More NBFCs will have to die if India's shadow-banking sector is to survive

A few quarters of pain in sectors that depend upon shadow financing is a small price to pay to produce a sector that winds up doing its job efficiently and sustainably.

Business Standard : The slowdown that began among India's shadow banks is spreading. Sectors that had come to depend on credit from what in India are called non-banking financial companies (NBFCs) are posting awful numbers. Insurance is slowing and real estate is troubled. The automobile sector -- which contributes half of India's manufacturing output -- is shrinking as stressed shadow banks prioritise survival above lending growth.

Naturally, Prime Minister Narendra Modi's government is worried. But it, and the Reserve Bank of India, should avoid any attempt to succor the shadow-banking sector with liquidity. Giving NBFCs the false appearance of health would only increase, not decrease the chances of a systemic crisis.

Speaking to Bloomberg News recently, RBI Governor Shaktikanta Das warned that the central bank sees "some signs of fragility," particularly in shadow banks that are exposed to the housing sector. The question is what to do about it. On the one hand, Das sought to reassure investors that the RBI would prevent another large NBFC from collapsing. (The current crisis was set off when highly connected Infrastructure Leasing & Financial Services Ltd defaulted last year.) On the other hand, he said, "If NBFCs have undertaken certain governance practice and certain ways of function and they have to a price for it, they will have to pay a price for it."

If those two statements don't quite seem to go together, that's because Indian policymakers and businesses are split over the right course of action. Many executives, and some ruling-party politicians concerned about growth, would like to see the sector bailed out. Anil Ambani, a tycoon with a large stake in financial services, has said that NBFCs are in intensive care and, "in the ICU, if you want to save the patient, what is needed is not Paracetamol but full life support."

But many regulators correctly doubt that's the best strategy. Shadow banks have come to occupy a space in the Indian economy for which they weren't built. Some of them gorged on money raised from the public -- from state-owned banks or debt mutual funds -- to lend to long-tenure projects, some of them in politically exposed sectors such as real estate or infrastructure.

NBFCs filled this niche by default: The government is short of money, there is no real corporate debt market in India, and the traditional banking system was burdened with bad loans.