Detailed paper with recommendations

The Confederation of Indian Industry has called for urgent interventions for “Financial Sector Stability”, citing ongoing problems.

“The financial sector is going through a phase of stress, which needs interventions in appropriate measure to ensure that the sector continues to play the financing role that it has been for the India growth story to remain uninhibited,” said Chandrajit Banerjee, Director General, CII said on 31 Oct 2018 in Delhi.

“CII has had wide consultations with leaders from the various segments of the financial sector and has come out with a detailed paper with recommendations, which are primarily for the regulator,” he said.

In its set of recommendations, CII has said that the Financial Sector in India over the last few years has become an integrated system with players like NBFCs, Banks, HFCs, Mutual Funds amongst others becoming symbiotically inter-connected and these no longer exist in isolation.

Any significant impact on one segment is bound to have a ripple effect in the entire system. The sector has become much more broad-based compared to even five years back.

Outlining the problem facing the sector, CII said in its release on 31 Oct 2018 that systemic imbalances have crept into the sector.

Currently, Mutual Funds have sectoral limit on investment in NBFCs upto 25% of the AUM of the particular scheme and HFCs can be additional 15%.

Considering the inherent risk profile of NBFCs and HFCs, such investment norms are increasing the risk exposure of mutual funds.

Therefore, CII’s first recommendation is for the RBI and SEBI to come out with a road-map to reduce the exposure of Mutual funds to NBFCs and HFCs from 40% to 25% in graded tranches.

CII also pointed out that NBFCs and Housing Finance Companies (HFCs) are suffering from Asset-Liability Mismatches (ALM) as they had borrowed short but are having to lend long.

This could set off a chain of problems, since NBFCs have borrowed from MFs and Banks. In a worst-case scenario, this could lead to a run on mutual funds and defaults in the NBFC sector, said CII in a press release.

In the current scenario of lack of liquidity, particularly of short-term Commercial Papers, it is leading to a contagion effect. Redemption pressure on Mutual Funds has increased and credit to NBFCs is drying out. The MFs may not opt for roll-over of the papers because of the risk perceived in NBFCs. Also, if the roll over happens it will be at a higher yield for NBFCs.

The RBI is required to intervene in the interest of the entire financial sector, CII said in the release.

The added issue is that 11 public sector banks have been put under prompt corrective action (PCA) which has further reduced the credit flow to the real sector. While there is a curb on lending, these banks have been receiving deposits which is getting routed only to repo market and not to the real sector further adding to the liquidity crunch in the market. Here again, there is action required from the RBI.

As per CII, the immediate concern is to alleviate investor and depositor’s concerns and such steps need to be taken with the intention to provide stability and certainty, as well as tackling the liquidity shortages.

In the recommendations that CII has shared with the regulator, the key ones for the short term are as follows:

One, RBI must encourage NBFCs to securitize their assets which can be purchased by Banks.

Second, is about backstop facility by the RBI – Reserve Bank of India (RBI) must provide backstop facility to Housing Finance Companies (HFCs) through the National Housing Bank (NHB). Additionally, RBI may also consider providing the same facility directly to the systemically important deposit taking NBFCs (NBFCs-D).

Third, regulators like RBI, SEBI, IRDAI, PFRDA and the government need to present a coordinated front while addressing the current issues.

Fourth, the regulator should ensure the market feels comfortable that the financial sector is well-regulated and will be provided liquidity, if required. This will lead to markets becoming more normal. Communicating to the markets and providing comfort is essential at this point in time or else the situation can deteriorate. The RBI has a huge role to play in this.

Fifth, the RBI must provide sufficient system liquidity – Reserve Bank of India (RBI) must work out further credit lines to provide sufficient liquidity as otherwise a severe credit crunch will dent consumer demand and growth of Indian economy.

Sixth, RBI may also revisit the lending restrictions of PCA banks and consider allowing them lending to NHB which in turn can use it to finance housing projects.

Seventh, the Reserve Bank of India needs to open limited special liquidity window (open direct lines of credit as RBI had opened liquidity window for mutual funds for a short-period in 2008 and 2013) to meet emergencies of Financial Institutions including Mutual Funds which have been significantly impacted.

Eighth, open a window for Mutual Funds, (say for 6 months), to get refinance directly / indirectly from RBI against quality collateral, so that desperate sales by mutual funds (on account of redemptions owing to deteriorating investor confidence) can be avoided. Desperate actions by mutual funds may distort the whole yield curve resulting in mark-to-market losses across the industry. Also, RBI may open a liquidity window for banks to obtain cheap refinance for specific on-lending to NBFCs. The level of liquidity crunch at which such a special window needs to be opened by RBI should be based on regulatory and policy judgement.

Ninth, the RBI and Government should keep itself in readiness, should there be a situation of further volatility of this nature which necessitates an intervention like a NRI bond issuance.

Tenth, RBI intervention should be there in the Rupee Market in such a manner that bond yields do not go out of control. fiinews.com