadow banking sector to avoid systemic risk, it announced on July 1.

The news is the latest sign that India’s finance sector, including both banks and non-bank financial firms, is coming under severe strain.

The government authorised the Reserve Bank of India to set up a special purpose vehicle (SPV) “to avoid any potential systemic risks to the financial sector”. The SPV has been established by the state-owned commercial lender State Bank of India, or SBICAP.

The SPV will purchase short-term debt from eligible non-banking financial firms (NBFCs) and housing finance companies (HFCs). These firms will only be able to use funds from the scheme to pay down existing liabilities.

The SPV will purchase negotiable certificate of deposits with an outstanding maturity of not more than three months and rated as investment grade. The facility will not be available for any debt issued after September 30, 2020, when the SPV is scheduled to stop purchases.

India’s banking sector is also facing major difficulties. Several smaller Indian banks had financing difficulties in 2019, before the RBI put the country’s biggest lender, Yes Bank, into a restructuring process in March. Yes Bank’s chief executive has continued to publicly insist that there are no serious problems with the lender’s finances.

The central bank’s independence has been significantly reduced by the government of the Hindu nationalist prime minister Narendra Modi. He effectively dismissed RBI governor Urjit Patel in December 2018 and replaced him with Shaktikanta Das.

Troubled sector

India’s non-bank finance sector has recorded a series of defaults over the last two years. For instance, in late 2018 the government took over the operations of Infrastructure Leasing and Financial Services (IL&FS), a major shadow bank.

This was followed by several defaults in the sector, including Dewan Housing Finance Corp and Altico Capital. Borrowing costs for non-bank firms have risen, limiting their lending capacity.

The Covid-19 crisis has added new challenges for them to access liquidity. A report by the news agency Reuters in April 2020 said that India’s major banks, state-owned and private, have stopped lending to the non-bank finance sector.

This was due to their exposures to businesses especially affected by the pandemic, the report said. Shadow banks’ debt collections have been hampered by the lockdowns the government of prime minister Narendra Modi has imposed in response to the coronavirus pandemic.

Conditions

In order to gain access to this scheme, both NBFCs and HFCs need to be registered with the authorities. The RBI says the firms’ capital adequacy ratio should not be below the regulatory minimum of 15% for NBFCs and 12% for HFCs respectively.

Their net non-performing assets should not be more than 6% as of March 31, 2019. They should have recorded net profit in at least one of the two preceding financial years, 2017–18 and 2018–19.

The scheme also requires them not to have defaulted on their payments to banks during the year before August 2018. They should not have been reported by any bank under SMA-1, where repayments have been overdue for between 31 and 60 days or SMA-2, with a delay of between 61 and 90 days.