Ripples of a crisis

The average liquidity deficit in the banking system widened during the week ended May 17 to Rs 43,001 crore, up Rs 3,191 crore from the previous week, notes CARE Ratings.

The troubles of the non-banking finance companies (NBFCs) continue to reverberate through the financial system, with the ripple effects of the crisis being felt in the broader economy, as seen in the sharp decline in car sales. Part of the problem can be traced to the continuing liquidity deficit in the system.

The average liquidity deficit in the banking system widened during the week ended May 17 to Rs 43,001 crore, up Rs 3,191 crore from the previous week, notes CARE Ratings. To be sure, the liquidity deficit has come down from mid-April to the first week of May, when the net outstanding liquidity deficit averaged Rs 92,979 crore. This decline is largely due to an infusion by the RBI through open market operations (OMOs) and currency swaps. And while the liquidity deficit is likely to ease up further as government spending ramps up in the coming months, the fundamental question is whether this rise in systemic liquidity will translate to operational liquidity for NBFCs? Some NBFCs such as HDFC and public sector entities are likely to find it easier to raise funds. But the rest will find it challenging, as banks and mutual funds are likely to continue to be risk averse. With rating agencies downgrading debt papers of several NBFCs, in some cases by several notches, it has further weakened their ability to raise fresh funds. Add to this the rise in the risk premium demanded by the market, and the situation is grim.

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There are some options available to the RBI to address this issue. It could, as has been reported, open a special borrowing window for the NBFCs. But there are questions over how this would work. For one, what would be the collateral against which the RBI would lend to the NBFCs? And how would it be valued? Perhaps, the RBI will route liquidity through banks, as it has done in the past. It is also possible that the current crisis will see some of the weaker NBFCs shut shop. Some could be merged with banks, while a few could be granted bank licences. Obviously, this will require the blessings of the central bank which is holding its board meeting this week to look into these issues. The RBI needs to act quickly to prevent the NBFC crisis from growing bigger.